6.5 The Role of International Institutions in Promoting Growth
After you have read this section, you should be able to answer the following questions:
- What are the main international organizations that help to promote growth?
- What do these institutions do to achieve their stated goals?
Governments acting alone can do a lot to promote economic growth. We have discussed the importance of protecting property rights and establishing a climate of political stability. These efforts by individual governments are complemented by international actions to promote growth and development in poorer countries. In this section, we describe three powerful and controversial international economic organizations: the World Bank, the International Monetary Fund (IMF), and the World Trade Organization (WTO). We briefly explain what these institutions do and how they go about reaching their goals.The websites of the World Bank, the IMF, and the WTO are, respectively, as follows: http://www.worldbank.org, http://www.imf.org/external/index.htm, and http://www.wto.org.
The World Bank
The World Bank is an international intermediary funded by 184 member countries. Its goal is to provide loans and grants to developing countries with the aim of eliminating poverty by promoting economic growth. Economists working at the World Bank rely on variants of the growth model used in this chapter to understand the growth experiences of different countries and determine the effects of policies in those countries.
The World Bank borrows money on international capital markets and also receives funds directly from member countries. The World Bank is similar to a bank that a household or a firm would approach for a loan to build a factory or a house, except that its borrowers are national governments. It often funds projects that would otherwise not be undertaken. In many cases, these are projects that promote infrastructure, education, health, and so forth. Projects like these may have social benefits yet not be profitable enough for private firms to undertake. Building a road in a rural part of a developing country is not the type of investment project one normally associates with a profit-seeking firm, for example, even though the road may have spurred rural development.
In 2010 the World Bank made about $45 billion in loan commitments and $29 billion in loan disbursements.“Annual Report 2010: Financial Information,” World Bank, accessed August 22, 2011, http://web.worldbank.org/WBSITE/EXTERNAL/EXTABOUTUS/EXTANNREP/ EXTANNREP2010/0,,contentMDK:22626599~menuPK:7115719~pagePK:64168445~piPK:64168309 ~theSitePK:7074179,00.html. At one level, this is evidently substantial—a project worth $100 million or more can certainly have a large impact on a poor country. At another level, it is not a huge sum of money in the global economy. For comparative purposes, BP set aside over $40 billion to pay for the cleanup of its 2010 oil spill in the Gulf of Mexico.
World Bank projects range broadly. They include funding for infrastructure construction, promoting health care (such as HIV/AIDS programs), promoting education, and so forth. Many of these projects involve the provision of public goods, so they create benefits for society as a whole that exceed the direct return on investment. That is, many of the projects that are funded by national governments in richer countries are funded through the World Bank in developing countries. At the beginning of this chapter, we saw an example of a World Bank project in Niger, which was aimed at increasing human capital in that country. As another example, here is a description of a recent World Bank loan to Guyana to provide water access to the poor.
Guyana: Water Sector Consolidation Project
GRANT AMOUNT: $12.3 million
PROJECT DESCRIPTION: This project’s main objective is to increase access to safe water among the poor. The project seeks to support the achievement of sustainable universal access to safe and affordable water for the population of Guyana, especially the poor. The project will also help to consolidate the water sector modernization and reform process undertaken by the government with support of the International Development Association (IDA) and other donors in recent years.“Water Sector Consolidation Project,” World Bank, July 12, 2005, accessed June 30, 2011, http://web.worldbank.org/external/projects/main?pagePK=64283627&piPK=73230& theSitePK=40941&menuPK=228424&Projectid=P088030&cid=3001_72.
The project described here would not likely be a profitable private sector project, but it is important for the development of Guyana. Notice, too, that this loan, like many other World Bank loans, is for the development of infrastructure (roads, bridges, schools, communication systems, etc.). In more developed countries, such projects are usually performed by governments, but in developing countries, these investments are frequently undertaken through the World Bank.
Investment in infrastructure is typically complementary to the accumulation of other physical capital, such as machines and plants. Even though developing countries have relatively low capital stocks, investment in plants and equipment may not be very profitable if basic infrastructure is lacking. There is no point in building a factory if there are no roads to take your goods to market. Investment in infrastructure can increase the marginal product of capital and make other investment more attractive.
The International Monetary Fund
The IMF was established to (among other things) provide short-term support for countries facing financial difficulties. This is explicitly stated in the IMF’s Articles of Agreement: “To give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, thus providing them with opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.”“Articles of Agreement of the International Monetary Fund,” International Monetary Fund, February 22, 2010, accessed June 30, 2011, http://www.imf.org/external/pubs/ft/aa/aa01.htm.
