Transformations in the International Economy during the Second Half of the 20th Century
Following Second World War, the Western powers- led by the United States- came together to rebuild the international economy. The emerging system was largely described as embedded liberalism which collapsed after about thirty years. Neo-liberalism took over as a new approach to international economy. So far, it is possible to assess the effectiveness of each system with embedded liberalism proving to be a booster of economic prosperity during the 1950s through 1960s. From the 1970s, there was obvious need for the system to change especially with skyrocketing oil prices that worsened balance-of-payment deficits in non-oil producing countries. The more free market (neo-liberalism) which has become a social system has had many problems which have been exacerbated by policies that were established by the International Monetary Fund this impact being felt more in poor and developing countries such as Latin America. The embedded liberalism is more effective than neo-liberalism since it puts all players on the same level hence ensuring a more democratic international economy.
Embedded liberalism and neo-liberalism
The embedded liberalism policy held that currency reserves could be converted into gold either directly or indirectly. There were set par values on which exchange rates depended. Also characteristic of this system was that the International Monetary Fund (IMF) acted as the principal financier of balance-of-payments (BOP) deficits (Cohen 315). Embedded liberalism was necessary since leaders did not want to plunge into the economic woes they had experienced after the First World War. The 1930s financial woes, more so after the departure of Britain from the gold standard, was a lesson well learnt by all the leaders who came to form the embedded liberalism system. All the 44 nations were aware of the importance of having enough liquidity save for pure float. The WWI had caused extreme inflation which led to gold shortage through 1920s making monetary gold stocks weak and a repeat of such history had to be avoided. At the same time “all understood…the need to set some upper limit on the availability of supplementary financing for balance-of payment purposes” (Cohen 324).
In 1944, 44 nations gathered at Bretton Woods to establish a monetary system that would facilitate BOP financing after WWII. The United States and the Great Britain were key players in formulating the postwar monetary system. Between the First World War and the Second World War, it had been observed that there were drawbacks in having freely changing exchanges. This therefore called for the conferees at the Bretton Woods to come up with a par value for each country’s currency in addition to taking intervention measures that would ensure that fluctuations were minimal. To ensure that supply of international liquidity was in line with a preplanned borrowing system in case of surplus reserves for all the countries or even a single country, the IMF was established (Cohen 319). Member countries subscribed to a measure of gold in addition to assigned quotas which were based on how crucial a country was in the world economy. There was a 25% payment made in form of gold or the U.S. dollar then since it was the only currency that could be converted into gold. The remaining 75% would be paid in the country’s own currency. In case a member country experienced a shortage in reserves, it was allowed to borrow foreign exchange from the Fund that was equal to its own currency. Members could only buy foreign exchange up to a given maximum, usually 25% of the gold tranche (Cohen 320).
The quota limits that were set under the embedded system gave a lot of freedom to governments as far as their access to the IMF resources was concerned. Member countries were supposed to abide by rules of the Fund in purchasing foreign currency until later when conditionality was introduced. The conditions were particularly instituted in 1948 and 1952 with focus being laid on the need to have each member country which borrowed from the Fund show how they intended to overcome BOP deficits. In the 1950s, stabilization programs were introduced into the Fund and each member was required to provide a stabilization program whenever they required financing through the credit tranches. The stand-by arrangement was also introduced in the 1950s where phasing (“specified amounts of finance…were made available at a specified intervals during the stand-by period” (Cohen 322)) was introduced. Failure to operate within the policy objectives meant that a member state would be interrupted from accessing the fund. In summary, the postwar regime financing was characterized by principles, norms, rules and decision-making procedures.
Effects of embedded liberalism and neo-liberalism
After the economic prosperity of the 1950s and 1960s attained through the embedded liberalism system, there was certainly going to be change in the system especially which rising oil prices in the early 70s. The problem of petrodollar recycling was hitting hard especially on oil-importing nations leading to a shift from the earlier system of dependence on the IMF for financing of BOP deficits. Private Banks came over to complement the role of the IMF with the OPEC countries experiencing surplus earnings which had to be recycled through bank credits as well as bond issues (Cohen 315). It is observable that by mid 1960s, industrial nations were going for other financing options such as private crediting although these acted as complements to the IMF and rarely as competitors. Only the third world countries and rather poorer countries in Europe were heavily dependent on the Fund and thus the rules of the Fund were almost entirely subject to these countries only. The bias was also extended in that the few rich countries could borrow from one another.
The petrodollar recycling problem made countries that imported oil require supplementary financing. This need was too huge and exceeded the IMFs capacity as a financier. The IMF had to increase borrowing quotas for member countries through several strategies such as the Oil Facility of 1974, the Extended Fund Facility of 1974, the Trust Fund of 1976 and the Supplementary Financing Facility of 1975. This system of international economics came to be classified as the neo-liberalism system. Of course the steps taken by the IMF were not sufficient to solve the problem as deficits increased enormously. This forced the deficit countries to pursue private credit markets for financing. The low absorption capacity of OPEC countries resulted into private credit financing. Private Banks were key financiers more so in developed countries. Poor and less developed nations had to continue depending on the Fund. Developing countries which were classified as creditworthy benefited from private bank credits and bonds. The initial role of the IMF was definitely changing and it was emerging that member countries could obtain unlimited BOP financing. The developed countries expanded their capitalism under the evolving liberalism while the developing countries were moving towards capitalism. There was creation of the underdeveloped nations, peripheral countries and developed and dominant centers (Cardoso & Faletto 17).
Changing role of IMF
Countries that were faced by BOP deficits would try to avoid adjustment measures as required by the Fund due to availability of bank credits. Easy financing options were dangerous in that foreign borrowers rarely had polices for adjusting to the deficit and the terms for financing were not yielding enough. Putting disciplinary measures on borrowers also did not guarantee the creditors of repayment and adjustment to the deficit. Since the IMF has well laid policies such as the stabilization program, the private lenders have been forced to consult the IMF to certify whether a borrower is creditworthy. The Fund is therefore regarded as an “arbiter of access to financing” (Cohen 332). The IMF has been seen to respond in times of financial crises such as the 1980s crisis on Latin America where fiscal austerity and stringent monetary policies helped in resolving the crisis (Stiglitz para 5). The Fund is however under criticism of failing to respond to crises on a case-by-case approach thus applying the same formula for all, leading to economic failures. Such happened for the East Asian countries in 1997 and austerity measures led to more recession, to the point of a depression. IMF policies are seen to benefit the interests of the U.S. rather than the countries experiencing deficits as experienced by the East Asia financial crisis in the 1990s. Countries such as South Korea and Malaysia which have followed their own policies other than the IMF prescriptions during recessions have performed better.
The IMF has changed from a financier in maintaining payments equilibrium in the short-term to one that finances countries for long-term periods as a way of recovering from deficits particularly in third world nations. This role has almost merged with the principal role of the World Bank. There is increased access to funds for long terms and an overall supplementation of private bank credits and this has blurred the line between the role of the IMF and the World Bank.
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