Ecumenical Reflexions on Political Economy. A summary of ten years
of deliberations on issues of development by an informed group of
economists, sociologists, political scientists and theologians. Compiled
by Catherine Mulholland. First published by WCC Publications,
World Council of Churches, 1988. Internet edition by Dr. Robinson Rojas

5. The International Financial System

Why this issue?

The international financial system is in a state of crisis. This may mean different things to different people, according to whether they believe that the crisis refers to the deep and sustained global recession which we have been experiencing or whether they are more alarmed by news reports that many third-world countries are unable to pay their massive debts, and that defaults on such a scale could undermine the stability of the entire system. Whatever the term crisis means to each person, it is clear that the crisis is a general one and touches every corner of the globe, even though some people and communities feel the changes more deeply than others. Because the international financial system - no matter how remote its decision-takers or how abstruse its technical analysis and vocabulary -affects the lives of all human beings and often affects them adversely, especially the poor among them, both individually and nationally, it is of valid concern to Christians. Those who are most vulnerable to the negative effects of the current economic change and crisis are the focus of our concern.

The AGEM explores here whether the values and vision of the dominant economic systems of the world are a reflection of the values and vision leading to a just, participatory and sustainable society and, if not, what alternatives might be preferable. The major concepts introduced in the AGEM's reflection on the international financial system are those of interdependence, dependency and self-reliance.

Reflection on the international financial system

In 1945 economic ministers and financial experts of the Allied Powers of the second world war met to hammer out an institutional framework for international economic stability and growth at Bretton Woods, from which the system they devised took its name. They sought to guard

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against a repetition of the financial crises such as those of the 1920s and 1930s, low and unstable growth, restrictive international trade practices, competitive devaluations. A major means chosen was to provide bridging finance to give time for non-chaotic adjustment, rehabilitation and development after the war. The major institutions which were created at or arose out of Bretton Woods and their roles are the following:

1) the General Agreement on Trade and Tariffs (GATT), to promote and to manage mutual reduction of tariff barriers to allow world trade to lead to world growth;

2) the International Monetary Fund (IMF), to enforce a system of stable exchange rates and to provide conditional bridging finance to allow orderly adjustment;

3) the International Bank for Reconstruction and Development (World Bank), to provide long-term capital loans to governments initially for rehabilitation and subsequently for redevelopment.

The Bretton Woods system in its original form lasted until 1971 and was marked by relatively sustained and stable growth, historically low rates of unemployment, and the unprecedented growth of world trade. But it was far from being a golden age except by comparison, and by the late 1960s was showing some major weaknesses which eventually led to its demise when dollar/gold convertibility was suspended in 1971.

The period that followed was and still is one of crisis management, inflationary pressures and the spectre of stagnation of growth resulting in the phenomenon of stagflation and the re-emergence of protectionism. The period 1980-85 was characterized by sustained, intensive ad hoc crisis contaimnent and the realization that the fundamental features of the international financial system were endangered by the very instability and unsustainability of the system.

The international financial system at the present time is indeed in deep crisis. The signs are all too obvious: inability of debtor states and enterprises to pay in full or on time; consequential weakness of many major financial institutions; severe cutbacks in government spending; near-record real interest rates; high levels of unemployment and of underutilized productive capacity as a result of lack of finance for investment and imports, as well as of inadequate personal purchasing power. These signs translate into very harsh realities for many people in both industrialized and developing countries. A large percentage of the world's population has felt the impact of the recent crisis in one way or another and each of these deserves our attention. But the AGEM has made an effort to focus our attention on the countries and peoples most affected by

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the crisis in order to express our concern for and show solidarity with the poorest, the powerless and the vulnerable.

The financial crisis of the third world

Developing countries are most profoundly affected by the present crisis due to the nature of their links with the international financial system. These links - which in theory are presented as a kind of interdependence - in practice show themselves to be a heavily dependent relationship whereby developing countries seek much-needed capital in international financial markets for their development, and then bear the brunt of economic change and adjustment in the international sphere, as well as the consequences of domestic economic policies in the major industrialized countries.

