Tuesday, 18 November 2014

AIIB and NDB - Exit and Voice

With hindsight, 2014 may well be noted as the year when serious competition has been built into multilateral development banking, especially for the World Bank and the Asian Development Bank (ADB). The new BRICS bank, officially called the New Development Bank (to be headquartered in Shanghai), has been launched at the sixth summit of the BRICS countries, held in Brazil in July 2014. The bank will have starting capital of US $50 billion, with Brazil, Russia, India, China and South Africa initially contributing US $10 billion. End October 2014, more than twenty Asian countries (including India and, a month later, Indonesia) signed as founding members a Memorandum of Understanding to create the Beijing-based Asian Infrastructure Investment Bank (AIIB), which specified the authorized capital of the AIIB as US $ 50 billion, half of which is paid in by China. Both new institutions are intended to concentrate on funding infrastructure projects.
The recalibration of the world economy (OECD 2010; Quah 2011) - with the centre of gravity shifting toward East Asia – is still not reflected in the executive councils of the multilateral development banks. The current imbalance of capital shares and voting rights in the existing multilateral banking system to the detriment of emerging market and developing countries (EMDCs) is well documented by Vestergaard and Wade (2014) who also show that the scope and pace of governance reforms have been dismal in the established international financial institutions (IFIs). Moreover, the EMDCs can have little hope that the advanced countries relinquish their control on the Asian Development Bank and the World Bank in particular through meaningful voice reform (Vestergaard und Wade 2013).  
The more imbalanced the system is in terms of representation and voice, the higher the pressure to rebalance toward fairer representation through creating institutions parallel to the established multilateral banks. The creation of AIIB and NDB corresponds to exit in Hirschman´s antinomy (Hirschman, 1970). Both exit and voice carry cost. The cost of exit is fragmented multilateralism. The cost of voice in an imbalanced system is the incapacity to influence priorities, principles and procedures in multilateral development lending. As the BRICS nations succeed to organise shadow institutions to the established Bretton Woods system, the value of EMDCs´ exit option may make voice in the established system relatively less attractive, even though it will probably increase the effectiveness of voice. Voice and exit are complements once exit has been organised (by creating new shadow institutions), but are substitutes when seen from the perspective of the initial decision to exercise voice or to organise exit (Gehlbach 2006: 402). Hirschman´s concept of loyalty by a country to the established system (say, to safeguard military protection by the United States) is reflected in a greater cost of exit. That explains why some Asian countries failed to join the AIIB after intense pressure from the US Treasury.
Gehlbach, S. (2006), “A Formal Model of Exit and Voice”, Rationality and Society, 18(4), 395–418. DOI: 10.1177/1043463106070280.
Hirschman, A.O. (1970), Exit, Voice, and Loyalty: Responses to Decline in Firms, Organizations, and States, Cambridge, MA: Harvard University Press.
OECD (2010), Shifting Wealth, Perspectives on Global Development, Paris: OECD.
Quah, D. (2011), “The Global Economy’s Shifting Centre of Gravity”, Global Policy, 2.1, 3-9 DOI: 10.1111/j.1758-5899.2010.00066.x
Vestergaard, J., and Wade R. H.  (2013), “Protecting Power: How Western States Retain the Dominant Voice in The World Bank’s Governance”, World Development, 46, 153-164.
Vestergaard, J., and Wade R. H.  (2014), “Still in the Woods: Gridlock in the IMF and the World Bank Puts Multilateralism at Risk”, Global Policy, DOI: 10.1111/1758-5899.12178.


Thursday, 30 October 2014

AIIB, NDB and the enforcement mechanism of the Bretton-Woods System

The new BRICS bank, officially called the New Development Bank (NDB, to be headquartered in Shanghai and first to be run by an Indian), has been launched at the sixth summit of the BRICS countries, held in Brazil in July 2014. I hear that it is making relatively slow process. So China has been pursuing recently the creation of yet another multilateral development bank (China-led), the Asian Infrastructure Investment Bank (AIIB), with registered capital planned at $100bn initially double the size of the BRICS bank. By end October 2014, 21 Asian countries – including India – had signed the Memorandum of Understanding on Establishing AIIB. AIIB will be formally established by the end of 2015 and headquartered in Beijing.

The establishment of BRICS-led multilateral development banks (such as the BRICS bank or the AIIB) will be beneficial for global development to the extent that it helps close infrastructure financing gaps and that it helps rebalance representation of the non-OECD countries on the multilateral scene that remains very much US-scripted. The new banks may even speed up ´voice reform´ in the Bretton-Woods institutions – so far effectively hindered despite all rhetoric by the West[1]. However, their very existence makes that reform now less important than in the past when the established MDBs (World Bank, ADB, AfDB, IDB) were the only important sources of infrastructure finance for many poor countries.

In a broader setting, the establishment of multilateral development banks outside the established Bretton-Woods system can be viewed as China´s shadow global diplomacy[2] that aims at undermining US-led governance structures established after WWII. Competition is building for the existing Bretton-Woods system.

So it does not come as a surprise that the US lobbying against those banks.[3] Jane Perlez (2014) cites a senior Obama administration official: the Treasury Department had concluded that the new bank (here the AIIB) would fail to meet environmental standards, procurement requirements and other safeguards adopted by the World Bank and the ADB, including protections intended to prevent the forced removal of vulnerable populations from their lands. By contrast, the ADB has become so encumbered with restrictions that it now takes up to seven years on average for a project to go from proposal to approval to completion, the official said. Consequently, a shift of multilateral lending toward would not only speed up ´voice reform´ but also the financing and building of infrastructure, possibly (not necessarily) at costs for the environment and habitats.

