GEI Newsletter Issue No. 7

International Institutions and Good Economics

by Sarah Hogg, Chairman, London Economics

Sarah Hogg (Baroness Hogg) is Chairman of London Economics. She was Head of the Prime Minister’s Policy Unit from 1990 to 1995. In this position she was the Prime Minister’s closest adviser on such international economic issues as trade negotiations and the creation of the World Trade Organisation. She played a leading role in the development of the UK’s strategy for securing a conclusion to the Uruguay round negotiations.

I was fortunate enough to be part of the British Delegation to the 1994 G7 Economic Summit. It was then, on a steamy summer evening in Naples, that conversation at the "informal" dinner of heads of government took off into a resolution to review the roles of the international institutions. The lighthouse beam of top-level statesmen’s concentration did not long remain fixed on this interesting but hardly life-threatening target, and little came of this enthusiasm by the time of the Halifax Summit the following year. Nevertheless, it gave momentum to the reconsideration of these institutions, of which the most impressive contribution has undoubtedly come from the GEI research programme. This no doubt has been in part due to an excellent choice of steering committee, under the chairmanship of Andrew Crockett, bringing a great deal of practitioner’s experience; and of academic director, in the person of David Vines.

What I will try to do today is to look at the issues from outside the territory these researchers are tilling so thoroughly, while ruthlessly exploiting their knowledge and insights. For what has struck me forceably when reading this material is that how much policy-makers and researchers (as, as the chairman of a consultancy which does a lot of work at the behest of the World Bank, I should still class myself in that category) tend to suffer from insiders’ blinkers. We may - indeed, frequently are - critical of how international institutions carry out their functions. We may think they should do different things, and do them differently. But we find it harder to think about issues of legitimacy and accountability, and to identify the endemic strengths and weaknesses of these institutions, because we are part of the same economic community.

So today I would like to start with the basic question: are the existing international economic institutions a Good Thing? And how should our approach to this question differ from a similar one applied to - say - Citibank or Marks and Spencer?

In the case of these private-sector institutions, we can find an objective answer to the question in the verdict of shareholders, employees and customers. If M&S cannot secure a profitable mix of capital and labour, if it cannot sell their combined product, then it is a Bad Thing. And the markets will, one way or another, get rid of it. Of course, we may add qualitative judgements as to the goodness and badness of private companies, independent of their profitability, according to whether they are good citizens, kind to animals, erect aesthetically pleasing buildings, offer equal opportunity or whatever. We may emphasise one or other of the respective "stakeholders" in making such qualitative judgements. But the bottom line remains the bottom line.

In the case of a bank, of course, the position begins to get a little blurred. Central Banks may feel obliged to intervene to rescue what has become a Bad Thing - on a market judgement - because its destruction would have systemic effects. That is one of the things governments have Central Banks for - though to what extent is a matter of continuing debate, not least in a country engaged in separating the Siamese twins of its existing monetary authority-cum-financial-regulator.

But now let us ask the question of the international economic institutions. To ask whether they are a Good Thing, we have to start be asking what they are for. Reading the literature of the research programme, I came frequently up against the very reasonable-sounding opinion that they were there to correct market failures and put right the things that governments muck up. This may be where we end up, but I do not thing it is where we can start. For there is an implicit assumption here that international institutions are accountable to some higher extra-terrestrial, who has landed them on planet earth to correct the miserable mistakes made by the humans who elect each other to run their affairs. I think we all know people who work for international institutions who have slipped into the belief that their work for the greater good is synonymous with Divine Right. I therefore think it important - not merely for reasons of diplomacy, but also for reasons of legitimacy - to stick with Andrew Crockett’s definition, which is that international economic institutions exist to help governments deal with market failure.

There is, of course, a kind of schizophrenia in the very operations of international economic institutions. Set up by governments, they spend their time telling governments what to do. We can, of course, argue that the issue of legitimacy is resolved by the fact that the International Monetary Fund, the World Bank and the World Trade Organisation are simply clubs. You do not make an irreversible transfer of sovereignty by joining a club; but you cannot expect to remain in the club unless you are prepared to obey the rules.

