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The Bretton-Woods Institutions and the BRICS Bank: an institutionalist
explanation for the creation of a new financial institution
Feliciano de SáGuimarães
Assistant Professor
Institute of International Relations
University of São Paulo, Brazil
Abstract: Did the lack of reform ofthe Bretton-Woods institutions have any
influence on the creation of a new international financial institution - the BRICS
Bank? In this paper wediscuss how the lack of quota reform of the IMF and the
World Bank has created strong incentives for unsatisfied developing countries, such
as BRICS countries, that they bypass these institutions and design a new financial
institution. This new institution mimics the responsibilities of both the IMF and the
World Bank, but with a more equal power distribution (quotas shares) among its
new members. Theoretically, we designed a model that explains the reasons behind
the BRICS Bank creation.Methodologically, we used qualitative instrumentsto
understand the circumstances behind the creation of a new international financial
institution. Our dependent variable is BRICS Bank creation. The independent
variables are exogenous shocks (redistribution of economic power and financial
crisis) and internal problems of Bretton-Woods institutions.
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Introduction
In this paper we aim to explain why the BRICS Bank institutions, Contingent
Reserve Arrangement (CRA) and New Development Bank (NDB), were created. We
provide an institutionalist explanation based on the strategic decisions using
institutional change and institutional making theories. Our hypothesis is that the
sum of powerful exogenous shocks and endogenous institutional problems has
created the opportunity for making new institutions. The paper is divided in three
parts. First, we develop our theoretical argument for the BRICS Bank creation.
Second, we discuss the endogenous shocks and endogenous problems of the
Bretton-Woods institutions. Finally, we discuss the chain of events that lead to the
creation of both the CRA and the NDB.
1. The argument
The study of international organizations is an important research area in the
field of international relations. Traditionally, researchers have sought to explain
why states establish international organizations (Keohane 1984; Abbott and Snidal
1998) and how they design international organizations (Koremenos et al. 2001).
Less attention has been devoted to the question of how international organizations
evolve or change after they have been founded(Van de Graaf and Lesage
2009,Barnett and Coleman 2005, Barnett and Finnemore2004). More importantly,
no attention has been given to the unintended consequences of the lack of
institutional change in international organizations. There are no studies to our
knowledge that explain the effects of not reforming institutions.How will unsatisfied
states with the status quo react to the situation of institutional inertia? In this paper
we argue that the absence of institutional reforms at the Bretton Woods institutions
increased the chances of new institutional making by BRICS states. Empirically, we
show this process using the example of the BRICS Bank creation.
Theories of institutional change aim to understand how
institutionstransform through exogenous and endogenous mechanisms (Greif and
Laitin 2004; Ostrom 2005) and in turn, theories of institutional making understand
institutional creation as a result of market failures(Keohane 1984; Axelrod and
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Keohane 1985). The BRICS Bank case does not fit entirely ineither ofthetwo groups.
Although market failures can be an important reason for the BRICS Bank creation, it
does not answer completely its constitution.A more complete view needs to
incorporate aspects not entirely understood by institutional change approach,the
unintended consequences of lack of reforms. In this sense, we have found no studies
that directly accountforthe effects of insufficientinstitutional change overnew
institutional making.
There are two types of studies that are somewhat similar to our approach:
nested institutions studies and strategic institutional alternatives studies. The first
one tries to explain how nested and parallel institutions are createdby states
(Aggarwal 1998; Abbott and Snidal 2006). However, these nested institutions are
usually created by the same states that had created the original institutions;so
nested institution studies do not face the problem of effects of institutional inertia
on the performance of rising powers or unsatisfied countries. The second group of
studies tries to move beyond traditional theories that implicitly focus on a single
(optimal) institution toemphasize the potentially rich range of institutional
alternatives available to states. That is, states can accomplish their goalsstrategically
choosing, reforming or creating institutions around the issue area (Jupille and Snidal
2006).Nonetheless, once more creating new institutionsis an exclusive alternative of
dominant powers and creation by developing countries is not the center of the
analysis. We argue that none of these two groups triesto answer why non-reforming
institutions create incentives for rising powers to create new institutions.
The literature points out two actors that can promotesuch variation and
institutional change, states and bureaucracies(Sweet et al 2001, Goldstein et al
2000, Haftel and Thompson 2006, Shanks et al. 1996). The first wave of studies of
IOs detailed their internal characteristics and how states mattered most in the
process of institutional reform (Cox and Jacobson 1974). Also Realism claims that
any change in the mandate or design of IOs owes to demands imposed by Great
Powers (Mearsheimer1995), andneoliberal institutionalism emphasizes howstates
design IOs assigning them various functions in order to overcome problemsof
collaboration and coordination. As a result, any change must be initiated and
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conducted by states,although it recognizes that institutions are resilient(Keohane
1984,Keohane and Martin 1995). A secondview ofinstitutional change does not
recognizestates as the only actors capable of reforming institutional settings;
bureaucracies also play their role. More recently, some authors show that
bureaucrats seek to expand their responsibilities and political power through a
series of incremental changes, sometimes acting against states interests(Guimarães
2012; Barnett and Coleman 2005; Weaver 2008; Hawkins et al 2006). None of these
studies, however, try to understand institutional change or creation by the sole
perspective of rising powers trapped in organizations that do not adjust according
to their interests.
