"Certainly, international financial organizations must be reformed to confront new challenges. But that reform should be seen not as a punishment for their mistakes but more as a needed evolution to adapt to the radically different needs arising from the global, internationalized, free-market oriented economy that they help it to create."

Just fifteen years ago no one would have dared to ask the question that the Wall Street Journal proposes as topic for our discussions today. International Financial Organizations used to be taken for granted as a solid component of the global financial landscape and a prominent actor in designing the monetary and financial destinies of much of the world. Today their existence and their relevance is a matter of debate. But I believe that is happening more as a result of their successes than as a consequence of their failures. Let me explain.
International financial organizations were designed as instruments to guarantee the stability and advancement of the market-oriented economy. They were certainly an instrument of economic and financial policy but also—and equally important—a tool of foreign policy for the West.
The Cold War between the capitalist and the communist visions of the economy was won in a substantial part because of the existence of this "strike force" of technocrats traveling around the world preaching, and sometimes prescribing, the benefits of orthodox macroeconomic management, private initiative and free markets to developing and emerging nations.
The existence of the IMF, the World Bank and the IDB guaranteed that inevitable economic crisis did not end up as major catastrophes which could have landed nations on the wrong side of the Berlin Wall. They also encouraged those countries that decided to rescue themselves from the tyranny of centralized and planned economies.
Certainly, international financial organizations must be reformed to confront new challenges. But that reform should be seen not as a punishment for their mistakes but more as a needed evolution to adapt to the radically different needs arising from the global, internationalized, free-market oriented economy that they help it to create.
Some of the functions of international financial organizations are evident: they finance development, they provide emergency relief under acute macroeconomic crisis, and they promote what they believe are reasonable policies. There are other functions that are less obvious but equally essential.
Organizations such as the IMF are an unavoidable point of reference for the international credit and capital markets when establishing the soundness of the economic policies and the degree of risk in a specific country. And, less popular but equally significant, they have the responsibility of inducing the adoption of drastic corrections that a macroeconomic breakdown demands to guarantee the long-term viability of a country and to contain the damage to the global system. Let me try to summarize the changes that I believe should be adopted by international financial organizations with each of the different functions mentioned above.
The traditional function of financing development by lending resources to governments to build physical infrastructure will always be relevant, particularly for projects in which private initiatives cannot be accommodated. But the tremendous emphasis that this activity had in the past must be reduced if the multilateral banks do not want to become obsolete.
And that is because today countries raise funds for basic infrastructure increasingly in the private capital markets or by passing the responsibility of building such projects to private investors. Countries have learned the hard way that the markets and the investors usually make wiser and less costly decisions than those made by government bureaucrats or multilateral bank officials. The role of multilateral banks in financing this kind of project should be limited to providing the leverage required to preserve and widen the space for private capital as well as to guarantee rational and technically sound programs.
On the other hand, the banks must be innovative in what they consider areas eligible for financing. The widespread recognition that human and social capital are as essential as infrastructure to achieve greater rates of growth, should lead the multilateral banks to devote a more significant proportion of their resources to this area.
The IDB and Enrique Iglesias have been leaders in financing non-traditional public investment in areas such as the modernization of the judicial system and the strengthening of democratic institutions. But much more should be done.
Multilateral banks have a kind of "magic touch". Generally, wherever they put money they create a more rational, informed and modern decision-making process. The quality of public policy often increases dramatically when multilateral financing is involved.
That is why, for example, in Latin America, we have good policy planning in the energy sector and very poor public administration in the health care and education sector. This example also supports the argument that the development banks should increasingly finance non-traditional public and social investments. This is not only because in those areas there is little role for the private sector and there are very scarce resources, but also because it is a way to promote badly needed improvement in policy making. An illustration of this idea being put to use is the recently inaugurated IDB center for the training of public officials working in the social sector.
And multilateral banks have to recognize that their clients have changed. They used to lend to governments. Now the driving force of the economy is the private sector. That is why I believe that a greater involvement of these institutions in directly financing the private sector will have a significant impact in promoting development and in consolidating economic reform. A good precedent is what the IFC has done, as has the CAF, the Andean Development Bank.
As was evidently illustrated by the Mexican crisis of late 1994, the scope and possibilities of international financial organizations, as lenders of last resort, has changed dramatically in recent years.