A country’s balance of payments has two main components. The first is the trade balance. A balance of payment maladjustment may mean that a country is running persistent trade deficits—that is, its imports are greater than its exports. This means the country is borrowing from other countries and is building up its external debt. The second component of the balance of payments is the interest that a country must pay on its existing external debt. This means that imbalances in the past lead to worse imbalances in the present. Imagine, for example, that Juan in Solovenia borrowed extensively in the past. It is then difficult for him to get out of debt because he has to pay so much interest. Moreover, the amount of external debt in a country cannot grow forever. When countries get into trouble by accumulating large amounts of debt, there is a temptation to default on outstanding debt. A key role of the IMF is to help countries through these difficult episodes.
IMF help has strings attached. A controversial aspect of the IMF’s mode of operation is in the phrase…under adequate safeguards. As part of a deal to provide resources to countries in need of funds, the IMF often makes explicit demands about government fiscal and monetary policies. This is termed IMF “conditionality” and is described by the IMF as follows: “When a country borrows from the IMF, its government agrees to adjust its economic policies to overcome the problems that led it to seek financial aid from the international community. These loan conditions also serve to ensure that the country will be able to repay the Fund so that the resources can be made available to other members in need. In recent years, the IMF has streamlined conditionality in order to promote national ownership of strong and effective policies.”“IMF Conditionality,” International Monetary Fund, March 18, 2011, accessed August 22, 2011, http://www.imf.org/external/np/exr/facts/conditio.htm.
A quick tour of the IMF website (http://www.imf.org/external/index.htm) provides a lot of information about past and ongoing loans. One example is the ongoing relationship between the IMF and Argentina.The IMF formulates country reports on an annual basis, and these are available on the IMF website. These reports summarize the dealings between individual countries and the IMF. Argentina had reached an agreement with the IMF in September 2003 providing Argentina with access to SDR 8,981 million. SDR means “special drawing right.” It is a unit of account used by the IMF whose value is an average of four key currencies. Its actual value on any given date can be found at http://www.imf.org/external/np/fin/data/rms_sdrv.aspx. In May 2011, 1 SDR was worth US$1.59. This agreement with Argentina came after Argentina was unable to meet demands for payment on some of its external debt and after real gross domestic product (real GDP) had fallen by nearly 11 percent in 2002. Agreement with the IMF was not immediate, partly due to the conditionality of a prospective loan. Though agreement was ultimately reached, there were lengthy negotiations regarding the conduct of fiscal and monetary policy in Argentina as a condition for IMF assistance.
The World Trade Organization
The WTO “makes the rules” for international trade. It is a relatively new organization—having been founded in 1995—and has 150 member countries. It arose from earlier trade agreements between countries, most notable the General Agreement on Tariffs and Trade. The WTO website describes the role of the organization as follows:
Essentially, the WTO is a place where member governments go, to try to sort out the trade problems they face with each other. The first step is to talk. The WTO was born out of negotiations, and everything the WTO does is the result of negotiations. The bulk of the WTO’s current work comes from the 1986–94 negotiations called the Uruguay Round and earlier negotiations under the General Agreement on Tariffs and Trade (GATT). The WTO is currently the host to new negotiations, under the “Doha Development Agenda” launched in 2001.
Where countries have faced trade barriers and wanted them lowered, the negotiations have helped to liberalize trade. But the WTO is not just about liberalizing trade, and in some circumstances its rules support maintaining trade barriers—for example to protect consumers or prevent the spread of disease.
[…]“What Is the World Trade Organization?” World Trade Organization, accessed June 30, 2011, http://www.wto.org/english/thewto_e/whatis_e/tif_e/fact1_e.htm.
The negotiations at the WTO set the ground rules for international trade. Using the mechanisms of the WTO, countries agree on trade policies, such as the levels of tariffs. This is also a forum for designing policies on the protection of intellectual property rights. The WTO also provides a forum for dispute resolution.
Many critics of globalization have focused their attention on the WTO. For example, the nongovernmental organization Global Exchange (http://www.globalexchange.org) lists 12 “top reasons to oppose the WTO,” including the claims that the WTO is increasing hunger, increasing inequality, trampling human rights, destroying the environment, and killing people through its policies. Critics such as this group argue that the WTO is fundamentally undemocratic, writing the rules so as to favor powerful corporations and rich countries. Defenders of the WTO argue that it gives poorer countries a much greater voice in international economic decision making. They point out, for example, WTO decisions are based on consensus, meaning that all 150 member countries must agree to them.
- The World Bank, the IMF, and the WTO are three leading international organizations that help countries in the development process.
- The World Bank funds projects in recipient countries, the IMF provides balance of payments support, and the WTO works to reduce trade barriers.
Checking Your Understanding
- In what way does the IMF work to promote convergence across countries?
- The WTO helps to govern intellectual property rights. What is the impact of those rights on development?