It is important to know how institutions are created in order to understand
how they change. According to institutionalist theory, states create institutions in
anticipation of the cooperation gains they will be able to achieve in the future. When
states are involved in situations of market failures where the outcomes of their
interactions are suboptimal- given the utility function at their disposal - then in
order to overcome these situations states build institutional settings in which
pareto-optimal results can be eventually achieved.However, creating institutions is
costly and risky for states since they are not certain of the future gains of
cooperation (Keohane 1984).
If creating new organizations is always costly and risky, then an alternative is
institutional maintenance which entails costs over the years that are generally lower
than those involved in creating new institutions. Only severe newcircumstances,
such as shifts in the distribution of power or the appearance of cooperation
problems, are likely to alter the original cost/benefit relationship of institutional
maintenance. Yet if the marginal costs of maintaining an existing institution
outweigh the costs of creating an entirely new set of: norms, rules, and procedures;
states will choose to sustain existing arrangements rather than abandon them. In
sum, for institutionalist theory the hypothesis of institutional variation and change
are related to transaction costs and distributional consequences perpetrated by
states actions (Keohane 1984,Wallander 2000).
Reform is never easy in institutional settings. The consequences of adopting
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new rules are often hard to predict,even if actors could modifyrules easily they may
hesitate due to uncertainty (Hall 2010). If change is going to negatively affect gains,
players may prefer the status quo, despite the necessity of change. Since institutions
are impregnated by tensions because they inevitably raise resources, considerations
and distributional effects,then changingthe rules means choosing between losers
and winners in a scenario of uncertainty. If organizationsare costly to construct and
modify, and those who design them are often risk-averse, we cannot expect
institutions to change smoothly in response to structural variables. Therefore, sunk
costs and risk-aversion behavior account for institutional inertia(Keohane and
Martin, 2003).
Nevertheless, change occurs under a few conditions. The literature shows
three reasons for change: external shocks, inefficient outcomes and internal
coordination problems(Barnett and Coleman 2005; Aoki 2007; Greif and Laitin
2004; Ostrom 2005; Kingston and Caballero 2009, Stein 1983).First, institutions can
be changed by exogenous shocks that shift the internal equilibrium between
members. When a shift in balance of power allows rising states to question the
status quo, thensome members start to perceive the cost/benefit relationship of the
current equilibrium as negative and, consequently, start demanding internal
changes. Second, inefficient outcomes can also prompt change; for example,
thelowefficiency of policiesbystatus quo institutions are taken in consideration not
only by countries directly affected by these policies, but also by countries that
designed them, whether they are dominant or rising powers.However, the
incapacity of rising powers to modify inefficient policiesdue to excessive control of
traditional powersover the decision making process can create incentives for these
countries to push for reforms where their policies views can become
predominant.Thirdly, endogenous changes are usually related to iteratedgames
within the institution that affects some of the members negatively. Unsatisfied
members start to perceive that status quo rules are not as favoring as before and
that dominant powers repeatedly reap the benefits.This represents a coordination
problem that forces unsatisfied members to callfor internal reform.
Exogenous shocks are indeed necessary for change, but the lack of internal
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reforming iskey to our argument. We aim to understand what happens if internal
reforms are non-existent despite mounting exogenous shocks, policies inefficiency,
and internal coordination problems.How will unsatisfied states react to situations in
which the absence of internal change impedes them to obtain gains from
cooperation?The literature shows that internal reforming can happen either by
removing the existing rules and introducing new ones or by introducing new ones
on the top of the existing rules (Mahoney and Thelen 2010).Ifneither of these
processes is taking place, or if reforms are perceived by new rising powers as
dramatically slow, the gap between unsatisfied countries perception and status quo
institutions performanceincreases over the years, creating powerful incentives for
new institutional making.
We argue that if existinginstitutions do not change in a way that favors rising
powers, these countries may eventually become unsatisfied to a point of
cooperation breakdown. Such situations tend to wind down the costs of creating a
new institution, outweighing the costs of status quo maintenance. When creating a
new organization becomes less expensive than institutional maintenance
unsatisfied states would seek for alternatives. These alternatives can be either
exiting currentinstitutions - a risky strategy that very few countries would be able
or willing to incur - or creating a more favorable parallel organization. In sum, we
argue that if (1) the relative costs of potential alternative strategies is lower than
pushing for internal reforms, and the (2) internal governance problems represent
insuperable obstacles to cooperation and future gains, it is likely that unsatisfied
and capable states will seek for a different equilibrium in other institutional settings
without defecting from the current ones.
Additionally, institutional inertia aggravates distributional problems in the
international system, especially for rising powers. Dominant powers are responsible
for the provision of public goods in an international system without sanctioning,
andas a result, they design institutions that produce the form of order they prefer.
Other actors may prefer different institutions, exacerbating distributional problems
(Morrow 1994);however, dominant powers can include the interests of rising
power through a process of reforming that contemplates gains for the new comers,
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if the inclusion is non-existent,the perception of rising powers reveals cooperation
as more beneficial to dominant powers. Furthermore, the inefficiency of policies
designed by institutions in which rising powers have less influencealso
reinforcesthe perception of dissatisfaction, so unsatisfied actors preferring for
alternative solutions is a byproduct of iterated problems of cooperation within the
dominant institutions.
