Case Study 6.1

raifferguson

AjamiGoddard_2015_Ch-06_Supranational_Organizations_and_International_Institutions1.pdf

Home >Business & Finance homework help >Management homework help >Case Study 6.1

181

Chapter 6

Supranational Organizations and International Institutions

“Mankind always takes up only such problems as it thinks it can solve.” —Albert O. Hirschman

Chapter ObjeCtives

this chapter will:

• Identify major international trade organizations, such as the World Trade Organization and the United Nations Conference on Trade and Development, and the roles they play in shaping the international business environment

• Describe the major financial institutions, such as the World Bank and the International Finance Corporation, and the assistance they provide in channeling financial resources to developing countries

• Review the growth of regional financial institutions and their important positions as providers of financial resources

BaCkground Increasing economic, financial, and commercial interdependence among nations of the world after World War II created a need to coordinate international action and policies to secure the smooth flow of trade. Apart from regular, periodic meetings of officials and business leaders from different countries, these nations recognized a need for the establishment of permanent organizations to provide stability and continuity to the process of international economic interchange. Some supranational bodies were set up in the period immediately following World War II, while more were established

Co py ri gh t @ 20 15 . Ro ut le dg e.

Al l ri gh ts r es er ve d. M ay n ot b e re pr od uc ed i n an y fo rm w it ho ut p er mi ss io n fr om t he p ub li sh er , ex ce pt f ai r us es p er mi tt ed u nd er U .S . or a pp li ca bl e co py ri gh t la w.

EBSCO : eBook Collection (EBSCOhost) - printed on 12/12/2018 2:22 PM via BARRY UNIV AN: 929355 ; Ajami, Riad A., Goddard, G. Jason.; International Business : Theory and Practice Account: s8987890.main.ehost

182 Chapter 6 • Supranational Organizations and International Institutions

in the following decades. Two major categories of international organizations can be identified as those having a global focus and those set up to meet the needs of particular regions.

general agreeMent on tariFFs and trade The General Agreement on Tariffs and Trade (GATT) was established initially as a temporary measure to reduce trade barriers among its founding members. Since its inception in 1947, GATT evolved into a permanent body to include most industrial and developing countries, excluding those of the socialist bloc.

GATT was originally established to avoid the kind of competitive protectionism that had plagued international trade in the period between the two world wars, which was reflected in high tariff barriers and a major slump in trade volumes. The objectives of GATT—liberalization of international trade restrictions and the lowering of tariff barriers—were to be achieved by multilateral negotiations and voluntarily agreed-upon rules of conduct. As a permanent international body, GATT was to provide the forum for the conduct of these negotiations and the development of necessary ground rules for liberalizing the international trade environment. GATT was also intended to serve as an agency for mediation and settlement of trade disputes.

One of the main tenets of GATT regulations is the requirement for its members to comply with the most-favored-nation clause, which obligates all member countries to give the same tariff concessions to all GATT countries that they give to any one member country. For example, if Germany reduces the import duty on Japanese television sets from 40 percent to 10 percent, then it must level the same rate of duty on television sets from other countries.

There have historically been important exceptions to the most-favored-nation clause, which recognized the need for preferential treatment to be given to the less-developed countries (LDCs), which without special treatment have not historically been able to compete on a one-to-one basis with the industrialized countries. The developing coun- tries thus have had preferential access to the markets of developed countries for some of their products under the generalized system of preferences, an advantage that has begun to erode in recent years.

Another major exception relates to the establishment of regional trading alliances: members of regional trade agreements can extend trade concessions to one another without extending these concessions to countries that are not members of the alliance. The European Union (EU), the North American Free Trade Agreement (NAFTA), and the Association of South East Asian Nations (ASEAN) are three examples of regional trade agreements. To ease the problem of dealing with tariffs and duties on individual products, most negotiations concern making generalized reductions in tariff rates for a large number of products in certain categories.

In the eight rounds, or negotiating sessions, under GATT,1 significant changes were made. The average tariffs on industrial products, levied by the developed countries,

Co py ri gh t @ 20 15 . Ro ut le dg e.

General Agreement on Tariffs and Trade 183

came down significantly. GATT countries have accounted for 85 percent of world trade since its inception. This trend has only improved since the creation of the World Trade Organization in 1995, as is shown in Figure 6.1.

There were still several problems with GATT, however, such as an increasing emphasis on protectionism, not only in the developing countries, but also in the in- dustrialized world. The use of nontariff barriers to discriminate against imports from other countries has enabled many member countries to negate the intended effects of the tariff reductions agreed to under the GATT rules of conduct. Further, since GATT regulations were imprecise, many signatory states found loopholes to evade the re- quirements, almost on a routine basis. Many trade issues arose in the 1970s and 1980s that had not been foreseen by earlier negotiations, and provisions for regulating them were not included in the agreements. There are also substantial difficulties between major trading partners, as relative economic and competitive strengths change and new arrangements and terms are sought by old trading partners. In the mid-1990s, the increasing importance of both the service sector and intellectual property rights led to the need for a fundamental change in GATT. In 1994, at the end of the Uruguay Round of trade talks, the decision was made to expand GATT into a new organization known as the World Trade Organization (WTO).2

