The Role of Bretton Woods Institution in the Restructuring of International Relations in the Post -War Period - Coursework Example

Bretton Woods was established in 1944, representing 44 nations to set standards by which international trade and finance could be conducted once the Second World War was over. Apart from the exchange rate and the payment systems, provision was also made to help the third-world nations that developed in the post-colonial era (O’Hara, n.d.). The primary architects of Bretton Woods were Harry Dexter White and John Maynard Keynes. The initial institutions included the International Bank for Reconstruction and Development (IBRD) and the International Monetary Fund (IMF). Their original rationale does not fit any more and their activities too have been altered as the world economy has grown (Krueger, 1998). Nevertheless, Bretton Woods institution did play a leading role in the restructuring of international relations in the post -war period. Exchange rates in the pre-war period were used to secure competitive advantage in the mercantilist world (Crockett, 1999). Current account payments were subject to severe restrictions. The International Capital Mobility evolved because the Great Depression discredited gold standard orthodoxy and the financial markets became unpopular. The attachment to gold was identified as the causes of economic calamity. Financial products and markets became closely regulated. Maintaining high employment was considered more important than preserving the value of currency (Obstfeld, 1998). The current account payments were to be progressively liberalized. These changed attitudes led to the establishment of the Bretton Woods Institutions. The basic idea with which this institution was promoted was to promote cooperation and humanitarian goals. The two architects had different goals and objectives right from the beginning. While White intended to favor incentives designed to create price stability within the worlds economies, Keynes wanted a system that encouraged economic growth (O’Hara). Hence, even before the plan was launched, there were compromises made from both sides although the final plan was largely American in nature. It was obligatory for each of the member country to adopt a monetary policy that maintained the exchange rate of its currency within a fixed value in terms of gold. IMF would bridge temporary imbalances of payments. The planners at Bretton Woods favored a liberal system relying primarily on the market with the minimum barriers to the flow of private trade and capital. It was believed that the fundamental cause of the two world wars lay in economic discrimination and trade warfare. The intention of the planners was that a liberal international economic system would enhance the process of peace post-war. Governmental intervention was felt necessary even by the developed countries. To ensure economic stability and political peace, states agreed to cooperate to regulate the international economic system (Wikipedia). In the initial years these International Financial Institutions (IFIs) performed well and earned their standing in the international economy. They evolved as they learnt through experience. As their understanding of the underlying issues improved and as the economy grew, their activities and policies too underwent change. The IMF was founded on the premise that it would serve to protect the ‘fixed but adjustable’ exchange rates. This policy would help overcome the drawbacks that had occurred during the Great Depression. Since the private international capital market had been destroyed by the Great Depression, official capital flows were expected to allow efficient allocation of resources to countries with high rate of return on investment and low savings rate (Krueger, 1998). That means it was primarily meant for countries undergoing reconstruction and the low-income countries undergoing development. To meet this perceived need, IBRD was established as a sister concern to IMF. The role of the Bretton Woods Institutions was to regulate the financial markets. Interest ceilings, credit controls and the entry restrictions served to protect the domestic institutions from competition and reduced the incentive for risk taking (Crockett, 1999). These institutions facilitated the rehabilitation of the damaged economies and helped the growth of trade in the post-war era. The industrialized economies could liberalize their trade and payment system and by 1950s had reintroduced the defacto convertibility fro current account payments. With the support of these institutions world trade grew steadily and the exchange rate became stable. Since this was an administered architecture the risks were minimum and the spillover effects from financial problems in one country were minor and could be handled. According to Helleiner (2006) capital controls and the exchange rate adjustments by the Bretton Woods institutions provided greater autonomy for governments to pursue more interventionist domestic policies. The period after World War II were characterized by strategic liberalization within a controlled international environment. The period also enjoyed the highest rates of economic growth and employment (Eatwell & Taylor, 1998). In the 1950s and the 1960s there was change in the attitude. The public sector objectives were typically expressed in terms of growth and employment. The economic performance was considered superior as the fiscal balances displayed low deficits and at times even surpluses. This was because of a high level of interdependence between the public sector and private sector balances. High levels of investment by the private sector supported by commitment to growth and employment by the public sector resulted in healthy fiscal balances. Macroeconomic discipline helped sustained economic growth during the 1950s and the 1960s. If private sector investment is discouraged by absence of public sector support, the result may be recession. Thus, the policies and change in attitudes during the post-war period was necessary to help the economies to grow after the Great Depression. Because of the support by the public sector, confidence in the private sector was sustained. Low level of confidence in the private sector would increase the desire for an opportunity to exit and this could cause both short-term and long-term damage. The fact that defaults on US corporate bonds and US business failures were at an all time low during the 1950s and 1960s demonstrates that the Bretton Woods institutions did contribute to stability during that period of crisis. Britain and France were amongst the first countries to take support in the aftermath of the Suez crisis (Krueger). Argentina and Peru too availed of the Fund programs. The Bretton Woods institutions have been subject to criticism from various quarters. IMFs prime function was to grant hard-currency loans to governments that would otherwise put their economies into recession in order to maintain a fixed rate of exchange. Countries that suffered from protracted balance of payments could realign their currencies subject to IMF approval. Loans were granted at almost the market rates and were payable in three to five years (Krueger). It was expected that