Then again, institutional inertia does not respond alone to new institutional
making,exogenous shocks have a key role as well. As environmental changes
associated with financial crisis empowers new countries and reduces the capacity of
dominant powers to control the decision-making process, unsatisfied countries
startto increase the internal pressure for change. As a result, balance of power
changes and market failures are also responsible for creating opportunities for new
institutional making. For instance, market failures have increased in the last
financial crisis and status quo institutions were not capable of solving the situation
alone. With a financial system almost collapsing it was clear that the
currentorganizations were insufficient and flawed to deal with this enormous
task.Hence, exogenous shocks have the capacity of changing the power equilibrium
that keep developing and developed countries together within certain institutions,
but it is the internal decisions for change or inertia that prompts or not new
institutional making.
Institutionalist arguments are built using counterfactuals. Our two key
variables are exogenous shocks and endogenous reform. Applying these variable to
the case of Bretton-Woods/BRICS Bank we argue that if exogenous shocks had
never existed, and internal reforms were still demanded by unsatisfied countries, it
would be unlikely that new institutional making would have happen. The status quo
institutions would continue to be the sole responsible for dealing with financial
governance in the international system due to the incapacity of developing
countries to create new organizations since their power did not raise accordingly.
On the other hand, if exogenous shocks had been followed by internal reforms or if
internal problems had never existed, it would be unlikely that Bretton-Woods
institutions would face the birth of a rival organization. The internal reforming
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process would include the interests of rising powers and securethem gains from
future cooperation.
We claimthat only the sum of powerful exogenous shocks and internal
governance problems dramatically decreasedthe costs of new institutional making.
If exogenous shocks are a necessary condition, the lack of institutional reform is a
sufficient conditionfor the creation of a new institution. The separated existence of
internal problems and exogenous shocks wouldhardly promote new organizations
in the financial area. This is the reason why the creation of global financial
institutions is such a rare event.
As we said before, creating new institutions is costly and risky. These general
factors reinforce the status quo bias of institutional choice. All other things being
equal, using the current institutionis the most commonly pursued strategy by any
country, selection among institutional alternatives the next most common, and
change and creation least common (Jupille and Snidal 2006). However, the financial
area is one of the few areas in international relations where there are almost no
institutional alternatives for rising powers. The regional banks are geographically
closed out to new global powers. If rising powers suffer serious macroeconomic or
developmental problems, there are only a handful of institutional choices available.
We show that exogenous shocks and institutional inertia only exacerbate the
necessity of institutional making.
One possible consequence of new institutional making is
unsatisfiedcountries pushing harder for internal reforms at Bretton-Woods
institutions after the inception of a new organization.BRICS countries do not aspire
for a new world order that competes with the status quoreshaping it is their overall
strategy (Abdenur, Esteves and Gama 2014). More importantly, the existence of an
institutional alternative empowers their claim for internal reforms at status quo
institutions because it creates margin of maneuver in the case of rejection. It is likely
thatthe decline in prestige and legitimacy of Bretton-Woods institutions following
the creation of BRICS Bank will put dominant powers in a position of reestablishing
the status quo by advancing reforms that had been denied before.
Based on this discussion, we suggest that the creation of the BRICS Bank has
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followedthe causal pathway below:
1. Redistribution of economic power in the international system, favoring
BRICS countries.
2. A financial crisis boosting the claim of rising powers for reforms in favorable
terms.
3. Status quo policies perceived by rising powers as inefficient.
4. Internal reforms of current institutions evolving slowly or inexistent due to
excessive control of traditional powers over the decision-making process.
5. New institutional making to overcome lack of reforms of status quo
institutions.
6. The existence of a new financial institution boosts even further the claims of
rising powers to deeper reforms of status quo institutions.
Decision-tree for BRICS countries
Cooperate?
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No Yes Unilateralism Use institution? No Yes Bilateralism Reform institution? No Yes Defect? Positive institutionalized cooperation
No Yes Create new institution?Unilateralism or bilateralism No Yes Negative institutionalized cooperation New institutional making
2.The exogenous and endogenous forces operating at the Bretton-
Woods institutions:
Exogenous shocks are the starting point of our argument. Powerful external
shocks triggered unsatisfied countries to seek for internal reforms within the IMF
and the World Bank, and more recently to look for institutional alternatives. These
shocks are related to two main factors: the 2008 global economic crisis and the
recent economic performance of BRICS countries.
Analysts and observers have predicted a relative decline in American power
and a return to a multipolar world economy1. The common scenario emerging is one
of decreased U.S. power and increased power for newly emerging powers. Whether
1World Bank Global Development Horizons 2011 Multipolarity: The New Global Economy.
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it is just a cycle and or a steady trend is something yet to be determined.However,
the real question is what emerging economies will de facto emerge and what will be
their responsibilities in the global system.A group that is becoming the most
prominent to fulfill these needs is the BRICS countries.
In 2003 the investment firm Goldman Sachs issued a research report that
coined an acronym: the “BRICs economies,” or Brazil, Russia, India, and China. At the
time of writing, the four large emerging economies collectively represented around
15 percent of the gross national product (GNP) of the six major advanced industrial
economies: the United States, Japan, Germany, France, Britain and Italy. However,
the prediction showed that BRICs would become in 30 years the world’s main
“engine of new demand growth and spending power”2.From a group of emerging
economies put together by Goldman Sachs, they went on to become one of the few
economies during the economic recession that had showed positive results.The
literature talks about “power shifts” from developed countries, mainly the G-7, to
BRICs countries over the next decades (Armijo 2007, Armijo and Roberts 2014,
Brustchand Pappa 2013, Cheng et al 2007, Griffith-Jones 2014, Abdenur, Esteves
and Gama 2014, Ban and Blyth 2013).