Of course this begs the question of internal governance - how the rules are set, and by whom. But let us leave that aside for the moment. The point I wish to mark at this moment is that the international institutions are not organs of world government responsible to a benevolent extra-territorial dictator, but merely the secretariats of clubs for which membership happens to be extremely popular. This is a polite reminder to both sides that international institutions cannot be that much better than the people to whom they are accountable. This is, I think, more apparent for other international institutions - notably for that umbrella organisation, the UN - than for international economic institutions. But I emphasise it because the newest of these institutions is bound to test the club principle in a different way.

For both the IMFand the World Bank, the club works in a rather simple way. From membership, rich countries gain the ability to use their financial muscle to influence the way the economies of poor countries are managed - and to do it at arm’s length (relatively) free of bilateral political argument. Rich countries also, as the GEI papers make clear, gain economies of scale and scope in the science of economic management from the existence of institutions to perform this task. Poor countries gain, equally, from this concentration of expertise - imbibing the distilled wisdom of impartial institutions. And, of course, they get the money.

Well, that’s the story. I’ll come back to its weaknesses later. But the broad picture approximates to the real world balance of power in these institutions. In recent years, no member of the G7 has been in the situation that used to be described here as "having to go cap in hand to the IMF". It is even longer since the World Bank had a role in funnelling capital to members of the G7. IMF "surveillance" of the economic policies of the G7 is at best a thoughtful exercise in futility. So far as the World Bank is concerned, middle income countries are also passing out of its influence; they may stay members as a kind of reinsurance, but to an increasing extent they prefer to borrow direct from the markets.

Now, these changes have, of course, resulted in well-remarked changes in the character of these institutions, and raised questions as to their continuing purpose and credibility. But these are going to be thrown into even sharper contrast by the overdue arrival of the famous "third pillar" of the Bretton Woods design: the World Trade Organisation.

The WTO is a quite different kind of institution. It is sometimes argued that the World Bank and the IMF have got their labels the wrong way round: that the Bank is more like a fund, and the Fund more like a bank. But no one could confuse either with the WTO. It is not merely that no money passes hands. What WTO members get from the club is (apart from a more-or-less valuable place at the trade negotiating table) a set of rules, which they can use its machinery to enforce against other countries. And this membership right is equally available to all members - subject (an important qualification) - to their ability to mount the economic case sufficiently clearly. Thus it is that the earliest prominent cases to appear before Disputes Settlements Panels have had some of the biggest and most powerful governments in the dock: Japan (with respect to the treatment of imports of alcoholic beverages); the United States (with respect to reformulated gasoline and textiles) and the countries of the European Union (bananas).

We can already see the extent to which the WTO is turning into a very different organisation from its predecessor, the GATT. The history of the GATT is proudly marked by a series of reductions in the height of tariff barriers worldwide. The GATT was a forum for negotiations between "contracting parties" to achieve this, a spur, a secretariat, a framework. As it succeeded, the job got harder, because negotiations had to focus more on non-tariff barriers - and this carried the negotiators deeper and deeper beyond customs posts into the regulatory regimes within sovereign countries.

At the same time, and for some of the same reasons, enforcing agreed trade liberalisation became more difficult and more important. The GATT had, of course, mechanisms for disputes settlement - but they were significantly weaker than those built into the WTO framework. The functions of this new body are thus significantly rebalanced towards the enforcement of an existing set of trade rules, and demand for it to carry out this function - to set up disputes settlement panels - is extremely strong.

I will now declare my hand. I believe that of the three most significant of our existing economic institutions, the World Trade Organisation is potentially the most important; but that it is going to strain the willingness of big economies to submit to the rule of international law, and thus the viability of the club; and that we should not be too complacent about its early success in achieving credibility.