Another concern, not publicly discussed yet to my knowledge, is that the establishment of alternative source of multilateral funding will act to weaken the enforcement mechanism of the existing MDBs. They might as well lose their preferred creditor status[4]. Willem Buiter and Steven Fries (2002) had discussed this after the EBRD had been created: A basic mechanism for fostering compliance with the terms and conditions of MDB loans to the public sector involves the dynamic incentives that arise from the repeated interaction between borrowing governments and the MDBs[5]. The potential for repeated loans, together with the credible threat to cut off future lending when terms and conditions are not met, can be exploited to help ensure borrower compliance. The incentive mechanism arising from repeated interactions is more effective when borrowers face limited access to alternative sources of financing. Therefore, it must indeed be envisaged that the incentive for borrowing countries to comply with the terms and conditions of, say, IDA loans will diminish as the end of the lending relationship nears and is replaced by loans from the AIIB or the BRICS bank.

[1] Vestergaard, J. and R. H. Wade (2013), “Protecting Power: How Western States Retain the Dominant Voice in The World Bank’s Governance”, World Development, Volume 46, June, pp. 153-164.
[2] Rudolf, M., M. Huotari und J. Buckow (2014), „Chinas Schatten-Außenpolitik: Parallelstrukturen fordern die internationale Ordnung heraus“, MERICS China Monitor No. 19, Berlin, 23. September.
[3] Jane Perlez (2014), „U.S. Opposing China’s Answer to World Bank”, The New York Times, 9th October.
[4] The term means that the obligations to MDBs by both sovereign borrowers and private entities have a priority claim and treated as senior to those of bilateral and commercial creditors.
[5]  Buiter, W. and S. Fries (2002), „What Should the Multilateral Development Banks Do?”, EBRD Working Paper No. 74, European Bank for Reconstruction and Development, London, June.

Thursday, 23 October 2014

IS/LM in the Eurozone and Germany´s surplus

The title is a reference to Lance Taylor´s seminal “IS/LM in the Tropics”[1] , the diagrammatic tool stems from Jeffrey Frankel´s paper on optimal sterilization policies in emerging countries, a debate to which I contributed almost a quarter of a century ago[2]. However, quite exceptionally for this blog, this entry is neither on the tropics nor on emerging countries. It is on the dismal zone, better known as Eurozone. The model will illustrate Bundesbank boss Jens Weidmann´s cynical statement about the Euro borrowed from Fisherman´s Friends drops and applied to the Euro: “Ist er zu stark, bist Du zu schwach”[3].

Germany has maintained a large surplus on the current account of its balance of payments – oscillating between six and eight percent of GDP in recent years - although the Eurozone outside Germany weakened, China´s merchandise imports stagnated and other large emerging markets (Russia, Brazil) were in trouble. As demonstrated by Patrick Artus´ team at Natixis Economic Research, the German surplus can be explained neither by a drop in its domestic demand (as is often done) nor by improved terms of trade. It is largely due to improved market shares and trade balances with the United States, Japan, non-euro-zone Europe and China, which has offset the deterioration in its trade position in the euro zone. As will be shown below, Germany´s hyper competitiveness slows down the depreciation of the Euro, required by the rest of the Eurozone to make it a bit less dismal.

IS/LM in the Eurozone

The Eurozone is illustrated by the familiar textbook macroeconomic general-equilibrium model, with the IS, LM, and BP curves denoting goods market, money market and balance of payments equilibrium, respectively. Demand for output Y is shown on the horizontal axis, with the price level predetermined in the short run. A move to the right on the y-axis thus denotes only employment gains (and no inflationary pressure), a move to the left employment losses. Y is the sum of domestic aggregate demand and the trade balance (net foreign demand for domestic output). The interest rate i is presented on the vertical axis; as the Eurozone has open capital markets, the interest rate i is equal to i*, the international rate. The overall balance of payments, BP, the sum of the trade balance and the capital account, is horizontal: the capital account rules, the current account follows, and a rise in i above i* sucks in infinite capital inflows (as long as the Eurozone is still ´investible´).
Germany´s surplus is so huge that it translates into a surplus of the Eurozone. The IS curve shifts to the right as the trade balance improves, putting upward pressure on the interest rate and therefore on the capital account. As the Euro is a flexible currency (outside the Eurozone), money inflows (not trade) will appreciate the Euro. In the model, the currency will appreciate far enough to return the trade balance, the IS curve, and domestic aggregate demand back to point A. In plain words, Germany´s improved trade balance has to be ´paid´ by even more depressed demand in the rest of the Eurozone. Maybe, Jens Weidmann should have said: “Is Germany too strong, it should abstain from using the Euro”?

[1] Lance Taylor (1981), „IS/LM in the Tropics: Diagrammatics of the New Structuralist Macro Critique”, Economic Stabilization in Developing Countries, Vol 502, Brookings Institution, Washington DC.
[2] Jeffrey Frankel (1997), „Sterilization of Money Inflows: Difficult (Calvo) or Easy (Reisen)?“, Estudios de Economía, Vol. 24.2, December, pp. 263-285.
[3] Interview Jens Weidmann „Ist er zu stark, bist Du zu schwach“,  in Süddeutsche Zeitung, 22.5.2014; see http://www.bundesbank.de/Redaktion/DE/Interviews/2014_05_22_weidmann_sz.html