The economic crisis of 2008 only exacerbated the performance gap between
the G-7 and BRICS. The collapse of US financial services firm Lehman Brothers in
September 2008 brought the crisis, exposing vulnerabilities across the financial
sector. The first wave of effects spread across countries that had opened up their
financial systems to global banking. Countries like Portugal, Iceland, Spain, Italy,
Ukraine started to go into economic turmoil. The second wave hit developing
countries. At first glance BRICs countries economies stood still. After years of rapid
growth the 2008 financial crisis seemed to be the last moment of BRICs economic
success. However, as the events passed BRICS economies were performing better
than G-7 economies in several indicators (Woods 2010, Gaddy and Ickes 2010). So it
is fair to say that the 2008 financial crisis speeded up the rising of BRICS countries
in the economic area.
2O’Neill, Wilson and Purushothaman, Dreaming with the BRICS: the path to 2050. Goldman Sachs Report 2003.
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Yet, exogenous pressures do not account entirely for the BRICS Bank
creation. As we said before, while exogenous shocks are obviously important, they
are not a sufficient condition to our argument. Endogenous problems are the
necessary condition for new institutional making. In this sense, the IMF and World
Bank reforms can be considered one of the most challenging and intricatedisputes in
the international governance structure. Changing quotas systems entails clear losers
and winners. If China’s quotas are increased from the current 3.81% to 6% (2008
proposal) somecountries will have their quotas necessarily decreased by a
comparable margin. This is not clear in other institutional settings. For example, if
Brazil gains a permanent seat at the UN Security Council, France or the United
Kingdom will not necessarily loose power, or at least they will not be certain by how
much exactly they are losing it. Quota is a fixed number that makes changes more
complicate and defeats clearer.
Reforms at the IMF and the World Bank quota system have different timings
and implications, but they have been historically connected. Yet, while reforming the
IMF can be considered the cornerstone of the international financial governance,
reforming the World Bank receives less attention both from the academia and the
media. Actually, changes at the IMF quotas will almost automatically promote
changes at the World Bank since they are usually approved together at
theIMF/World Bank Annual Meetings. An analysis of literature on the IMF and
World Bank reforms will show that countries dispute quotas shares more fiercely at
the IMF than the World Bank. So the IMF dispute represents the true quest for
financial power in the international system3.
The history of IMF/World Bank quota systemreform is long and
controversial. Since their foundation quotas had been changed to accommodate just
a handful of rising countries, such as Japan and Saudi Arabia, leaving behind several
important candidates (Boughton2001, De Vries 1986). Theoretically, every country
should have a quota share somewhat related to the size of its GDP. However, after a
3The literature on IMF/World Bank reforms is vast. See Buira 2002 and 2003, Bird and Rowlands 2006, Bryant 2008, Truman 2014, Woods 2000 and 2010, Vestergaard2011, Vestergaard and Wade 2012 and 2014, Virmani2012.
13
couple decades a series of developing countries became seriously underrepresented
despite their GDP advances. For example, China currently holds 3.81% of the
shares;a number calculated when China had half of today’s GDP. In 2010, the
proposal of quotas adjustment recommends that China quotas should be increased
to 6.07%, a number still below its GDP in 2014.As we will see below, this proposal is
still pending. Currently, the US holds 16,75% of the voting shares, the five biggest
European economies (Germany, France, UK, Italy, and Spain) hold 19,18%, and
BRICS only 11,03%, bearing in mind that BRICS represent nowadays 25,5% of
world’s GDP while Europe only 15,31%.
More recently, two rounds of reforms took placeat the Annual Meetings.
First, in Singapore March 2006 it was agreed that the most underrepresented
countries were to be given an immediate increase in their quotas(China, Korea,
Mexico and Turkey). Four other reforms were endorsed in March 2008 and
constitute the second round of reforms. These were: a new quota formula4; a second
round of ad hoc quota increases based on the new formula; a increase of basic
votes5;and an increase in the representation of African Countries on the Executive
Board (Woods 2010).
In April 2008, the IMF’s Board of Governors announced ‘far-reaching
reforms’ aimed at rebuilding its ‘credibility and legitimacy’. The reforms taken
together have had an overall shift of 5.4% of voting power in the IMF including
increases in quota shares for Korea (+106%), Singapore (+63%), Turkey (+51%),
China (+50%), India (+40%), Brazil (+40%) and Mexico (+40%). Some
industrialized countries were prepared to forgo a part of the quota increase for
which they were eligible, including Germany, Ireland, Italy, Japan, Luxembourg and
the United States (Woods 2010). In the midst of an enormous economic crisis G-7
countries implemented none of these changes and nothing went into effect.
In 2009G20 leaders agreed to reform the governance of the IMF and the
World Bank once again. They committed themselves to push for a shift of at least
4The formula determines a country’s economic size thereby its voting power and access to resources in the IMF. 5Minimum votes share for every country.