100

150

200

250 Y

e a r

1 9 5 8

1 9 6 0

1 9 6 1

1 9 7 0

1 9 7 1

1 9 7 3

1 9 7 6

1 9 7 7

1 9 8 1

1 9 8 3

1 9 8 6

1 9 8 7

1 9 8 9

1 9 9 1

1 9 9 2

1 9 9 3

1 9 9 4

1 9 9 5

1 9 9 6

1 9 9 7

1 9 9 8

1 9 9 9

2 0 0 0

2 0 0 1

2 0 0 2

2 0 0 3

2 0 0 4

2 0 0 5

2 0 0 6

2 0 0 7

2 0 0 8

2 0 0 9

2 0 1 0

2 0 1 1

RTA Annual

RTA Total

Figure 6.1 Proliferation of (In-Force) Regional Trade Agreements (RTAs) Since 1958

Source: World Trade Organization, “Welcome to the Regional Trade Agreements Information System (RTA-IS),” http://rtais.wto.org/UI/PublicPreDefRepByEIF.aspx.

Co py ri gh t @ 20 15 . Ro ut le dg e.

184 Chapter 6 • Supranational Organizations and International Institutions

World trade orgaNizatioN Since GATT had been successful in reducing tariffs worldwide since 1948, and given the increasing importance of the service sector and intellectual property rights in the modern economy, the members of GATT formed the World Trade Organization in January 1995 to increase the scope of the trade agreements beyond manufactured products. The WTO currently has more than 150 member nations that participate in trade discussions. The WTO is both a forum for resolving trade disputes and an arena for agreeing on the rules of operation for international trade. Since we have already outlined GATT, we will next focus on providing a brief description of the other two primary areas of the WTO, the General Agreement on Trade in Services and the Agreement on Trade-Related Aspects of Intellectual Property Rights.

General Agreement on Trade in Services The General Agreement on Trade in Services (GATS) is the first and only set of multi- lateral rules governing international trade in services. The inclusion of services, negotiated in the Uruguay Round, was developed primarily due to the increase in importance of the service sector in the developed world and also due to the greater potential for trading services brought about by the advancement in communications technology over the past few decades. All services are covered under GATS, and the most-favored-nation treatment applies to all services as well.3 GATS identifies four modes of trading services:

1. Cross-border supply: services supplied from one country to another 2. Consumption abroad: consumers or firms making use of a service in another

country (i.e., tourism) 3. Commercial presence: foreign company setting up a branch or subsidiary in

another country 4. Presence of natural persons: individuals traveling to another country to supply

services

The reason that these definitions are necessary is that the trade in services is a much more diverse area than the trade in manufactured goods. The business models of service sector industries such as financial services, telecommunications, tourism, and even restaurants are very different. These varied industries under the service sector umbrella perform their operations in very different ways.

GATS requires member governments to regulate their services reasonably, objectively, and impartially, and the agreement does not require that any service be deregulated. As you will recall from the discussion concerning the Asian financial crisis, the lack of ef- fective regulation in the banking sector was at the heart of the problem. Thus, if GATS had required deregulation of the service sector by its member nations, the problem of moral hazard could not have been improved.

Co py ri gh t @ 20 15 . Ro ut le dg e.

General Agreement on Tariffs and Trade 185

Another important tenet of GATS is transparency. GATS specifies that all governments should adequately publish all laws and regulations that deal with the service sector. This will provide for easy access to the domestic service regulations for foreign companies and governments wishing to conduct business in another country. The guiding principle of these transparency rules is nondiscrimination, or the treatment of foreign enterprises on the same basis as domestic enterprises. The industrialized countries are likely to press for progressive liberalization of trade in services, while the developing countries may demand greater shares in the international services market and greater mobility of their workforces to move to the developed countries as a part of the liberalization of rules regarding manpower services.

agreeMeNt oN trade-related aSpectS of iNtellectual property rightS (tripS) Another creation of the Uruguay Round was the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS). The purpose of TRIPS is to allow for the creation of domestic laws that concern the protection of intellectual property rights, as well as the enforcement of such laws in violating countries. TRIPS established minimum levels of protection that each WTO member government must provide to the intellectual property of fellow WTO member states. TRIPS covers the following types of intellectual property.4

• Copyrights • Trademarks (including service marks) • Geographical indications, such as “Champagne,” “Scotch,” and “Tequila” • Industrial designs • Patents • Layout designs of integrated circuits • Undisclosed information, including trade secrets

TRIPS provides guidelines for how basic principles of the trading system and other international intellectual property rights agreements should be applied. It also spells out how various WTO member governments must provide adequate protection of intellectual property rights in their domestic laws, and it sets rules for how countries should enforce intellectual property rights within their own borders. TRIPS also provides a means of settling disputes regarding intellectual property between members of the WTO.