Capital inflow and growth of production

The case for capital inflow in its simplest form is that developing countries are poor and their domestic savings are low. Domestic savings are needed to invest in infrastructure and in directly productive assets in agriculture and industry. They are also needed to invest in the development of people in order to ensure better educated, better trained and healthier people who will ensure the future development of the country. But because domestic savings in developing countries are often too low to finance investment levels high enough to generate a rate of growth of production in excess of population growth, they need to be augmented by foreign savings. This much-needed foreign capital may come from loans raised from international lending institutions, foreign investment either direct or indirect in the country, or from aid.

In order to try to repay the interest and principal on the loans they contract for development, developing countries rely primarily on the foreign exchange they raise through exports. In most countries of the developing world these exports consist largely of primary products such as coffee, rubber, timber, cotton, cocoa, oil, etc. But at the same time this valuable foreign exchange is being used to purchase the necessary imports for development - intermediate goods the country needs for development or even operating existing capacity such as steel or oil, capital equipment for investment to expand capacity, and things which the country needs but may not be able to produce itself such as food or basic consumer goods. Trying to juggle imports and loans with the exports to pay for it all results in many cases - in virtually all of Latin America, the Caribbean and Africa - in a balance of payments

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deficit whereby the money being paid out for things exceeds the money coming in and the country finds itself in the middle of a financial crisis.

Causes

So the financial crisis of much of the third world, which has led many of these countries into the debt trap and the acceptance of severely contractionist programmes imposed by the IMF, can in the first instance be traced to the chronic imbalance in their balance of payments. These chronic payment deficits can at a second level be traced to the interaction between three fundamental factors: (1) external causes; (2) internal problems; (3) structural problems.

Many of the external causes stem from the fact that most developing countries are producing and exporting natural resource-based products which have lost their growth dynamic. This means that keeping their balance of payments in line by balancing exports and imports is becoming increasingly difficult due both to volume sluggishness and to price declines. This problem is exacerbated by protectionism in developed markets which puts quotas on imports of the kinds of things developing countries are hoping to export, as well as by rapid technological change creating substitutes for such commodities as cotton, rubber, copper, aluminium and steel.

Another major external cause of the financial crisis in the third world stems from the developed countries' domestic policies. The clearest example is the effect of American monetary policy on the price of other countries' external debt. Many of the developing countries borrowed heavily to finance development in the 1960s and early 1970s when the international financial situation was more stable and interest rates were low. Since that time, and especially since the demise of the Bretton Woods system with its fixed exchange rates, US monetary policy has encouraged high domestic rates of interest which ramify into international capital markets and substantially increase the debt service burden of the third-world debtors. Where countries owe large sums of money, the extra burden caused by even a one percent rise in interest rates can run to hundreds of millions of dollars annually or even to a billion in the cases of Brazil and Mexico. This system protects the banks who lend from suffering the losses that they would have incurred if interest rates moved up under a fixed-rate system. Instead, the risk and the cost of upward rate variations are passed on to the borrowers. Add to the interest rate problem the sudden surge upwards in prices of imports (food 1972, oil 1973-74

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and 1979-80, manufactured goods 1974-76) and the result is payments deficits, financial crises and debt.

But external causes cannot completely explain the financial crisis in the third world. In many cases the impact of external causes could be avoided or mitigated if these countries possessed experienced, sophisticated governments which could lead economic activity from declining product areas to new products for which demand is burgeoning. But developing countries are often faced with internal crises which lead to the destruction of existing production (including export sectors), failure to get out of moribund economic activities in time, failure to identity and set up new growth sectors in a timely fashion, weakness in import replacement activities, societal demoralization and foreign exchange crises.