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5% of voting power from developed to developing countries in the IMF and at least
3% in the World Bank. These proposals were sent to the respective Executive
Boards. In Seoul 2010 the executive boards of both organizations agreed to even
greater changes than the G20 leaders called for. They also agreed that countries’
share of world GDP should be the primary criterion for countries’ share of
votes(Vestergaard and Wade 2014).
The 2010 Seoul package of IMF quota and governance reforms had three
major elements: (1) Doubling IMF quotas, with a corresponding reduction in the
size of commitments to the New Arrangements to Borrow (NAB) for some countries,
mainly the United States, and a reallocation of quota and voting shares in the IMF,
especially towards developing countries. (2) An amendment to provide an all-
elected executive board6. (3) An understanding that the “advanced” European
countries would reduce their representation on the 24-person executive board from
the current eight or nine seats by two seats7.
More importantly, changes in quotas shares proposed in the package meant
decreasing participation of countries like the USA (-0,28%), United Kingdom and
France (-0,27), Germany (-0,50%) and Japan (-0,10%), while countries like China
would increase their shares by 2.26% and Brazil by 0,5%. In the years following the
2010 announcements, however, changes have been much more modest, and some
are even going in the opposite direction. In both organizations developed countries
have increasedtheir voting power relative to GDP. The current voting shares (early
2014) of developing countries are significantly lower than what was agreed in 2010
- 3.11% lower in the Bank, and 2.54% lower in the Fund (Truman 2014,
Vestergaardand Wade 2014).
For Vestergaard and Wade (2014), the notion of relative country economic
weight is at the core of the stalemate. The default position for most countries
6Currently, the five IMF members with the largest quotas are entitled to appoint an executive director: the United States, Japan, Germany, France, and the United Kingdom. Nineteen persons are elected every two years to fill the remaining seats. The voting power of China, Russia, and Saudi Arabia is sufficient to allow each of those countries to elect their own executive directors. The remaining 16 seats are formally contested, but the outcome is normally pre-negotiated (TRUMAN 2014). 7See G-20 Summit Seoul Declaration, October 2010, Paragraph 5.
15
remains ‘share of world GDP’, mainly because of its simplicity. But the Europeans
insist that integration with the world economy must have great weight in the
formula, along with GDP. Europeans insist they are underrepresented, not
overrepresented – an assertion which provokes much scoffing from other
participants, including the BRICS.
However, criticism to the Seoul package didnot come from Europeans alone.
Since all of these changes were subject to ratification in local legislatives, the most
important challenge came not from Europeans parliaments, who would most likely
loose power with the package, but from the US Congress. Within both the House and
the Senate criticism of the 2010 package reform loomed large and it came in several
shapes. From lending too much to Europeans during the crisis to the apparent
decline of US power in the Executive Board (Truman 2014).
Blocking the Seoul package in the last couple years had interesting
consequences. The US share of the world economy has declined from 23% in 1980
to 19% in 2010. Yet they have chosen to hold 15% of the quota shares and continue
to remain below their share of the World economy, although it is enough votes to
use veto power. The Euro area plus UK's share of the World economy has declined
from 25% of total in 1980 to about 18% in 2010, while their quota share is still
27.5% (2009). For Virmani (2012) there is another very important fact that is often
obscured, sometimes deliberately in the debates. The financial contribution of the
"Rest of the World", including BRICS countries, has increased by 10% from 33.8% in
the 1980s to 43.4% in the 2000s.That is, the traditional power not only still holds on
to their quotas share, but they are also decreasing their financial contribution to the
organizations.
In short, these circumstances only reinforce the idea that Europe, Japan and
the US have full control of quotas reforms. Even when developed countries agree on
some changes, whether it is at the Annual Meetings or at a G20 Meeting, their local
legislatives block further reforms. Moreover, Europeans insist in a loose
interpretation of the GDP weight in the quotas calculus. It is quite obvious that
traditional powers still have an overwhelming control over the decision-making
16
process. This impressive grip over the rules of the game has been labeled as “the art
of power maintenance” (Wade2013).
Other things being equal, the more institutionalized the organizations - and
the IMF and the World Bank are probably the most institutionalized financial IOs in
the world - the more they are to persist in the face of environmental change. Europe
and US having de facto veto power makes reforms almost impossible to accomplish,
especially if they mean decreasing their relative power8 . The initial power
distribution during the formation of Bretton-Woodsinstitutions has created super-
majority rules that solidifies the initial uneven power in a way that makes almost
impossible for developing countries to foster deep reforms despite the new power
distribution in the international system. This makes the Bretton Woods institutions
almost impenetrable from either exogenous shocks or internal transformation when
comes to power redistribution. But it also means that the costs of institution
maintenance for developing countries are increasing while their vote shares
decreasing.
The excessive control of traditional powers over the decision-making process
is not the only negative aspect affecting developing countries.The inefficiency of
their economic policies is another important factor. The debate on the consequences
of IMF conditionality programs and World Bank development projects is
controversial910, but the literature shows that IMF’s conditionality programs are
more negative than beneficial to countries that request them (Dreher 2009).