When the WTO came into being in January 1995, the developed countries of the world were given one year to harmonize (or equalize) their intellectual property laws so that they were in compliance with the specifications required by TRIPS. Some developing countries were given until the year 2000 to ensure that their laws and practices conform to the TRIPS agreement. LDCs were initially provided eleven years (until 2006) to meet these requirements.5 Currently, there is a phase-in period for LDCs regarding the imple- mentation of pharmaceutical patent protection until 2016.

Co py ri gh t @ 20 15 . Ro ut le dg e.

186 Chapter 6 • Supranational Organizations and International Institutions

The TRIPS agreement has been a point of contention for many years between the developed world and the developing nations. The countries of the developed world see the need for strict intellectual property rights enforcement as a way of recouping their research and development costs for products such as pharmaceutical drugs. The LDCs see these same protections as trade restrictions. In the case of pharmaceutical drugs, the LDCs argue that in lieu of intellectual property restrictions, much cheaper versions of the drugs could be provided for a greater number of people. This is similar to the utili- tarian viewpoint made famous by such philosophers as Jeremy Bentham, who, in the eighteenth century, argued that moral values are reflected in policies that provide the greatest happiness to the greatest number of people. These same arguments have been made by students around the globe recently concerning online music sharing; high school and college students have found it reasonable to argue that music provided online or via Apple iPods should be provided either without cost or at a much-reduced cost. While the arguments are essentially the same, the impact of not being able to enjoy online music is of no comparison to the inability to access pharmaceutical drugs for the affected citizens. Discussions like these will only continue with the increased integration of world markets and with the continued importance of the TRIPS for all WTO member nations.

doha ageNda In November 2001, at a WTO conference in Doha, Qatar, the member nations of the WTO agreed to launch a new round of trade negotiations. One of the primary thrusts of the new trade round concerns the problems faced by the developing countries in implementing some of the changes decided upon in the Uruguay Round (e.g., TRIPS). Another important area for reform is agricultural trade barriers. The countries of the developing world claim that agricultural protectionism by the countries of the developed world (i.e., United States, Canada, and the members of the European Union) leaves them without the ability to sell their agricultural products to the most developed nations. Thus, their primary avenue for income growth has been closed. At the start of the Doha trade round, both developed and developing nations made promises to improve market access for agricultural and other products via reductions in export subsidies, quotas, and tariffs. To date, final agreements have not been possible owing to the inability to agree on the appropriate level of reduc- tion of trade barriers for both the developed and the developing world.

united nations ConFerenCe on trade and developMent The United Nations Conference on Trade and Development (UNCTAD) was estab- lished in 1964 to address concerns of developing nations regarding issues of international trade that affected their economic development. The main concern of most developing countries was that, under the old system, unequal players were asked to play on a level playing field. The LDCs, which were extremely weak economically and industrially back-

Co py ri gh t @ 20 15 . Ro ut le dg e.

United Nations Conference on Trade and Development 187

ward, had no way of competing with the industrialized nations in the world market on the same terms. Moreover, they argued, given the structure of the international economy, they were parting with more of their goods as exports than they were receiving as imports. In effect, the prices of their exports were not rising as did the prices of their imports. This feature is conceptualized in economics as the terms-of-trade argument. Further, LDCs’ exports suffered from low demand and low price elasticity, which meant that they could not raise export prices by reducing supplies. On the other hand, their imports were criti- cal for them and their supplies were controlled by large monopolistic entities that could charge exorbitant prices.

UNCTAD was established to provide a forum for the developing countries to com- municate their views on international trade issues to the industrialized countries and to seek trade concessions from them. After considerable and sustained pressure from the developing countries, the developed countries agreed to an across-the-board reduction of tariffs for developing countries under an arrangement known as the generalized sys- tem of preferences (GSP). The GSP tariff reductions, however, were for only limited amounts of imports from developing countries and did not create any significant niches for developing-country exporters in the markets of industrialized countries. Moreover, since the liberalization in tariffs was only for manufactured goods, many developing countries with little industrial activity cannot benefit from the reduced tariffs.

Membership of UNCTAD increased from 119 countries in 1964 to 194 countries in 2012. Although the deliberations and resolutions of UNCTAD have not solved the problems faced by developing countries in the international trade area, they have had important positive effects on the international trade environment in general. UNCTAD conferences have resulted in a better and more informed understanding of the respective positions on various issues of the developed and developing countries. In recent meetings of the Trade and Development Board in Geneva, issues concerning trade between the developed countries (the North) and the developing countries (the South) have been the topic of discussion. Under the current heading of “Prosperity for All,” UNCTAD is committed to studying the factors that have left many African nations behind in their ability to participate in the benefits of globalization. The UNCTAD participants agree that it is the moral responsibility of the organization as well as other supranational orga- nizations previously discussed to find ways of improving the performance of LDCs in the world economy.

A number of permanent working committees, such as the Commission on Trade in Goods, Services, and Commodities; the Commission on Investment, Technology, and Related Financial Issues; and the Commission on Enterprise, Business Facilitation, and Development, have been created to deal with major issues and analyze complex problems in depth, thereby contributing to an increase in the level of understanding of the problems by representatives and officials of different countries. Thus, UNCTAD has become a permanent international organization that focuses global attention on the trade devel- opment problems of LDCs. At the time of its inception, the creation of UNCTAD was

Co py ri gh t @ 20 15 . Ro ut le dg e.

