Is the New Bretton Woods Conceivable? -- Address by Michel Camdessus
January 19, 199696/1
Managing Director of the International Monetary Fund
Société d'Economie Politique
Paris, January 19, 1996
It is a very great pleasure to be here with you today, and a particular pleasure to have this opportunity to speak frankly and informally among so many friends. In coming here today, I was asked the question: is a new Bretton Woods conceivable? Friends have a way of asking the most provocative questions! I confess that after nearly ten years at the IMF, this simple question brings a multitude of thoughts to my mind--about the bold objectives of the 45 nations whose representatives gathered at Bretton Woods, New Hampshire in the summer of 1944 to establish a new economic order; about the extent to which these ambitions have been fulfilled; about the many new challenges that have arisen in the world economy since Bretton Woods; and where, in view of these challenges, we should go from here. Allow me to share some thoughts on these questions with you.
It is certainly true that the international monetary system has changed considerably since Bretton Woods--and in ways that were largely unforeseen in 1944. Instead of a system of fixed exchange rates among major currencies, we now have a floating rate system. Where capital controls were once pervasive, we now have global financial markets of hitherto unimaginable size and complexity. From the relatively small group of 35 countries that became the founding members of the IMF, Fund membership has expanded to include virtually every economy in the world--181 in all. I would add that in the last year, the international community has been sorely tested by a crisis that would have been practically inconceivable in 1944: Mexico and the risk of spill-over effects in other emerging markets. Indeed, amid all the complexities and uncertainties that the existing international monetary system presents, "Bretton Woods" seems to evoke a more orderly and cohesive world, raising the question of whether the international community should not strive toward a "new" Bretton Woods.
In order to answer this question, however, one must first consider more fully what "Bretton Woods" and the International Monetary Fund, the institution established to oversee the new monetary order, were intended to achieve. In this age of sound bites, "Bretton Woods" has become almost synonymous with the fixed exchange rate system that prevailed from the time of the IMF's establishment until the abandonment of fixed rates in 1973. However, the visionaries at the Bretton Woods conference had broader objectives in mind. As stated in the IMF's Articles of Agreement, they were striving toward a system that would "promote international monetary cooperation," "facilitate the expansion and balanced growth of international trade," and "contribute thereby to the promotion and maintenance of high levels of employment and real income...." They also aimed to "promote exchange stability...maintain orderly exchange arrangements among members and...avoid competitive exchange depreciation." At the same time, they wanted to "assist in the establishment of a multilateral system of payments in respect of current transactions between members and in the elimination of foreign exchange restrictions which hamper the growth of world trade." As these goals suggest, the purpose of "Bretton Woods" was above all to establish a more stable and prosperous world economy, and the role of the IMF, to help promote the preconditions for this. The IMF carries out this role by exercising "firm surveillance" over the policies and performance of member countries, a subject I shall return to shortly.
In considering whether a "new" Bretton Woods is conceivable--or indeed desirable--one must first evaluate how much progress has been made toward the broader goals I enumerated above. Let me begin, therefore, by reviewing the record in two key areas--the expansion and balanced growth of international trade and exchange rate stability--and by discussing how IMF surveillance advances these objectives. I will then offer some thoughts on what the record to date suggests about the possibilities for a "new" Bretton Woods.
The expansion and balanced growth of world trade
So what does the record tell us about the expansion and balanced growth of world trade? There can be no doubt that the expansion of world trade is one of the great success stories of the post-war period and a major contributing factor in world economic growth. During the past quarter century, for example, world trade grew at an average rate of 5 1/2 percent per year, outstripping the 3 1/2 percent rate of growth in world GDP. This rapid expansion of world trade is partly the result of countries' recognition of the benefits of outward-looking economic policies--policies which the Fund strongly supports in its advice and technical assistance to member countries, as well as in the stabilization and reform programs it supports with IMF resources--and policies that now form the core agenda for virtually every country in the world.
In this connection, I would note that current transactions--that is, payments for goods and services--are now fully convertible in 114 countries. This constitutes a major step toward the Bretton Woods goal of eliminating "foreign exchange restrictions which hamper the growth of world trade." Moreover, with more than 60 IMF members having also eliminated controls on capital transactions, international capital movements have become much freer than the founders of the Bretton Woods system had thought possible. This increased capital mobility is, in turn, one of the factors that has sparked one of the most striking developments in the world economy: international financial markets of unprecedented size, speed and agility.
Has world trade also become more balanced? In a number of respects, it undoubtedly has. The five decades since the Bretton Woods conference have witnessed the emergence of a number of important new players in international trade--notably in Asia. Moreover, developing countries as a group now represent a much larger share of world trade than they did in the immediate post-war period. In this connection, I would add that it was the strong growth in 35-40 developing countries, sustained in part by their strong trade performance, that helped cushion the global effects of successive recessions in most industrial countries in 1991-93. In addition, the reintegration of the formerly centrally-planned economies of Eastern Europe and the former Soviet Union into the international economy--though by no means complete--offers the potential for a further broadening of world trade.