Vreeland finds that IMF programs reduce economic growth in the short run, without
producing any compensating long-term benefits. Further, IMF programs lower
wages, redistributing income to the owners of capital (Vreeland2003,
Przeworskiand Vreeland 2000). And since IMF policies are very
8The literature showing the US and G-7 influence on the decision-making process of the IMF and the World Bank is long: Dreher, Sturm and Vreeland 2009a and 2009b, Kaja and Werker 2009, Thacker 1999,Gould 2003, Oatley and Yackee 2004, and Stone 2002. 9The literature on the conditionality is vast. It seams to be the most controversial subject of the IMF and to a lesser extent to the World Bank. Important works on this subject are Williamson 1983, Bird 1995, Vreeland 2003 and 2007,Przeworskiand Vreeland 2000, Gould 2003a and 2003b,Polak 1991, Babb and Buria 2004, and Dreher 2009. 10On the discussions of World Bank’s development projects see Guimarães 2012 and Weaver 2008.
17
comprehensive,influencing a variety of economic and social policies, World Bank’s
developmental programs are also affected by its inefficiency, despite World Bank’s
effort to improve programs ownership11 (Weaver 2008).
Indeed, the fact that such policies are inefficient affects not only BRICS
countries, but also all members and institutions credibility. However, BRICS
countries are dealing with a decision-making process in which their input has a
minor effect.As a matter of fact, BRICS countries usually feel left out when comes to
design such policies, especially at the IMF. There are two additional reasons for
BRICS to feel excluded: Senior Management and bureaucracies composition. The
literature shows that G-7 countries control the selection process of Senior
Management candidates, as well as the selection of bureaucrats in both institutions,
particularly at the IMF (Guimarães 2012, Babb 2003, Babb and Buria 2004, Birdsall
2002). The directors and economists hired by these institutions are responsible for
designing and implementing such policies. If the G-7 controls how these employees
are selected, it is less likely that BRICS countries will have leverage to decide. Biased
employees tend to favor G-7 views to the detriment of BRICS countries.
Our argument, therefore, is that endogenous causes of new institutional
making are the sum of (1)policy design control, and (2) decision-making control by
G-7 countries. Facing a situation in which influencing the results is very limited,
BRICS countries started to perceive these institutions as not only biased towards G-
7 countries, but also expensive to maintain in the long run. The shadow of the future
for cooperation, as put it by Keohane and Axelrod (1986), seemednegative, allowing
them to look for institutional alternatives.
3. The Empirical Patterns of the BRICS Bank creation:
The BRICS Bank formation is twofold: the simultaneous creation of the CRA
(Contingent Reserve Arrangement) and the NDB (New Development Bank). The CRA
is a stabilization fund of US$ 100 billion in reserves shared by the respective central
11 Policy ownership means that the recipient is responsible not only for the implementation, but also for the program design.
18
banks whose main goal is to provide emergency resources during balance of
payment crisis of any of its members. Indeed, the CRA is a coordinated central bank
fundset up to provide mutual liquidity during crisis. The contribution of China for
the CRA is around US$ 40 billon,while Brazil, India, and Russia contribute around
US$ 18 billon each, and South Africa close to US$ 10 billion. It is agreed that China
contribution will never exceed 50% of the fund. The CRA is still far from IMF’s in
terms of lending capacity. Before the 2008 economic crisis the IMF lending capacity
was around US$ 250 billion. In 2014 is reaching US$ 1 trillion.In turn, the NDB aims
to finance investment in infrastructure in BRICS and other emerging economies.
Based on a diagnostic that sources for infrastructure are very limited and their
needs on this area tremendous, BRICS countries decided to make the case for a
major step in investment in infrastructurethat will foster economic growth. The
initial NDB’s fund is about US$ 50 billion, having each member depositing US$ 10
billion per year. The current World Bank lending capacity per year is US$ 50 billion.
The history of the BRICS Bank starts in 2009 during the first BRIC Summit in
Yekaterinburg, Russia. Although the official joint statement is broad and superficial
there is an important paragraph showing BRIC countries (South Africa was not yet a
member) unsatisfied with the reforms at Bretton-Woods institutions:
“We are committed to advance the reform of international financial institutions, so as to reflect
changes in the world economy. The emerging and developing economies must have greater voice and
representation in international financial institutions, and their heads and senior leadership should be
appointed through an open, transparent, and merit-based selection process”12.
At the same time,BRIC countries were involved in dealing with the effects of
the 2008 financial crisis and the G-20 seemed to be the best forum to tackle the
issue.Although it was not central to the agenda, the reform of the IMF/World
Bankappeared at the Summit Declaration in London, April 2009. The G-20 had
committed to implement the 2008 IMF package of quota and voice reforms:
12 See I BRIC Summit, Yekaterinburg Declaration, June 2009, Paragraph 3.
19
“We commit to implementing the package of IMF quota and voice reforms agreed in April 2008 and call on the IMF to complete the next review of quotas by January 2011 (…) we commit to implementing the World Bank reforms agreed in October 2008. We look forward to further recommendations, at the next meetings, on voice and representation reforms on an accelerated timescale, to be agreed by the 2010 Spring Meetings”13.