188 Chapter 6 • Supranational Organizations and International Institutions

hailed as one of the most important events since the establishment of the United Nations. Although the concrete impact of the organization has been limited, it has kept alive the dialogue between the industrial and developing world. Given the current impasse of the Doha Development Agenda in the WTO, organizations such as UNCTAD will continue the quest to allow all parts of the world to share in the benefits of globalization.

regioNal trade groupiNgS Regional trade groupings have emerged in the past two decades as major forces shaping the pattern of international trade. These arrangements have enabled countries located in different geographic locations to pool their resources and lower restrictions on trade among themselves in order to achieve greater economic growth.

Regional groupings offer several advantages over global trade arrangements to their members. Because there are fewer countries involved, and their state of economic devel- opment is relatively homogeneous, it is easier to find commonality of interest and arrive at a workable agreement on the basis of voluntary adherence by member countries. As was illustrated in Figure 6.1, the proliferation of regional trade agreements since 1995 has been unprecedented. Although some experts hail the accelerated pace of regional trade agreements as a success, others, such as economist Jagdish Bhagwati, refer to the various agreements as a “spaghetti bowl” with each successive arrangement moving the world further from true free trade. True free trade can be seen as an environment where no trade barriers, customs duties, or government interventionist policy limits international trade, whereby the cost of said trade is not increased by the barriers put into the marketplace.

The controversy surrounding the unprecedented increase in such arrangements aside, regional groupings do offer advantages of cultural, geographical, and historical homogene- ity, which provides an environment conducive to the spirit of mutual cooperation. Even with all the positive factors, however, regional groupings can still face severe internal dissension among member states, especially if the general economic situation is poor and countries follow restrictive, inward-looking policies. The experience of regional groupings in international trade has therefore varied considerably. While the European Union and the Association of South East Asian Nations are notable successes, trade ar- rangements in Africa and Latin America have not achieved many significant benefits for their member countries.

ForMs oF regional integration Many nations have entered into bilateral agreements (involving two countries) or mul- tilateral agreements (involving more than two countries) in the attempt to increase trade between member states. There are five different forms of regional economic integration. Some of these forms of economic integration also include some degree of political integra- tion. Some have existed for many years, while others are relatively new. These forms of regional economic integration are listed in increasing order of integration as follows:

Co py ri gh t @ 20 15 . Ro ut le dg e.

Forms of Regional Integration 189

• Free trade area • Customs union • Common market • Economic union • Political union

free trade area The first form of regional economic integration is the free trade area. The United States has entered into many of these bilateral agreements recently. Over the last few years, the United States has signed bilateral free trade agreements with countries as diverse as Sin- gapore, Chile, Vietnam, and Jordan. These agreements are between just the United States and the designated bilateral partner (e.g., Chile); the agreements reached between these two countries pertain only to them. Free trade areas eliminate trade barriers among their members (at least the barriers agreed to in the free trade agreement), but members can set their own trade policies with nonmembers. Thus, while the United States has bilateral agree- ments with Chile and Vietnam, Canada does not have to honor these agreements. In fact, Canada has signed its own separate free trade agreement with Chile. Some observers argue that these agreements are really not free trade agreements at all, just reduced trade barriers for specific goods and services, with those items not addressed still being protected.

The most commonly known multilateral free trade agreement is the North American Free Trade Agreement (NAFTA). NAFTA, which came into effect in 1994, is a free trade agreement of the United States, Canada, and Mexico. The origins of NAFTA were in the United States-Canadian Automotive Agreement from 1965. NAFTA has been suc- cessful in increasing the volume of trade between its member nations, but critics cite the movement of jobs from the United States to Mexico as an example of a flawed system. Mexican companies have formed maquiladoras, or manufacturing facilities located in the northern part of Mexico, in an attempt to capitalize on the southern movement of manufacturing plants from the United States.

A weakness of free trade agreements is that they are vulnerable to trade deflection, a process in which nonmember nations reroute their exports to member nations with the lowest external trade barriers. Thus, free trade areas require rules of origin specifications to clarify what actually constitutes member goods and services within the free trade agree- ment. As an example, if Mexico had the lowest external trade barriers when compared with Canada and the United States, a country that is not a member of NAFTA (such as Brazil) could attempt to access the US and Canadian markets more cheaply by sending goods to Mexico for re-export into the United States or Canada. Another weakness of free trade areas is that they are vulnerable to trade diversion. This occurs when member nations stop importing from lower-cost nonmember nations in favor of member states. Since the goal of a free trade area is the reduction in the prices that consumers pay for products via the reduction of protective trade barriers, such trade diversion would seem to be counterproductive.

Co py ri gh t @ 20 15 . Ro ut le dg e.