Nevertheless, not all countries share fully in the benefits of international trade, especially the poorest. This is a particular concern for Africa. Since the early 1980s, sub-Saharan Africa as a whole has slipped farther behind the rest of the world--and the rest of the developing world--in terms of its share of total world exports. This poor trade performance is part of the explanation why--even if Africa is performing better economically than in the recent past--economic progress is still much too slow to have a significant impact on poverty and to make credible headway toward sustainable growth.
At the same time, it must be recognized that the globalization of the international economy raises the stakes for every participant in the world economy. With the larger amounts of investment capital available to countries that can tap the international financial markets, and with continually improving technology and expanding export markets, globalization offers considerable opportunities to accelerate trade and economic progress throughout the world. However, globalization is not without risks. In particular, policymakers in the emerging market economies that are now able to tap the international capital markets must remain vigilant lest a shift in investor sentiment trigger a destabilizing capital outflow, as occurred in Mexico last year. At the same time, they must remain alert to the complications that large capital inflows can sometimes cause for domestic economic management. There is also the danger that countries that are unable to compete in international capital and goods markets will become marginalized. All of these risks are to be avoided--both for the economic well-being of the countries concerned and for the stability of world economy at large.
Exchange rate stability
How much progress has been made toward the Bretton Woods goal of exchange rate stability? Overall, the floating exchange rate system in effect since 1973 has proven reasonably resilient--it has coped with the oil crises of 1973 and 1979, differences in countries economic cycles in the 1980s and 1990s, and the expansion of the international financial markets in the late 1980s and early 1990s. In addition, within the European Monetary System, increasing monetary and fiscal discipline among participating countries has helped narrow inflation differentials, thereby creating a zone of relative stability in Europe and helping to promote intra-European trade.
Nevertheless, neither the floating rate system in effect among the Group of Seven industrial countries, nor the EMS, has worked as well as many of us would have liked. In particular, neither system has prevented the emergence of currency misalignments--that is, when exchange rates depart from economic fundamentals for relatively long periods or reflect inappropriate or unsustainable economic policies. Although "equilibrium exchange rates" are hard to define precisely, major misalignments can generally be identified. As occurred in the mid-1980s with the overvalued dollar, such misalignments among the world's major currencies can cause serious damage--by misallocating resources, deepening adjustment problems, fueling protectionist pressures, and increasing trade frictions. At times, misalignments have also emerged within the EMS, causing turmoil in exchange markets and undermining the credibility of established parities.
Completing the transition from centrally planned to market economies; seizing the opportunities of globalization, while avoiding the risks of destabilizing capital outflows and the marginalization of the poorest countries; averting exchange rate misalignments among the currencies of industrial countries--these may seem to be a rather disparate group of issues and concerns. But appearances can be deceiving! While these problems differ in their details, their respective solutions are broadly similar: they lie in the pursuit of sound domestic macroeconomic policies and a receptivity to structural reform when needed, which the IMF promotes through its surveillance activities. And it is through the pursuit of such policies that the broader objectives of Bretton Woods can be achieved. Let me explain.
IMF surveillance is based on the conviction that strong and consistent economic policies will lead to a stable system of exchange rates and a growing and prosperous world economy. Toward this end, the IMF holds regular, thorough and frank consultations--once a year, or more often when necessary--with each of its 181 members. These consultations, which cover the full range of fiscal, monetary, exchange rate and structural issues, allow the Fund to provide the entire membership with a candid assessment of each member's economic policies, performance and prospects. The messages that the IMF is conveying to member countries in the course of its surveillance activities are clear: the need to maintain reasonable price stability; the need for fiscal consolidation and structural reform; and the urgency of tackling these difficult tasks now, while the world economic situation and prospects are reasonably favorable. These are also the principles that the IMF promotes through its technical assistance and through the adjustment and reform programs it supports with Fund resources. In addition, the Fund participates in, and contributes to, the surveillance exercise of the G-7 countries, in particular by drawing attention to the economic situation in the rest of the world and its implications for G-7 policies. Let me say a few words about how these broad policy prescriptions apply to the groups of countries I have just mentioned, beginning with Africa.
For African countries, as with every IMF member, the first requirement is to get the economic fundamentals right, beginning with restoring and maintaining financial stability, including relatively stable prices, since there is overwhelming evidence that inflation and growth are inversely related. Fortunately, a growing number of African countries are doing just this. The IMF is seeking to build on the experiences of these more successful countries in the design and implementation of Fund-supported adjustment programs in Africa--of which there are currently about 20.
