3 International Financial Institutions
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The other type of economic IO that has drawn extensive attention from political
scientists is the IFI. IFIs such as the IMF and the World Bank play a major role in the
world of internationalWnance and money, and we are just beginning to understand
how the interaction of politics and economics works in these institutions. In order to
understand what IFIs do, we need to begin with some insight into the fundamental
strategic problems that they confront. These problems have led many analysts to use
a principal–agent framework to study the IFIs, asking about the relative freedom of
maneuver available to these organizations, given patterns of state interests. As in the
case of trade, this problem is played out in an ongoing battle between rules that
attempt to constrain state behavior and the continual exercise of state power.
And, again as in the case of trade, the empirical evidence shows both that
rules matter and that they have not succeeded in fully defeating power
politics. While the theoretically-informed study of IFIs is newer, and therefore
not as deep, as that of trade institutions, some intriguing insights are emerging.
The IMF and World Bank are known as the Bretton Woods institutions, as they
were created at the end of the Second World War at the Bretton Woods conference.
Initially, the main purpose of the IMF was to oversee the functioning of aWxed
exchange rate regime. In order to make this regime work, the IMF was to organize
short-term support for members that were facing balance-of-payments crises. Over
time, the exchange rate regime fell apart. However, by then the IMF had proven
itself valuable at providing relief for states facingWnancial crises, and has continued
to play the central role in these situations. The World Bank was initially intended to
provide funding for development eVorts, particularly for states too poor reliably to
access the private international capital market. Thus, the Bank funded longer-term
development projects, such as the construction of dams and roads. Over time the
speciWc types of programs funded by the IMF and Bank have tended to converge,
but some distinction remains.
In anyWnancial transaction, institutions need to walk a Wne line between
encouraging the provision of funding that will be beneWcial for both the borrower
and the lender and encouraging moral hazard. Moral hazard is a serious concern in
these transactions. Consider the typical case addressed by the IMF. A country has
fallen into aWnancial crisis, either through poor policy or exogenous shocks. The
governmentWnds itself unable to make good on its commitments to make pay-
ments on its outstanding debt, and the value of its currency is collapsing. If the
roots of the crisis will pass, the provision of temporaryWnancing will beneWt both
the country that receives theWnancing and lenders, who will be likely to recover
more of their assets once the crisis has passed. However, a government that knows
that it will be bailed out of such crises is likely to behave more recklessly, adopting
inappropriate policies and overborrowing. This is the moral hazard dilemma.
666 lisa l. martin