190 Chapter 6 • Supranational Organizations and International Institutions

cuStoMS uNioN The second form of regional economic integration, customs union agreements, combine the elimination of internal trade barriers among member nations with the adoption of common external trade policies toward nonmembers. Thus, a customs union is a free trade area with a common external trade policy. This eliminates the trade deflection problem that is associated with free trade areas. The most well-known customs union is the Mercosur Accord, an agreement signed by Argentina, Brazil, Paraguay, and Uruguay in 1995; Venezuela joined in 2012. The Mercosur Accord covers 260 million people, with a combined annual GDP of $2.9 trillion. Within three years of the formation of the customs union, the trade between the member nations doubled. The Mercosur Accord nations have recently been talking with European Union officials about forming the world’s largest free trade area.6 Thus far talks have not produced a new agreement. This idea was inspired by the existing example of a customs union between the European Union and Turkey.

Another example of a customs union is the Andean Community, an agreement signed by five Latin American countries—Bolivia, Chile, Colombia, Ecuador, and Peru—in 1969, in effect creating a sub-regional trading arrangement. An important motivation for the creation of the Andean Community was a growing dissatisfaction among several Latin American countries about restrictions on trade in goods and services. The Andean Community works through a secretariat that handles all administrative and executive matters. The decisions of the community are made through a commission made up of a representative from each member country. Disputes between members on the interpre- tation of the pact’s statutes are heard and settled by the Court of Justice of the Andean Community. Although progress has been relatively slow, some important steps toward regional integration have been taken by the Andean Community countries. The community covers 1.8 million square miles and 98 million people.

Under the industry sectoral programs, a number of industry sectors are selected for the implementation of coordinated or rationalized development plans that aim to achieve the best utilization of competitive advantages available in different countries in the region. Thus, the country having a competitive advantage in a particular industrial product will concentrate on the production of that product, while other products related to that indus- try will be manufactured by other member countries. Countries exchange their allocated products with other member states on a tariff-free basis. At present, sectoral cooperation in industrial activity encompasses petrochemicals, automotive products, and metals.

The members of the Andean Community have been able to establish coordinated policies to promote and control foreign direct investments, with the goal of achieving a certain similarity of restrictions in all member countries in order to develop leverage in negotiating investment permissions with overseas investors. At the same time, by creat- ing intraregional competition to attract foreign investment flows, the community aims to prevent the possibility of the investors gaining unfair advantages by playing one country of the region against another. Chile, however, wanted to attract greater levels of foreign

Co py ri gh t @ 20 15 . Ro ut le dg e.

Forms of Regional Integration 191

direct investments but could not hope to do so under the community’s restrictive provi- sions, so it left the Andean Community (at the time called the Andean Pact) in 1976.

The Andean Community has made little progress in tariff reduction among its member countries. Further regional cooperation in Latin America has been limited because most countries have been repeatedly beset by serious internal economic problems.

coMMoN Market The third form of economic integration, the common market, increases the agreements in place for a customs union to include the elimination of barriers that inhibit the movement of the factors of production. The member nations involved in a common market agree that labor, capital, and technology are able to move across borders without any barriers. Many of the countries engaged in customs unions have the eventual goal of becoming common markets.

The Central American Common Market was formed by a 1960 treaty signed by El Salvador, Guatemala, Honduras, and Nicaragua; Costa Rica joined later. The Caribbean Community and Common Market was formed in 1973. This group includes many island nations in the Caribbean, including the Bahamas, Belize, Haiti, Jamaica, Saint Lucia, and Trinidad and Tobago.

The most famous example of a common market is the European Economic Area (EEA). This group includes the European Union plus Iceland, Liechtenstein, and Nor- way. The three countries outside of the European Union decided to keep the common market status that they had prior to increased integration in the European Union in 1992. The common market status of the EEA allows these three countries to participate in the internal market of the European Union, but not in the full integration of the twenty-eight nations that currently make up the European Union. One weakness of this approach for EEA members is that they must accept the regulations and laws of the European Union without influencing the vote in the European Parliament.

Each of the non-EU members of the EEA has its own economic reasons for not joining the European Union in its entirety. Norway and Iceland have historically depended on the fisheries industry and have objected to some of the provisions of the European Union’s common agricultural policy (CAP). While the fisheries industry represents less than 1 percent of Norway’s GDP, it remains its most protected industry.7 Additionally, Norway has a large current account surplus due in large part to the export of oil and gas. Norway’s current account surplus has trended upward since 1998, as shown in Figure 6.2.

Since 1990, Norway has saved the surplus in its annual government accounts into the State Petroleum Fund. The existence of this fund may shed additional light on why Norway has not thus far been interested in pursuing further European Union integration: many citizens in Norway fear that this fund could be used to fund problem areas of other nations in an integrated Europe.8 In the wake of the recent financial crisis, this fear may have been proved correct.

Liechtenstein has not integrated further than the EEA with the European Union given

Co py ri gh t @ 20 15 . Ro ut le dg e.