In April 2010 during the II BRIC Summit in Brasilia, BRIC countries decided
to stress out more boldly the need for reforms at Bretton-Woods, arguing that they
contributed tremendously to increase the lending capacity of the IMF, especially
China, but the institution had not yet reformed itself:
“We will strive to achieve an ambitious conclusion to the ongoing and long overdue reforms of the Bretton Woods institutions. The IMF and the World Bank urgently need to address their legitimacy deficits. Reforming these institutions’ governance structures requires first and foremost a substantial shift in voting power in favor of emerging market economies and developing countries to bring their participation in decision-making in line with their relative weight in the world economy (…) We do also agree on the need for an open and merit based selection method, irrespective of nationality, for the heading positions of the IMF and the World Bank. Moreover, staff of these institutions needs to better reflect the diversity of their membership (…) The international community must deliver a result worthy of the expectations we all share for these institutions within the agreed timeframe or run the risk of seeing them fade into obsolescence”14.
The coming G-20 meeting in Seoul, Korea must have had effect on BRICS
intentions towards reforming Bretton-Woods. One of the byproducts of that meeting
was going to be the “Seoul package” mentioned above.So in April 2011 in Sanya,
China the BRICS Summit Declaration does not mention a single time the reforms.
They only stress the need for G-20 to continue its effort to stabilize the world
economy15. The same effect can be seen at the 2011 G-20 Cannes Declaration where
the reform are not even mentioned16.
In March 2012 BRICS countries met again in New Delhi. By then the quota
reform seemed to be back in agenda. As the Seoul package had received criticism
and developed countries were blocking its approval, BRICS countries restarted their
demand for change showing concern at the slow pace of reforms:
13See G-20 Summit, London Declaration, April 2009, Paragraph 20. 14See II BRIC Summit, Brasilia Declaration, April 2010, Paragraph 11. 15See III BRICS Summit, Sanya Declaration, April 2011, Paragraph 14. 16See G-20 Cannes Declaration, November 2011.
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“We are however concerned at the slow pace of quota and governance reforms in the IMF. We see an urgent need to implement, as agreed, the 2010 Governance and Quota Reform before the 2012 IMF/World Bank Annual Meeting, as well as the comprehensive review of the quota formula to better reflect economic weights and enhance the voice and representation of emerging market and developing countries by January 2013, followed by the completion of the next general quota review by January 2014. This dynamic process of reform is necessary to ensure the legitimacy and effectiveness of the Fund. We stress that the ongoing effort to increase the lending capacity of the IMF will only be successful if there is confidence that the entire membership of the institution is truly committed to implement the 2010 Reform faithfully. We will work with the international community to ensure that sufficient resources can be mobilized to the IMF in a timely manner as the Fund continues its transition to improve governance and legitimacy. We reiterate our support for measures to protect the voice and representation of the IMF’s poorest members”17.
In Los Cabos, Mexico G-20 countries pushed again for the reforms. It seems
that BRICS countries had showed their dissatisfaction in the meeting pushing for
stronger words at the final declaration:
“We reaffirm our commitment to implement in full the 2010 Quota and Governance Reform by
the agreed date of the 2012 IMF/World Bank Annual Meetings. These reforms are crucial to enhancing the IMF’s legitimacy, relevance and effectiveness, and will support efforts to further strengthen Fund surveillance and to ensure that the IMF is adequately resourced to play its systemic role. As part of these reforms, we are committed to completing the comprehensive review of the quota formula, to address deficiencies and weaknesses in the current quota formula, by January 2013 and to complete the next general review of quotas by January 2014. We agree that the formula should be simple and transparent, consistent with the multiple roles of quotas, result in calculated shares that are broadly acceptable to the membership, and be feasible to implement based on timely, high quality and widely available data. We reaffirm that the distribution of quotas based on the formula should better reflect the relative weights of IMF members in the world economy, which have changed substantially in view of strong GDP growth in dynamic emerging markets and developing countries”18.
The G-20 efforts were in vain. As we mentioned before, by 2013 the US
Congress started to block the Seoul package using a plethora of arguments against it.
The long overdue reform was once more in peril. BRICS countries reacted in March
2013 at their conference in Durham, South Africa. Anticipating the G-20 meeting
that would take place in St. Petersburg later that year, BRICS countries decided to
create two institutions at the same time. According to the Durham Declaration the
decision to create the CRA happened in Los Cabos in 2012 and it was taking shape in
Durham:
17 See IV BRICS Summit, Delhi Declaration, March 2011, Paragraph 9. 18 See G-20 Summit, Los Cabos Declaration, June 2012, Paragraph 33.
21
“In June 2012, in our meeting in Los Cabos, we tasked our Finance Ministers and Central Bank Governors to explore the construction of a financial safety net through the creation of a Contingent Reserve Arrangement (CRA) amongst BRICS countries. They have concluded that the establishment of a self-managed contingent reserve arrangement would have a positive precautionary effect, help BRICS countries forestall short-term liquidity pressures, provide mutual support and further strengthen financial stability. It would also contribute to strengthening the global financial safety net and complement existing international arrangements as an additional line of defense. We are of the view that the establishment of the CRA with an initial size of US$ 100 billion is feasible and desirable subject to internal legal frameworks and appropriate safeguards”19.
In the same meeting BRICS decided to move forward on the preparations to
create a new development bank to finance infrastructure:
“In March 2012 we directed our Finance Ministers to examine the feasibility and viability of
setting up a New Development Bank for mobilizing resources for infrastructure and sustainable development projects in BRICS and other emerging economies and developing countries, to supplement the existing efforts of multilateral and regional financial institutions for global growth and development. Following the report from our Finance Ministers, we are satisfied that the establishment of a New Development Bank is feasible and viable. We have agreed to establish the New Development Bank. The initial contribution to the Bank should be substantial and sufficient for the Bank to be effective in financing infrastructure”20.