When countries were more or less isolated from the international private credit and capital markets, major balance of payment crises rarely threatened the stability of the global economy. Not any more. The increasing globalization of finance and the fact that private actors in both wealthy and poor countries are investing and financing their capital needs abroad in a scale without precedent, makes the stakes involved in a economic breakdown significantly higher.
This new reality, and the scale of the rescue operations, have pushed industrialized countries to go beyond the traditional IMF-World Bank balance of payments lending and into organizing massive commitments with the participation of countries and non-traditional lenders. Although the urgency of the circumstances under which these arrangements have been made justifies the ad-hoc basis of country-to-country emergency lending, it is certainly not the most efficient way to proceed if similar problems arise in the future.
The international financial organizations should be able to recover and maintain the leadership of an institutionalized methodology to effectively manage future balance of payment crises. Leaving this for countries to solely operate under ad-hoc rules of engagement has tremendous political risks.
The political tolerance to substantial international financial commitments for rescue operations from the part of governments is very thin nowadays. We cannot leave the health of the international financial system on the shoulders of very moody domestic constituencies. The IMF should be able to handle the balance of payment crisis by having as a broader mandate an approved and agreed protocol and--more importantly—counting with discretionary access to an established multilateral facility with a significantly greater funding.
Finally, international financial organizations must acknowledge explicitly the role private markets assign to them as tacit guarantors of the performance of countries. This cuasi-supervisory role is critical in today’s markets as was made evident during the recent Mexican crisis.
Many private actors were surprised by the magnitude of the problem, basically because they perceived an institutional endorsement to what was happening. Those misplaced expectations should have been corrected earlier in a smoother way.
That is why I think that this cuasi-supervisory role of international financial organizations should be institutionally separated from the regular credit operations of international financial organizations. This separation will probably increase the transparency and objectivity of the assessments of economic performance and economic policy in countries who participate in the international capital and credit markets.
To conclude I will say that international financial organizations have been very successful so far but to do so in a radically different political and economic environment, they have to change and change fast.
WALL STREET JOURNAL
CONFERENCE ON THE AMERICAS
New York City, New York, September 28, 1995

"Certainly, international financial organizations must be reformed to confront new challenges. But that reform should be seen not as a punishment for their mistakes but more as a needed evolution to adapt to the radically different needs arising from the global, internationalized, free-market oriented economy that they help it to create."

Just fifteen years ago no one would have dared to ask the question that the Wall Street Journal proposes as topic for our discussions today. International Financial Organizations used to be taken for granted as a solid component of the global financial landscape and a prominent actor in designing the monetary and financial destinies of much of the world. Today their existence and their relevance is a matter of debate. But I believe that is happening more as a result of their successes than as a consequence of their failures. Let me explain.
International financial organizations were designed as instruments to guarantee the stability and advancement of the market-oriented economy. They were certainly an instrument of economic and financial policy but also—and equally important—a tool of foreign policy for the West.
The Cold War between the capitalist and the communist visions of the economy was won in a substantial part because of the existence of this "strike force" of technocrats traveling around the world preaching, and sometimes prescribing, the benefits of orthodox macroeconomic management, private initiative and free markets to developing and emerging nations.
The existence of the IMF, the World Bank and the IDB guaranteed that inevitable economic crisis did not end up as major catastrophes which could have landed nations on the wrong side of the Berlin Wall. They also encouraged those countries that decided to rescue themselves from the tyranny of centralized and planned economies.
Certainly, international financial organizations must be reformed to confront new challenges. But that reform should be seen not as a punishment for their mistakes but more as a needed evolution to adapt to the radically different needs arising from the global, internationalized, free-market oriented economy that they help it to create.
Some of the functions of international financial organizations are evident: they finance development, they provide emergency relief under acute macroeconomic crisis, and they promote what they believe are reasonable policies. There are other functions that are less obvious but equally essential.
Organizations such as the IMF are an unavoidable point of reference for the international credit and capital markets when establishing the soundness of the economic policies and the degree of risk in a specific country. And, less popular but equally significant, they have the responsibility of inducing the adoption of drastic corrections that a macroeconomic breakdown demands to guarantee the long-term viability of a country and to contain the damage to the global system. Let me try to summarize the changes that I believe should be adopted by international financial organizations with each of the different functions mentioned above.