In this regard, do you know what President Museveni of Uganda answered when I asked him about the secret of his country's remarkable success in macroeconomic stabilization? "First, eliminate inflation! Second, eliminate inflation!" This is a lesson that all countries would do well to learn! Controlling inflation means, of course, that fiscal deficits must be reduced to the point that they can be financed in a non-inflationary way and do not crowd out private sector activity.
The second requirement--which also applies to other countries outside of Africa--is to establish an institutional framework in which investors--both domestic and foreign--have confidence to invest. A key step in this regard is to establish a positive perception of the government's role in the economy. Governments can do this by concentrating on doing a few things well: ensuring law and order, providing reliable public services, and establishing a simple, transparent regulatory system that is equitably enforced.
Experience also shows that to make a decisive difference in the domestic economic climate, policies must be reasonably consistent and achieve a critical mass of reform, thereby convincing economic agents that reform is irreversible. Partial reform may not elicit much response if substantial impediments to economic activity remain in place. That is why the IMF has adopted an increasingly comprehensive approach to economic policy, integrating macroeconomic stabilization with structural reform, and working closely with the World Bank. In some countries, the domestic consensus does not yet permit the pace of reform required to attain this critical mass. In these cases, it is up to national leaders to build the required domestic consensus so that reform can move ahead more decisively.
• Transition economies
Many of the same lessons apply to the countries in transition in Eastern Europe and the former Soviet Union. However, the transition process poses some special challenges, especially since most countries of the former Soviet Union had no history of either market economies or democracy. As in Africa, the Fund stresses that macroeconomic stabilization must be accompanied by structural reforms; in the transition economies, this entails, among other things, privatization, strengthening the banking sector, reform of social insurance systems, new legal frameworks that allow for the enforcement of contracts and other features of market economies, and better targeted social safety nets to protect the most vulnerable segments of society.
Nearly all of the countries in transition are either pursuing economic reform programs supported by Fund resources or are actively considering doing so. The Fund has also greatly expanded its program of technical assistance to these countries, providing hands-on advice in the areas of IMF expertise, including treasury and central bank operations, tax administration and statistics. The results of these efforts are now becoming evident. In those countries that have pursued stabilization and reform with the greatest vigor--including, for example, Albania, the Czech Republic, Poland, Slovakia, Slovenia, the Baltics, and the Kyrgyz Republic--inflation has declined dramatically and growth has resumed.
• Emerging market economies
For the emerging market economies, the first priority must also be to maintain sound domestic macroeconomic policies, as these are the policies that will attract and retain the investor confidence. In the course of its surveillance, the Fund emphasizes that the scope for these countries to depart from traditional macroeconomic policy discipline is now sharply reduced, and that the market can greatly amplify the adverse effects of any policy mistakes. Under no circumstances should the presence of large capital inflows--so often viewed as a sign of market confidence in a country's domestic economic performance--lull governments into relaxing policy discipline!
Second, the Fund encourages countries to enhance their ability to maintain stable long-term capital inflows by accelerating structural reform. Trade liberalization, privatization, and the establishment of transparent regulatory systems, among other measures, help create an environment in which capital inflows can be more readily used for long-term productive investment. Removing impediments to private sector activity in general will widen the channels for absorbing foreign capital and reduce the risks of sudden capital outflows. At the same time, it is critically important to establish solid domestic institutions--especially independent central banks and strong domestic banking systems--that can accommodate tighter fiscal and monetary conditions as the need arises.
• Industrial countries
Let me add a few additional remarks about the particular challenges that face industrial countries. Fortunately, major progress has been made toward achieving reasonable price stability. Inflation rates in nearly all of the industrial countries have converged to their lowest levels in three decades, and countries appear determined to preserve this accomplishment. However, considerably more action is needed in the area of fiscal consolidation.
In many countries, the fiscal problem is largely structural and is partly related to significant increases in social benefit programs. Moreover, unless action is taken, these fiscal problems are likely to intensify as aging populations increase pressure on health and public pension systems. In order not to discourage production and employment, the emphasis will need to be on cutting expenditure in appropriate areas. Moreover, as the scope for minor budgetary cuts is exhausted, governments must reform major programs--including pension programs, public health care systems, subsidy programs, and indexation schemes--in order to reduce fiscal deficits and levels of public debt as a share of GDP. This will not be an easy task, as the European countries striving toward EMU are very much aware. Still I am convinced that a broad EMU is feasible, though this will require intensified efforts in some countries. Indeed, European countries must bear in mind that their adjustment efforts are essential--not only to fulfill Maastricht goals--but, more importantly, to ensure Europe's continued role as a dynamic force in the world economy. From this perspective, fiscal consolidation ought to go much further than the Maastricht criteria require.