Finally, it is important to point out the internal problems of a structural nature. Perhaps the biggest hurdle developing countries face is that it takes time to set up materials fabrication industries which are necessary for constructing reasonably integrated industrial, power, mining and construction sectors. In addition to the time it takes, it is expensive in terms of finance, foreign exchange and skilled personnel. But all of this structural reorganization is ultimately necessary if the economy is to become effectively industrialized and if it is to develop the real productive flexibility of a dynamic exporter. In general the more integrated and high productivity an economy, the more flexible it is. The closer it is to producing little other than food for self-provisioning and primary products for export, the more rigid is its economic structure and the slower, more costly and problematic becomes adjustment to external shocks or trends - a pattern which is too clearly illustrated by most of low income sub-Saharan Africa.

Critique: what is wrong with the international financial system viewed in the light of Christian values?

In its critique of the problems in the international financial system which have led to the current crisis with its negative impact on the third world, the AGEM focused on the actors in that system, their roles and responsibilities, the political economic models they adopt and the values on which they are based.

Actors in the system - their roles and responsibilities

Decision-making in the international financial system is concentrated in the hands of three sets of actors:

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1. Private institutions, especially large transnational banks: Transnational banks, state banks and other credit agencies (both public and private) have responsibilities to their sources of funds and owners for the proper stewardship of their resources and pursuit of their interests. Development is not their primary objective. Indeed it cannot be, because banks are properly accountable to their depositors, lenders and owners as well as to borrowers. But this does not mean that critical questions cannot be asked as to their social responsibility in lending to imprudent and unjust governments, pushing overpriced loans and projects on unwary borrowers, or insisting on repayment terms which cripple the borrower and imperil ultimate recovery of the debt as well as future business.

2. National governments: They play a substantial role in the international financial system if their power to regulate TNC banks has been eroded by the rise of offshore financial markets. The nations with the most decision-making power in the system are the major industrial economy governments, with Saudi Arabia, Kuwait and the largest developing economy governments playing secondary and other developing economy governments peripheral roles. But developing economy governments, while largely unable to have much impact on industrial economy or TNC bank actions, do have some scope in determining their relationship to the system and their vulnerability to shocks. Imprudent borrowing, ineffective use of resources and corruption linked with private capital flight offsetting external public (or private) borrowing are practices which greatly weaken an economy in respect both to its creditors and to its ability to endure shocks.

3. International financial institutions (the IMF and the World Bank):

The IMF's responsibilities are not centred on development or on long,term concerns. They are focused on providing interim financial support to overcome external imbalance in order to sustain output and trade in the world economy. But whether the IMF does provide adequate resources on terms compatible with meeting these goals without causing unnecessary loss of output in the economies of borrowing states and placing avoidable burdens on poor people and vulnerable groups is hotly disputed.

The World Bank and bilateral development assistance agencies are primarily concerned with promoting development. At least verbally, the Bank and most bilateral agencies are committed to providing resources in. ways suitable to the reduction of absolute poverty and raising the production, incomes and access to public services of poor people. None has unlimited resources and each, therefore, is forced to consider what uses of its funds will be likely to prove effective in furthering develop-

The International Financial System 47

ment and consistent with raising additional resources to continue its programme in the future. That cluster of concerns has become more pressing since 1979 as resources available have tended to stagnate while potential calls on them have become more urgent and numerous. One result has been an increasing attempt to apply policy conditionality relating not only to the project or programme financed but to the overall economic and development strategy of the recipient.

Political economic models, adjustment and conditionality

The need for many semi-industrialized and developing countries to adjust is not at issue. However prudent a country's strategy and policies before 1979 and however deep its commitment to the poor, the continuation without any changes of that strategy and those policies in the radically changed economic context of the 1980s is very unlikely to meet any reasonable performance tests or to be an effective way of implementing a commitment to the poor, to self-reliance, to basic human needs or to participation. The real choice has been, and is, among political economic development models and, primarily, between endogenously planned and phased adjustment reconciling national goals and commitments with the realities of the international economic financial system as it confronts that country, and sudden, unplanned adjustment imposed by the interaction of inadequate domestic resources, external creditors and international agencies.