The NDB and CRA institutional designs and their lending capabilities would
only take form at the Fortaleza meeting in July 2014.In the preparation or that
meeting, a high Brazilian diplomat and one of the responsible for the negotiations
declared that the creation of new financial institutions were linked to the lack of
reforms in Bretton-Woods:
“BRICS proposals to reform the IMF and the World Bank are not been taking into consideration for well know reasons. In a way, the creation of the CRA and NDB will accomplish this necessity (…). As the bank and the arrangement mirror the World Bank and the IMF, their creation show that BRICS countries do not depend anymore on Bretton-Woods”21.
In July 2014, BRICS officially created two new international institutions.
Firstly, the NDB was born with an initial authorized capital of US$ 100 billion and a
subscribed capital of US$ 50 billion divided equally among its members. Mimicking
the World Bank they also created the Board of Governors, the Executive Board, and
the Senior Management whose first presidents are going to be Russian, Brazilian,
19 See V BRICS Summit, Durham Declaration, March 2013, Paragraph 10. 20See V BRICS Summit, Durham Declaration, March 2013, Paragraph 9. 21 See “Banco dos BRICS é a resposta a falta de mudança no FMI”, Valor Econômico, July 09th 2014.
22
and Indian respectively. The headquarters of the bank shall be located in Shanghai,
China and a regional office is going t be open in South Africa. In the declaration
BRICS make clear that theory goal is to expand to number of members in the near
future.Secondly, the CRAwas born with a US$ 100 billion provision. The agreement
is a framework for the provision of liquidity through currency swaps in response to
actual or potential short-term balance of payments pressures22. On contrary to the
NDB, the CRA will not expand its membership at a first moment. The idea is to have
an “IMF miniature” for the five countries as an alternative to the IMF in case of
balance of payment crisis, as pointed out by a Brazilian diplomat23.
The decision-making process of the new institution is still under
constructions, but certainly will represent more equally the power of founding
countries. There is some evidence that, in the case of the NDB, each founding
country will have an equal share varying from 10% to 20% of the votes, more than
double of what they currently have at the Bretton Woods Institutions.For important
decisions, such as increasing the capital or new memberships, four out of five votes
(2/3) of funding countries are necessary.The possibility of China becoming too
powerful is taking into consideration to not unbalance to distribution of power
within the institution. The reforms were not forgotten in the declaration. Showing
grave concern on their delay BRICS countries continue to push for changes:
“We remain disappointed and seriously concerned with the current non-implementation of the 2010 International Monetary Fund (IMF) reforms, which negatively impacts on the IMF’s legitimacy, credibility and effectiveness. The IMF reform process is based on high-level commitments, which already strengthened the Fund's resources and must also lead to the modernization of its governance structure so as to better reflect the increasing weight of developing countries in the world economy (…) We reiterate our call on the IMF to develop options to move ahead with its reform process, with a view to ensuring increased voice and representation of developing countries, in case the 2010 reforms are not entered into force by the end of the year. We also call on the membership of the IMF to reach a final agreement on a new quota formula together with the 15th General Review of Quotas so as not to further jeopardize the postponed deadline of January 2015”24.
This chain of events reinforces our argument that the lack of reforms created
the possibility to new institutional making. After repeated delays in implementing
22 See VI BRICS Summit, Fortaleza Declaration, July 2014, Paragraphs 11, 12 and 13. 23 See interview Ambassador Flávio Damico, July 10th 2014. 24See VI BRICS Summit, Fortaleza Declaration, July 2014, Paragraph 18.
23
reforms, BRICS countries changed the strategy seeking for institutional alternatives.
In this sense, the creation of BRICS Bank represents a concrete example of what has
been called by the literature a “two-pronged approach” in international relations. In
order to overcome stalemates and increase the effectiveness and legitimacy of the
established architecture, the BRICS have two basic options, which are not mutually
exclusive. The first route involves acting within the system: that is, using their
membership in established institutions in order to push for structural reforms. The
second strategy entails the creation of new institutions so as to increase the
pressure for reform of established institutions – or, in certain cases, to bypass them
altogether (Abdenur, Esteves and Gama, 2014).
It is important to stress out that BRICS countries will not exit the IMF or the
World Bank. On the contrary, it islikely they will continue to seek for internal
reforms, as the Fortaleza Declaration shows it, but they will the new institutionsas
an additionalargument to push for different type of reforms. That is, they will
probably argue that the slow process of reformonly pushes them to seek for
financial help outside the IMF and World Bank, automatically decreasing their
importance and increasing the centrality of the BRICS Bankin the international
financial system. The demise of Bretton Woods’s institutions is not in question, but
only their relative decline.
4. Conclusions:
The casual pathways lead to the following predictions:
Prediction 1# - if powerful exogenous shocks change the balance of power
within the status quo institutions, unsatisfied countries will seek for internal
24
reforms (casual pathway 01, 02 and 03).
Prediction 2# - if institutional reform is non-existent because dominant
powers control the decision-making process, unsatisfied countries will seek
for a institutional alternative (casual pathway 04 and 05).
Prediction 3# - if a new institutions is created by the rising powers that
would give them extra power within status quo institutions to push for
reforms (casual pathway 06).
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