192 Chapter 6 • Supranational Organizations and International Institutions

the country’s high level of integration with Switzerland. Liechtenstein has had a customs union with Switzerland since 1924, has the same currency as the Swiss, and relies on the Swiss for defense. Since the Swiss failed to ratify the EEA amendment in 1992, any further integration by Liechtenstein with the European Union has been stalled. Both countries are known to maintain higher bank secrecy than other European nations, which also has slowed momentum for joining the EU.

ecoNoMic uNioN The fourth level of economic integration, economic union, involves eliminating internal trade barriers, adopting common external trade policies, abolishing restrictions on the mobility of the factors of production, and coordinating economic activities. As discussed in Chapter 4, the European Union (EU) is the primary example of this form of integra- tion. The original fifteen EU member states agreed to coordinate their monetary, fiscal, taxation, and social welfare programs in an attempt to blend these formerly sovereign nations into a single economic entity. As evidenced by the EU sovereign debt crisis, some EU member nations—such as Greece, Ireland, and Spain—did not maintain the level of fiscal responsibility relative to other EU member states. Chapter 4 itemizes the various methods used to converge various member states into one economic entity. The

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

Figure 6.2 Norway’s Current Account Surplus, 1998–2011 (US$ millions)

Sources: World Trade Organization, “Trade Policy Review Norway,” September 2004, www.wto.org. and indexmundi.com, October 2012.

Co py ri gh t @ 20 15 . Ro ut le dg e.

Association of South East Asian Nations 193

European Central Bank (ECB), based in Brussels, Belgium, was created to serve as the central bank for all members of the European Monetary Union. While the ECB formulates monetary policy for the European Union, the European Commission and the European Parliament are in charge of the European Union’s fiscal policy. Managing the fiscal and monetary integration of the EU member states has proved challenging. In the wake of the EU sovereign debt crisis, a concerted effort has been made to ensure that the future fiscal irresponsibility of a few member states does not cause contagion for the EU at large. If the EU is to continue successfully, more fiscal oversight by the EU on member states is to be expected, as has been seen in the past.

political uNioN The fifth and final level of economic integration is political union. This represents the complete political and economic integration of all member states, in essence making them one unified country. Many Euro-skeptics believe that this will be the eventual result of the integration process of the European Union, although it remains to be seen how suc- cessful the current level of economic integration will be over the long term. The primary example of a successful political union was the Articles of Confederation, which made the thirteen separate colonies into the United States of America. The founders of the United States who assembled for the Second Continental Congress agreed to the formation of the union in 1776, but it was not without compromise. The member states retained free- dom in all matters that were not expressly delegated to the Congress, and the politically divisive issue of how to handle slavery was eliminated from the discussions so that the union could be formed expeditiously.9

assoCiation oF south east asian nations The Association of South East Asian Nations (ASEAN) was founded in 1967 by Indone- sia, Malaysia, the Philippines, Singapore, and Thailand. Brunei joined when it attained its independence in 1984. The association has been expanded over the years to include Cambodia, Laos, Myanmar, and Vietnam.

Over the past twenty years, ASEAN has made significant progress. Preferential trading arrangements have been established under which special, lower tariffs are levied on the import of goods from member states. Members cooperate on the coordinated develop- ment of industry in the region through the industrial project scheme, whereby member states select a particular project for establishment in a country and in which every other member state holds equity. To counter the problem of food shortages in some parts of the region, member states created the food security reserve scheme, under which a com- mon stockpile of rice is maintained for supplementing the needs of any member country experiencing a shortfall.

Several other coordinated projects have proved that this regional arrangement has worked. An ASEAN finance corporation was established to finance joint ventures, and

Co py ri gh t @ 20 15 . Ro ut le dg e.

194 Chapter 6 • Supranational Organizations and International Institutions

agreements between central banks of member countries reduce exchange-rate fluctuations and exchange imbalances by using currency exchange arrangements among themselves. ASEAN has fostered regional cooperation in other categories, such as projects for educa- tion, population control, and cultural exchanges among member states.

ASEAN has enabled the member states to represent their region as a collective body and improve their bargaining position with nonmember states, especially the industrialized countries. The aura of political stability and regional amity engendered by the body has also been a major factor in attracting overseas investment in several member countries. In recent years, the region has been one of the leading recipients of foreign direct invest- ment, trailing only China and India.

Active cooperation between members is supported by a small secretariat located in Jakarta, Indonesia. Among the other notable achievements of ASEAN in the more than four decades of its existence are the following:

• An emergency sharing scheme on crude oil and oil products • Joint approaches to problems in international commodity trade • A program for cooperation on the development and utilization of mineral

resources • A planning center for agricultural development • A program for tourism cooperation • An agreement to align national standards with international standards (such as the

International Organization for Standardization)

ASEAN has not been an unqualified success, however; progress has been slow, particu- larly in coordinated industrial development, because of several constraints. The level of complementarity between the member states is low, and many of them have competitive economic structures, especially because industrial output in most countries tends to be quite similar. Additionally, some ASEAN members are under significant financial stress, making it difficult to mobilize the resources needed to fund their ambitious development programs and government expenditures. Because import duties constitute a major source of revenue for the ASEAN countries, tariffs can be reduced only to the extent that mem- bers are able to absorb the resulting revenue loss. The lack of financial resources also constrains the development of joint industrial projects. The issues of equitable distribu- tion of benefits from jointly owned or jointly run projects and of tariff preferences are difficult to resolve, given their complex implications.