The WTO is, more obviously than the IMF or the World Bank, living on the edge of its seat of authority. It is small, not very well established, and lightly staffed. Its panels are locking horns with some very big beasts; so far, they have been able to divide and rule, but for how long? There is a serious danger of overstrain. The contracting parties have already shown an irresponsible desire to increase its responsibilities, rather than thinking about the difficulties it will face in carrying out its existing ones effectively. What can we learn from the history of our other two institutions, to help us make a success of this one?

Let us come back to the question: what makes - or does not make - each of these institutions a Good Thing? Let us take as the test: do they help governments correct market failures? And let us add: do they do so more effectively than national institutions?

The IMF and the World Bank were set up very differently from the WTO - as large, important, institutions with big agendas. Much of those agendas has disappeared with the collapse of the postwar exchange-rate regime and the globalisation of capital markets. David Vines has produced what seems to me the best modern taxonomy of functions, which ascribes to the IMF the enforcement of macroeconomic stability in less-developed countries, and to the World Bank microeconomic policy advice enforced by conditional project-based lending. Everything else traditionally ascribed to the functions of these two institutions he (in my mind, rightly) ascribes either to national governments, to OECD, G7 or of course the WTO.

I think I can agree that, with a focus as described, these two institutions can still be seen as a Good Thing - that is to say, they use their lending power, in combination with their economies of scale and scope in expertise, to improve on the results that would be achieved in developing countries by markets alone, or - at least in aggregate - by individual national governments acting alone. But we should not accept that too easily. I am not wholly comfortable with the argument that international institutions are better at designing and enforcing conditionality than the the financial institutions who lend on the basis of such programmes. And it has to be said that there have certainly been phases in their history when it would have been particularly hard to make this case for the World Bank and the IMF. The massive flow of funds into the public sectors of third world countries since the creation of the World Bank has resulted in some dreadful waste of resources. The concentration on lending to governments, even at a time when first world countries were busily privatising, went on far too long. Equally, if perhaps less expensively, the IMF went through the motions of managing an extinct global regime ridiculously long. And the history of conditionality is - how shall we say? - mixed, with far too many countries moving from one teat to another, never quite meeting IMF conditions or being weaned from dependence on its assistance.

In the World Bank’s case in particular, I believe that - though change is far from over - it has taken place in a way which has made the institution less vulnerable to the charge that it can get stuck in a groove of outdated, and even actively unhelpful, economic policy. The pursuit of mixed developments in client countries, involving the private sector and independent advice, is injecting a greater pluralism. But one has to ask oneself why it is that, with all those economies of scale in research capability, the World Bank should have found itself behind the curve - since this goes to the heart of the argument for its continued existence in a world of free-flowing capital.

A particular feature of international institutions is that they can develop a mindset of their own, independent of their political masters. They may have to listen a bit harder to a superpower - or, I should say, the superpower - than to others. But officialdom in an international institution never has to go through the re-orientation that may take place some spring morning to the British civil service, or the wholesale replacement that may take place some winters around the White House. This, of course, many would see to be a strength - a "depoliticisation" of policy. Maybe. But at the same time, it puts a greater onus on the staffs of these organisations to avoid the perpetuation of internal prejudices.

To be fair, however, some of these rigidities are not the result of culture but of system. For the same reason as those described above, the purpose and functions of international institutions take a long time to change. The concentration of the World Bank on public-sector lending was not, after all, a whim but a requirement. Clubs find it difficult to change their rules. This, not merely the tendency to over-develop instutional approaches, impedes the development of their economics, and counterbalances the advantage of a concentration of skill and talent amongst their resources.

Which brings me back to what I want to say about the WTO. Not that the question of international institution versus national government or private sector solution arises in the same way. Trade problems which markets do not resolve satisfactorily are by definition international; and it is, I think, pretty overwhelmingly clear that for the world economy as a whole multilateral solutions are better than bilateral ones. (One must, of course, note in passing that the argument has separately to be made that such solutions are better for big bilateral players, too!)