Political economic models and adjustment programmes are inextricably linked as the prescription (adjustment programme) is determined by the economic fitness programme (development model) which is espoused. Since 1945 four major models for development have been dominant. These are:

1) export-led growth which depends on the rapid growth of world trade and on potential new exporters achieving competitive prices for their products;

2) import substitution which argues that domestic market-oriented production is more secure, and that some production, even if it is inefficient, is better than leaving resources unemployed;

3) national need orientation which overlaps with the more sophisticated import substitution strategies in emphasizing reduction of dependence on external trade and enhanced national economic integration;

4) basic human needs focused on productive employment (including selfemployment) and priority to the satisfaction of basic human needs including basic public services.

48 Ecumenical Reflections on Political Economy

In practice, these paradigms are not totally mutually exclusive, but they have influenced the ways in which development, and hence adjustment policies, have been pursued. Each has different implications for the international financial institutions as well as for developing countries. In general, the financial institutions and in particular the Bank and the Fund - have not been neutral among these paradigms but have usually favoured export-led growth.

This choice of development model has implications for the kind of adjustment prescribed by international financial institutions. The basic differentiation in ways to adjust is between cutting demand and raising supply. The International Monetary Fund often, if not always, imposes policy prescriptions primarily concentrated on demand constraints including the adoption of deflationary measures such as higher rates of interest, more taxes, less government expenditures, and credit ceilings. The prescriptions of the World Bank in its structural adjustment programmes include the adoption of policies leading towards export-oriented industrialization, import liberalization, dismantling of protection for local industries, and opening up the country to private investments. They are, however, basically supply-oriented and usually do stress enhanced food production.

The problem is that these ways of adjusting - and particularly demand contraction - are not likely to be appropriate as a primary means of adjustment for countries whose imbalances arise from sudden falls in command over resources, nor for a world economy whose dominant characteristics are massive under-utilization of capacity and devastating levels of unemployment. These prescriptions as frequently imposed on third-world clients often add up to a serious impairment of their national sovereignty in the sense of selecting and acting on a development strategy seen as consonant with national needs or interests.

Conditionality

In theory a developing country sets the conditions of its adjustment programmes in consultation with those from whom it hopes to secure finance, e.g. the IMF, the World Bank and bilateral sources of finance. In practice there is often a high degree of external coercion on the part of the lending sources who find themselves in a position of almost total power over a petitioner whose bargaining position is very weak.

The criticism of the IMF stabilization programmes is that they show considerable rigidity in analysis, selection of targets, instruments of acceptable adjustment and the pace of adjustment required. The result is

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fairly uniform prescriptions to reduce demand and imports and to increase exports. Adjustment by cutting demand can frequently be achieved faster with less external support but in practice it has many problems including higher human and economic costs, especially for the poor, because this method brings balance of payments under control by reducing total real production and employment and reducing imports.

The positive side of the World Bank Structural Adjustment Programmes is that:

1) they are less uniform at one time and over time than the IMF programme;

2) the World Bank is in the development business and has asserted priorities for the poor in respect to absolute poverty reduction and achievement of basic needs.

The negative side includes such features as:

1) rigidity in considering different sets of instruments and ways of adjustment;

2) lack of consideration of the policy implications and requirements resulting from a priority for the poor;

3) adherence to disputed economic ideological perspectives such as a near equation of rapid economic growth with development and a belief that market forces mediated through price signals are highly efficient means to achieve almost all political economic goals under almost all circumstances.