In 1992, the ASEAN Free Trade Area (AFTA) was established. The goal was to in- tegrate the ASEAN economies into a single production base in order to create a regional market of 500 million people. This agreement required that tariff rates levied on a wide range of products traded within the region be reduced to no more than 5 percent by 2008.10 The free trade area covers all manufactured and agricultural products, but approximately 1 percent of products are not included in the agreement. These products, listed in the

Co py ri gh t @ 20 15 . Ro ut le dg e.

Asia-Pacific Economic Cooperation Forum 195

General Exception List, are typically excluded in order to maintain national security, to protect human, animal, or plant life and health, and to preserve things of artistic, historic, or archeological value. The eventual goal of AFTA is the elimination of all import duties and the creation of the ASEAN economic community by 2015.

On balance, ASEAN has been a significant success. Trade among ASEAN countries grew from US$44.2 billion in 1993 to US$376.2 billion in 2009. This represents an annual increase of 13.42 percent.11 If the member countries have the political will to sustain the progress of cooperation, there is no doubt that the arrangement will bring greater economic and political coordination to the region, which has already emerged as an important economic zone, even by global standards. The leaders of ASEAN estab- lished the ASEAN-China free trade area in 2010. This has the potential to significantly increase ASEAN’s exports to China and China’s exports to ASEAN nations. Similar discussions have also taken place with Japan, Korea, India, and Australia. The group is also interested in forging trade alliances outside of the Asia-Pacific region and has been discussing possible agreements with the European Union, the United States, and Canada as well.

asia-paCiFiC eConoMiC Cooperation ForuM In response to the growing interdependence among the economies of the Asia-Pacific region, the Asia-Pacific Economic Cooperation Forum (APEC) was established in 1989. It has become the primary regional vehicle for promoting open trade and economic cooperation. The goal of APEC is to advance Asia-Pacific economic dynamism and the sense of community among the member economies. APEC now has twenty-one members, including the People’s Republic of China, the Republic of Korea, New Zealand, Peru, Russia, and the nations composing such smaller groups as ASEAN and NAFTA. The membership totals more than 2.5 billion people with a combined GDP of approximately $20 trillion. The nations of APEC comprise almost half of world trade, which while impressive, illustrates the high importance of agreements made by the members.

In 1994, the leaders of APEC agreed on the future vision of the organization at their annual meeting in Bogor, Indonesia. The “Bogor Goals” include three areas of cooperation, which are known as the “three pillars” of APEC: trade and investment liberalization; business facilitation; and economic and technical cooperation. These goals would seem to be complementary to those of the WTO. Unlike the WTO, APEC does not require any treaty obligations of its participants. APEC is the only intergovern- mental group in the world that operates on the basis of nonbinding commitments, open dialogue, and equal respect for the views of all participants.12, 13 The decisions made in APEC are reached via consensus, and the commitments are undertaken voluntarily by the member economies.

Co py ri gh t @ 20 15 . Ro ut le dg e.

196 Chapter 6 • Supranational Organizations and International Institutions

FinanCial organizations World baNk The World Bank was created (along with the IMF) at the Bretton Woods Conference in New Hampshire in July 1944, and it officially came into existence on December 27, 1945. The objective of the World Bank was initially to make financial resources available to European countries to rebuild their war-shattered economies and later to provide criti- cally needed external financing to developing countries at affordable rates of interest. The creation of the World Bank, together with the IMF, was also intended to strengthen the structure and encourage the development and efficiency of international financial markets. The World Bank consists of four main agencies: the International Bank for Reconstruc- tion and Development (IBRD, generally known as the World Bank); the International Development Association (IDA); the International Finance Corporation (IFC); and the Multilateral Investment Guarantee Agency (MIGA).

International Bank for Reconstruction and Development

The main objective of the World Bank today is to support social and economic progress in developing countries by promoting better productivity and utilization of resources so that their citizens can live better and fuller lives. The World Bank seeks to achieve its objectives by making financial assistance available to developing countries, especially for specific, economically sound infrastructural projects, for example, in the areas of power and transport. The basic rationale for the emphasis on such projects is that a good infrastructure is necessary for the developing countries to carry out programs of social and economic development. In the 1970s World Bank loans were also given to promote the development of the social services sectors of borrowing countries: educa- tion, water supply and sanitation, urban housing, and so on. Loans were also provided for the development of indigenous energy resources, such as oil and natural gas. Since the early 1980s much World Bank lending has been policy-based; that is, it has aimed to support economic adjustment measures by borrowing countries, particularly those faced with heavy external debt-service requirements. Policy-based lending, sector- policy lending, and structural-adjustment lending programs of the World Bank provide critically needed financial assistance to countries attempting to alter the current orien- tation of their economies by enhancing productivity and efficiency in the allocation of resources, improving external competitiveness, reducing overburdening subsidies, and repairing other economic distortions that prevent a higher rate of growth and create macroeconomic instability.