IMF could prevent countries from devaluing their currencies but in reality the Bretton Woods Institution became a virtual fixed-exchange rate system. Subsequently IMF started giving funds only when a stabilization program was agreed upon. The conditions imposed by IMF were based on the size of the fiscal deficit, domestic credit and other macroeconomic variables. They even removed ceilings on interest rates. The conditions in lending were not publicly reported. This lack of transparency was a major reason for criticism that IMF faced. Although IMF played a significant role in the fixed but adjustable exchange rate, gradually these rates became rigid and it led to the emergence of the defacto dollar exchange standard. Asymmetric pressure was placed on the deficit and surplus countries although this happened only in the late 1960s (Krueger). IBRD also undertook project lending to developing countries and their terms were commercial or near-commercial (Krueger). These terms made it difficult for the poor countries to borrow which led to the establishment of the International Development Association (IDA) by World Bank (formerly IBRD) to provide soft loans to poor countries. IDA received replenishments from the industrialized nations. Prior to this, the World Bank has also created the International Finance Corporation in 1956. Certain other problems that were perceived were that there was no mechanism to ensure that gold reserves would increase in line with the world economy. The US had emerged after the Second World War with the strongest economy. It experienced rapid industrial growth and capital accumulation. The US had the most to gain from opening the world to trade. It would have a global market for its exports and have unrestricted access to raw materials (Wikipedia). Holding of dollars played a growing role which led to the criticism that the US enjoyed a privilege that it could absorb resources from the rest of the world (Crockett, 1999). Fixed exchange rates could not be sustained for long because of divergent policies pursued by key nations. These divergences began to grow by the late 1960s. The unsustainable trends could be felt by the market participants and they used the financial markets to protect themselves from the consequences. The capital controls were accepted immediately after the war but they did not really enjoy widespread support. The businesses, the public and the policy makers were looking for freedom to undertake cross-border transactions. Capital flows were reflection of divergences in savings and investment preferences. Besides, capital flows were seen as vehicles of technology and managerial know-how transfer. As mentioned above, the US ran large balance-of-payments surpluses until 1950s but as the European economies recovered, the US payments balanced slipped into deficit. Until 1958 this deficit was negligible but then started to rise sharply (O’Hara). This occurred because there was no mechanism in place to deal with chronic payments imbalances. The deficit countries were simply allowed to declare devaluations. The balance of payments can be affected by ‘asymmetric shocks’ hitting a Community country (Maes, 2006). France experienced the two most asymmetric shocks – in the late 1950s and in 1968. The economic situation was volatile and it was living through political uncertainty. Monetary and fiscal policies were lax. In 1958 inflation exceeded 10% and the balance of payments showed a deficit. These caused great concern in all quarters and in 1958 radical measures were taken in devaluing the French Franc by 14.8% and introducing orthodox economic policies. The same shock was repeated in 1968 and this time Italy was also included. Although the French government invoked the safeguard clause and took protectionist measures in 1968 but in 1969 the French Franc was again devalued by 11.1%. This demonstrated the fragility of the Bretton Woods fixed exchange rate system even within the Community (European Economic Community). Nevertheless, as far as the external environment was concerned the Bretton Woods system provided the EEC with a favorable international monetary environment for most of the 1960s (Maes, 2006). Stable exchange rates facilitated the integration process. Helleiner (2006) however maintains that Bretton Woods vision did not ignore the development issues but rather attempted to pioneer a new model for world-wide economic relations. They were never exclusively concerned with the problems of industrialized countries. These institutions embraced a multilateral financial order of stable currencies and current account convertibility. The publicly-controlled international financial institutions supplemented market mechanism by offering short-term balance of payments support and long-term investment capital. Thus it can be seen that under the Bretton Woods institutions international monetary system developed although they did not consider gold standard as a feasible option in the postwar economy. They sought a system of fixed exchange rates. Nations could either revalue or devalue their currencies. The IMF supported in various ways by encouraging international trade and helped the developing nations by lending money at market rates. Capital was controlled but the situation demanded some measure of control to allow economies to evolve from the Great Depression. It had to monitor economic policies and provide technical assistance. Through the institutions the Bretton Woods system helped avoid the recurrence of closed markets and economic warfare. They established procedures which helped minimize conflicts over economic issues. The criticisms against the system may have some base but under the circumstances that prevailed then, control was necessary to support both the developed and the developing nations. The system did extend stability to the post war period by creating an environment conducive to recovery. it encouraged trade and investment, capital flows, confidence in the private sector as it was supported by public sector investment. The Bretton Woods institution played a leading role in the restructuring of international relations in the post -war period. References: Crockett, A., (1999), International Financial Arrangements: Architecture and Plumbing, The Australian Economic Review, vol. 33, no. 2, pp. 109–19 Eatwell, J., & Taylor, L., (1998), International Capital Markets and the Future of Economic Policy, Center for Economic Policy Analysis, 14 Aug 2007 Helleiner, E., (2006), Reinterpreting Bretton Woods: International Development and the Neglected Origins of Embedded Liberalism, Institute of Social Studies, Development and Change 37(5): 943–967 Krueger, A. O., (1998), Whither the World Bank and the IMF? Journal of Economic Literature, Vol. 36 pp. 1983-2020 Maes, I., (2006), THE ASCENT OF THE EUROPEAN COMMISSION AS AN ACTOR IN THE MONETARY INTEGRATION PROCESS IN THE 1 9 6 0 s, Scottish Journal of Political Economy, Vol. 53, No. 2, May 2006 Obstfeld, M., (1998), The Global Capital Market: Benefactor or Menace? The Journal of Economic Perspectives, Vol. 12, No. 4. (Autumn, 1998), pp. 9-30. OHara, P., (n.d.), Bretton Woods System and Post Bretton Woods System, 14 Aug 2007 Wikipedia, Bretton Woods system, 14 Aug 2007 Read More