Towards alternative adjustment strategies

Despite rhetoric to the contrary, there is an alternative to cutting demand, as indeed the Bank accepts. Another possibility for adjustment is to raise supply. For most developing countries the foreseeable future is one of growth and development constrained by inadequate foreign exchange. Neither plausible rates of growth of exports, of concessional finance, of commercial borrowing, of foreign investment, nor of all added together are likely to end the limitations placed on capacity utilization and expansion in most poor countries by lack of adequate import capacity. The way forward beyond this paradox is effective mobilization of domestic resources to reduce the required levels of imports and for levels, types and uses of foreign borrowing consistent with sustained growth and development.

This necessitates a change in domestic policies whereby the pattern of domestic consumption and production techniques must be made less import-intensive and export earnings must be maximized through self-

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reliant policies. The technical manner of doing this will include redirecting existing savings out of capital flight abroad, curtailing unproductive investment in speculation and luxury while at the same time providing incentives to saving through institutions which channel resources productively, more access to small investment opportunities for low- and average-income households (especially peasants and artisans) and increased taxation (to finance public services and investment).

An important element in this adjustment experience is the search for greater self-reliance. Self-reliant development is based on effective control by people over their country's natural resources and production. Its central productive focus is not response to external demand but identifying and acting on internal potentialities to fulfill people's most urgent needs. This is the only way a country can both avoid being restructured from outside and achieve a responsible - in the sense of just and participatory - development dynamic. Domestic resource mobilization through greater self-reliance should not be interpreted as implying autarchy or as rendering exports unimportant. It is appropriate to import resources which are crucial but are either not domestically available or are available only at a very high cost. Interdependence - especially with countries in the same region at relatively similar levels of development, but also more generally - and self-reliance, not autarchy and isolation, constitute the valid external political economic goals of domestic resource mobilization.

Reform - working for a better future

Values involved in finding the right balance

Ultimately many choices and decisions regarding how to adjust, over what time frame, and with what balance of instruments and targets rest on value judgments. For each choice of policies there are important questions to be asked such as: If demand is to be cut whose command over resources is to be curtailed?... If supply is to be enhanced, supply of what and for whom? A commitment to the poor cannot usually be articulated effectively by opposing adjustment, but only through informed choices in respect to adjustment, especially as to who bears costs and receives benefits. The answers from the point of view of that commitment, which is ultimately one of values and of ideology, do differ from those consistent with commitments to maximize production as an over-riding end in and of itself, to maximize national military capacity or to stabilize and expand the power and perquisites of existing dominant elites.

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So how do we incorporate values into and relate the goals of equity, justice and sustainability to the international financial system? In the abstract it is relatively simple. Equity posits the transfer of resources from the relatively rich to the relatively poor on terms and conditions which will enable the poor to achieve development. Justice requires support for the third-world countries' development efforts and especially for those which both seek to and make progress towards meeting basic human needs. Sustainability entails avoiding imposing or maintaining terms and conditions which crush a borrower's or recipient's development efforts, and acting purposefully to avoid or contain international financing crises and to do so with the minimum additional burdens on poor people and poor countries. To state these conditions is to see immediately that the present system is not very efficient in fulfilling any of the three goals.

In order to work towards these goals consistent with our Christian commitment we must work for what the AGEM termed an "international moral and ethical order". Two basic principles are at the core of the search for this order:

1) international responsibility for all the world's people;

2) universality in the approach to finding and funding solutions to the world's financial problems.

This approach will be based on a just socio-economic and political economic order, local, national and international. Prominent among its values are: fulfilment of basic physical and spiritual needs; justice, self-reliance; sustainability; globality; equity for the most vulnerable; and furtherance of peace.

These same principles and values must guide the policies and actions of the institutions in the international financial system. In order to ensure that financial institutions are fulfilling their fundamental role in working towards a more just international order they should ask themselves the following questions:

1. To what extent have they furthered and supported and to what extent imposed and hampered national development efforts?

2. Have their affirmations of concern for helping poor people been backed by substantial resource allocations and to what extent have these been effective?

3. How - in the present context of limited resources and increased demand - can they act more effectively to protect development efforts and poor people in poor countries?