Nor would I argue that the WTO has created a big bureaucracy with its own self-reinforcing mind set. Quite the reverse. This time, the secretariat is clearly too small; its masters over-reacting against the size of the World Bank and (to a lesser extent) the IMF. Indeed, Mr Ruggiero himself has frankly admitted that WTO staff have no time to indulge in the luxury of research into issues in the development of world trade. There is, however, a danger that the WTO will find itself enforcing rules that do not always make good economic sense. At the very least, interpretation will need to evolve through the disputes settlement process. The way in which markets are defined; the use of appropriate economic techniques to demonstrate substitutability between products - all these will need to be developed and applied if the WTO’s judgemental role is to command respect.

Let me, if I may, highlight three particular issues here. One is that the panels are very dependent on the evidence brought before them, since the secretariat’s own resources are very stretched. This, in turn, can lead to an imbalance of advantage between parties, with small developing countries lacking the legal and economic expertise embedded in the bureaucracies of big governments. I know the WTO is very well aware of this problem, and it was recognised as an important issue at the recent Commonwealth Summit.

A related issue is the extent to which companies may lobby their governments to initiate trade dispute proceedings. This may be contrary to the inter-governmental spirit of the WTO, but there are countries where big investing companies may be better equipped to mount a challenge to restrictions on overseas market access than governments themselves. Moreover, this may be taking place, even in countries with big and powerful governments, because companies facing access problems have become frustrated in their attempts to use domestic competition policy machinery to resolve them. This is very much a key issue in the current dispute between Japan and the US over photographic film. If such disputes can be turned into a complaint against government policy in the country concerned, then the WTO dispute procedures may become an alternative field on which to fight restrictive practices.

Which leads me to the third issue I would like to raise here: the inter-relationship between national competition policies and trade disputes. I believe this is the clear exception to the principle that the WTO - like all international institutions - is better with a narrow focus; I once again strongly agree with David Vines that a diffusion of responsibilities, a multiplicity of objectives, leads to confusion and poor results. I strongly believe the contracting parties would be unwise to lumber the WTO with some kind of judgemental responsibility for monitoring either the environmental or the social policies of members, in enforcing trade rules. But competition policy and trade policy cannot be kept distinct. All experience suggests that running two systems of economic market regulation in isolation from each other will end in tears. There are very difficult issues of economic sovereignty involved here; but if WTO judgements are to deliver good economics, members are going to have to grip these. And the WTO is the right framework within which to do so.

And so to my final paradox. To develop what I said earlier, I believe the WTO’s importance can easily be under-estimated. The disputes settlement procedure was created at the very end of the Uruguay round - rather, as was said of the British Empire, in a fit of absence of mind. It is potentially a very powerful weapon for improving the functioning of the world economy, if treaty language is interpreted well and judgements evolve into an economically sound body of case law. Those are, of course, big ifs. The paradox is that the WTO should be so important at a time when technology might suggest that trade barriers will be over-run without the help of an institution. All our economies are shifting towards information industries, where such barriers are extraordinarily hard to maintain; there are no customs posts in cyberspace. These markets are developing their own standards and means of self-regulation, without any inter-governmental direction at all.

Well, yes. I believe these effects are very powerful. But they will, of course, have their greatest impact on domestic regulatory regimes, which can no longer hold their doors shut; and which will lead governments, increasingly, to look to international organisations to help them live with the consequences. The WTO is the body to which they will turn - indeed, are turning. The challenge is immense. Understanding the economics of globalisation, and enforcing competition rules within it, is a formidable agenda. Potentially, it is clear, the WTO can be a very Good Thing. But if its main contracting parties do not understand the full challenge, it will founder under the strain. And that would be a very Bad Thing indeed.

For further information, contact Mahmud Nawaz at London Economics, 66 Chiltern Street, London, W1M 1PR.

telephone: +44 20 7446 8400

website: http//www.londecon.co.uk fax: +44 20 7446 8484/5

email: mahmud@londecon.co.uk

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