Because of the prominence of the dollar, the yen, and European currencies in the world economy, the United States, Japan, and European countries also have special responsibility to help ensure a reasonable degree of exchange rate stability. And because of its mandate "to promote exchange stability," the IMF takes a strong interest in their efforts. What does the IMF advise?
The first step is to identify emerging problems that could lead to imbalances and to make the necessary corrections before such imbalances materialize. This is a major objective of IMF surveillance. Second, when macroeconomic imbalances do occur, the IMF urges countries to correct them as soon as possible in order to reduce the risk of greater market turmoil. When imbalances are allowed to persist, credibility suffers, and stronger action to correct the imbalances is likely to be required in order to demonstrate government resolve. At times, there may be a limited role for exchange market intervention, but only as a temporary signal to markets that they should take a closer look at economic fundamentals. And without policy changes, it may be difficult to convince currency markets that exchange rates are out of line with longer-term fundamentals, or in the case of the EMS currencies, that exchange market pressures should subside.
More fundamentally, however, countries must recognize--and live up to--their international responsibilities. Since the United States has the largest economy and the most important currency, it has a particular responsibility. This includes pursuing a mix of monetary and fiscal policies that promote price stability and enhance domestic savings; it also includes cooperating with other nations in promoting exchange rate stability. However, such obligations are by no means limited to the United States. All countries--especially major industrial ones--must recognize that by helping to ensure that the economic fundamentals are sound in their own countries, they can make a major contribution to improved economic performance in the world economy and thereby to enhanced exchange rate stability.
Structural reforms are also needed. In Japan, further action is needed to strengthen the domestic banking system, and to deregulate the economy and expose it to greater competition in world markets. In Europe, reforms are needed to enable the labor markets to function more smoothly and to reduce structural unemployment. An effective labor market reform that successfully addressed the problem of structural unemployment could help reduce fiscal deficits, as well as enhance the credibility of longer-term plans for fiscal consolidation. This, in turn, could create a "virtuous circle"--where labor market reform contributes to fiscal consolidation, thereby helping to ease interest rates, and where lower interest rates contribute to investment and growth, thereby improving employment prospects. This is feasible and would be one of the surest ways of easing tensions in European currency markets.
Strengthening Fund surveillance
Of course, as I have mentioned, the private financial markets also provide their own form of surveillance. And indeed, the prospect of market discipline can be very beneficial in maintaining the resolve of government policymakers to pursue strict economic policies. However, the discipline exercised by the market is not always smoothly and consistently applied. The IMF, through its surveillance activities, can encourage timely policy adjustments before exchange markets force these adjustments to be made in a far more costly way. Moreover, as the main forum for international monetary cooperation, the IMF endeavors to bring about cooperative solutions to exchange rate problems and global macroeconomic maladjustments.
Particularly in response to the experience with Mexico, the Fund has given considerable attention to the ways in which its surveillance can be strengthened so that emerging problems can be more readily addressed before they become crises. Thus, we are endeavoring to ensure more regular and timely provision of data to the Fund by member countries, intensifying our dialogue with country authorities, and paying greater attention to the soundness of domestic banking systems, to financial flows and their sustainability, to countries where the risks are greater, and to countries where financial market tensions are likely to have spill-over effects. At the same time, we are developing standards to guide members in the provision of economic and financial data to the public, so that markets will be better informed and less prone to surprises.
Toward a "new" Bretton Woods
These reflections bring me back to the question of a "new" Bretton Woods. Despite the considerable changes that have occurred in the international economy since the Bretton Woods conference, I believe that the Bretton Woods goals are as valid today as they were half a century ago. Moreover, since Bretton Woods, considerable progress has been made in achieving them. International trade has expanded; orderly exchange rate arrangements have generally been maintained; and the international economy has prospered. With the now nearly universal membership of the IMF and the institution's extensive expertise, the necessary machinery is in place to facilitate further progress in these directions.
Yes, the framework and the machinery are in place, but the smooth functioning of the international monetary system involves a further requirement: international cooperation. If countries are to deal successfully with the many new challenges confronting the international monetary system--and I firmly believe that it is in all of their interests to do so--they must work for it. In this respect, to the extent that a "new" Bretton Woods is needed, it would be to re-establish the strong sense of purpose and determination that motivated the founders of the Bretton Woods system.
What does this mean? It means that countries must make a greater effort
to understand the economic policies of other countries and that they must
listen to the judgment of others about their own national policies. It
also means that they must take a more enlightened view of their own national
interests, recognizing that it is in their own self-interest to take the
interests of other countries into account. These are the principles that
could rekindle the spirit of Bretton Woods and that the Fund seeks to promote
through its surveillance activities. But there is one further requirement.
Countries must have the leadership to act upon these principles. This is
a hard task indeed, but one that is essential in an increasingly integrated
world economy where a much broader and more exacting view of cooperation