The traditional function of financing development by lending resources to governments to build physical infrastructure will always be relevant, particularly for projects in which private initiatives cannot be accommodated. But the tremendous emphasis that this activity had in the past must be reduced if the multilateral banks do not want to become obsolete.
And that is because today countries raise funds for basic infrastructure increasingly in the private capital markets or by passing the responsibility of building such projects to private investors. Countries have learned the hard way that the markets and the investors usually make wiser and less costly decisions than those made by government bureaucrats or multilateral bank officials. The role of multilateral banks in financing this kind of project should be limited to providing the leverage required to preserve and widen the space for private capital as well as to guarantee rational and technically sound programs.
On the other hand, the banks must be innovative in what they consider areas eligible for financing. The widespread recognition that human and social capital are as essential as infrastructure to achieve greater rates of growth, should lead the multilateral banks to devote a more significant proportion of their resources to this area.
The IDB and Enrique Iglesias have been leaders in financing non-traditional public investment in areas such as the modernization of the judicial system and the strengthening of democratic institutions. But much more should be done.
Multilateral banks have a kind of "magic touch". Generally, wherever they put money they create a more rational, informed and modern decision-making process. The quality of public policy often increases dramatically when multilateral financing is involved.
That is why, for example, in Latin America, we have good policy planning in the energy sector and very poor public administration in the health care and education sector. This example also supports the argument that the development banks should increasingly finance non-traditional public and social investments. This is not only because in those areas there is little role for the private sector and there are very scarce resources, but also because it is a way to promote badly needed improvement in policy making. An illustration of this idea being put to use is the recently inaugurated IDB center for the training of public officials working in the social sector.
And multilateral banks have to recognize that their clients have changed. They used to lend to governments. Now the driving force of the economy is the private sector. That is why I believe that a greater involvement of these institutions in directly financing the private sector will have a significant impact in promoting development and in consolidating economic reform. A good precedent is what the IFC has done, as has the CAF, the Andean Development Bank.
As was evidently illustrated by the Mexican crisis of late 1994, the scope and possibilities of international financial organizations, as lenders of last resort, has changed dramatically in recent years.
When countries were more or less isolated from the international private credit and capital markets, major balance of payment crises rarely threatened the stability of the global economy. Not any more. The increasing globalization of finance and the fact that private actors in both wealthy and poor countries are investing and financing their capital needs abroad in a scale without precedent, makes the stakes involved in a economic breakdown significantly higher.
This new reality, and the scale of the rescue operations, have pushed industrialized countries to go beyond the traditional IMF-World Bank balance of payments lending and into organizing massive commitments with the participation of countries and non-traditional lenders. Although the urgency of the circumstances under which these arrangements have been made justifies the ad-hoc basis of country-to-country emergency lending, it is certainly not the most efficient way to proceed if similar problems arise in the future.
The international financial organizations should be able to recover and maintain the leadership of an institutionalized methodology to effectively manage future balance of payment crises. Leaving this for countries to solely operate under ad-hoc rules of engagement has tremendous political risks.
The political tolerance to substantial international financial commitments for rescue operations from the part of governments is very thin nowadays. We cannot leave the health of the international financial system on the shoulders of very moody domestic constituencies. The IMF should be able to handle the balance of payment crisis by having as a broader mandate an approved and agreed protocol and--more importantly—counting with discretionary access to an established multilateral facility with a significantly greater funding.
Finally, international financial organizations must acknowledge explicitly the role private markets assign to them as tacit guarantors of the performance of countries. This cuasi-supervisory role is critical in today’s markets as was made evident during the recent Mexican crisis.
Many private actors were surprised by the magnitude of the problem, basically because they perceived an institutional endorsement to what was happening. Those misplaced expectations should have been corrected earlier in a smoother way.
That is why I think that this cuasi-supervisory role of international financial organizations should be institutionally separated from the regular credit operations of international financial organizations. This separation will probably increase the transparency and objectivity of the assessments of economic performance and economic policy in countries who participate in the international capital and credit markets.
To conclude I will say that international financial organizations have been very successful so far but to do so in a radically different political and economic environment, they have to change and change fast.