4. Is their present policy advice sound or is it too rigid? Are national programmes considered on their merits or tested by uniform and

52 Ecumenical Reflections on Political Economy

restrictive standards as likely in particular cases to deter as to promote development?

5. Have they taken adequate initiatives to raise and deploy resources to protect the poorest countries and people from the adverse global economic environment?

6. Are they adequately open to the concerns, experiences and proposals of resource recipients?

7. Do they in fact encourage nations to pay greater attention to their obligations to poor people by being particularly responsive to programmes and policies designed to raise their incomes, meet their basic needs and reduce their vulnerability to economic shocks, or - as is frequently contended - do their actual policy advice and resource allocation pattern have the opposite effect? What should they do when the national decision-takers of borrowing countries do not give priority to the poor?

Reforms in the international financial system

Based on changes in values informing the international financial system and financial relations among states, as well as changes in the balance of economic power within financial institutions, the AGEM identified five fundamental elements for reform and restructuring of the IMF, the World Bank and national governments:

I. The domination of the international financial institutions by the major industrial economies, and particularly by the USA, needs to be challenged.

2. There should be universality of membership.

3. The operations of international financial institutions should be transformed to reflect a recognition of the intellectual and theoretical mistakes of the past - mistakes which have led to much human suffering without producing corresponding benefits of growth and transformation.

4. International financial assistance to poor countries is provided with "conditionality". The issue is not whether or not there should be "conditionality", but rather that conditions are appropriate and equitable.

5. National governments have a duty to be responsible stewards of their economies, to act in ways consistent with promoting the welfare of their people, to respect human and democratic rights and to conduct their economic affairs in ways which do not - deliberately or otherwise - shift the costs of national policies and

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problems to other members of the international community without their prior consent.

Other complementary areas in which reforms are needed

But reforms are not only needed in international financial institutions and national governments. Because many of the problems in the international financial system stem from such related areas as trade and monetary policy, complementary reforms must be considered in the following areas:

1. International trade relations: World trade system reforms are interrelated with and complementary to financial system reforms because trade fluctuations and barriers to expanding exports contribute both to causing external payments and debt crises and to making it harder to escape from them. Reforms shall include:

a) alleviation of the impact of price fluctuations on export earnings as a priority within UNCTAD, the IMF and the EEC;

b) reaffirmation and re-establishment of the principles of non-discrimination, multilateralism and transparency should be within the General Agreement on Trade and Tariffs (GATT);

c) South-South solidarity and cooperation manifested in South-South trade development both within and beyond regional groupings.

2. Availability of long-term loans on reasonable terms: The problem is that financial flows to developing countries have fallen in monetary and even more in real terms. A related problem is that most loans including IMF drawings have been for relatively short periods, often in the unrealistic and unfounded belief that the time span was sufficient.

Therefore:

a) development institutions such as the World Bank, the International Development Association (IDA), and the regional development banks and bilateral aid agencies should increase their long-term funding to poor countries;

b) funds should be made available on reasonable terms particularly in relation to interest rates, grace and repayment periods and performance criteria;

c) poor nations should have a substantial degree of autonomy in deciding on the utilization of long-term resources in accordance with their own national priorities and goals.

3. Stabilization of exchange rates and introduction of international reserve currencies additional to the US dollar: Progress towards reducing risks and costs to vulnerable nations requires two parallel types of change:

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a) recreating stable (rather than freely floating, volatile) exchange rates;

b) adopting a new set of agreed rules of the game encouraging small, and

if necessary frequent, changes of individual exchange rates in response to differential national rates of inflation or alteration in relative strengths of real economic sectors of each country.

4. Reconsideration of processes and structures of decision-taking in international financial forums: By nature neither the technical discussions nor the actual decision-taking can be realized by the general public, but it could take place in a framework accessible to, and in a context of principles laid down by open and democratic processes. On the day-to-day operational level a more democratic voting system involving all members equally can and should be introduced.

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