Another important aspect of financial assistance provided by the World Bank is loan guarantees. The World Bank helps member developing countries to obtain increased access at better terms to international financial markets by guaranteeing repayment of loans. This form of assistance has been increasingly used to improve resource flows from

Co py ri gh t @ 20 15 . Ro ut le dg e.

Financial Organizations 197

private creditors to the highly indebted developing countries. The use of guarantees is also being considered by the World Bank in order to help member-country borrowers issue securities in the international financial markets.

World Bank Lending

There are five major categories of World Bank loans:

1. Specific investment loans are loans made for specific projects in the areas of agricultural and rural development, urban development, energy, and so on. They have a maturity ranging from five to ten years.

2. Sector operations loans, which constitute about a third of the World Bank’s lending, are aimed at financing development of particular sectors of a country’s economy such as oil, energy, or agriculture. Loans under this category are also provided to the borrower’s financial institutions, which then lend the funds to actual users in a particular sector of the economy.

3. Structural adjustment and program loans are targeted at providing the financial support needed by member countries that are undertaking comprehensive insti- tutional and policy reforms to remove imbalances in the external sector. These loans, therefore, support entire programs of structural adjustment and are not specific to any particular project or sector of the economy.

4. Technical assistance loans are provided to member countries that need to strengthen their technical capacity to plan their development strategies and design and implement specific projects.

5. Emergency reconstruction loans are provided to member countries whose econo- mies, especially the infrastructure, have experienced sudden and severe damage because of natural disasters, such as earthquakes or floods. The emphasis of these loans, apart from restoring the disrupted infrastructural facilities, is also on strengthening the capacity of borrower countries to handle future events of this type.

Since 1982 World Bank loans have been made at variable rates of interest that are adjusted twice a year and are based on a spread of 0.75 percent on the average cost of the outstanding borrowings of the bank.14 Apart from interest, World Bank borrowers have to pay a front-end fee and a commitment fee on their borrowings. Repayment terms, including grace periods and final maturity, are determined on the basis of the per capita income of the borrowing country. Final maturity can range up to twenty years for countries with the lowest per capita income. In 2012, the World Bank loaned a total of US$20.6 billion in support of ninety-three projects throughout the world. The total outstanding loan commitments by the bank surpassed US$136 billion in 2012.15

Co py ri gh t @ 20 15 . Ro ut le dg e.

198 Chapter 6 • Supranational Organizations and International Institutions

Fund-Raising by the World Bank

The primary capital resources of the World Bank come from contributions made by its 188 member countries, but nearly all loan funds are raised by borrowings in international financial markets. The bank enjoys a credit rating of AAA in the world’s financial mar- kets, which enables it to obtain easy access to funds and excellent borrowing terms in its chosen markets. Funds borrowed by the bank had surpassed US$100 billion by the end of 2003. Borrowings are made in a variety of major international currencies that reflect the nature of the bank’s loan portfolio. Approximately twenty different currencies have been used by the bank to raise funds in the international markets. The World Bank typically borrows at variable interest rates, which are adjusted twice a year. Fixed-spread loans were introduced by the bank in 2000; these loans have a fixed spread over the London Inter-Bank Offered Rate (LIBOR) for the life of the loan.

The World Bank has played a pioneering role in the development of the currency swap market, whereby it improves its access and terms to preferred markets or adjusts its borrowing currency mix with the lending currency mix. The bank also uses interest- rate swaps to adjust mismatches in its borrowing and lending portfolios and improve the management of interest-rate risk.

The bank has made significant profits on its operations over the years, even though it charges a relatively low spread to its borrowers. As a matter of policy, all profits are transferred to the general reserve, which is maintained as a safeguard against the contin- gencies of loan or other financial losses.

Organizational Structure

Each World Bank member country subscribes to a certain proportion of the total paid-in capital of the bank. The subscription of each country differs and depends generally on its international economic importance. The member countries are, in effect, the shareholders of the bank and the ultimate guarantors of its financial obligations. The United States has the largest share of paid-in capital (28.9 percent) and is, therefore, the largest shareholder of the bank. Major industrialized countries, such as Japan, Germany, United Kingdom, and France, are among the other important shareholders.

The board of governors of the bank is the highest policy-making body, and each mem- ber state appoints one representative to the board, usually either its finance minister or the governor of its central bank. Each country also appoints an alternate member to the board of governors. The board of governors makes only major policy decisions about the functioning of the bank, such as capital increases, major changes in lending emphasis, and the creation of new affiliates, which are approved at its annual meetings.

Day-to-day administration of the bank’s work is entrusted to the president of the bank, who has traditionally been from the United States. The president is supported by a twenty- five-member board of executive directors, who are appointed by member governments. The major industrial countries, Saudi Arabia, and China have their own executive direc-

Co py ri gh t @ 20 15 . Ro ut le dg e.

Financial Organizations 199

tors, while other member states, with lesser shares, form regional groupings to appoint executive directors. The bank has four major administrative divisions:

• The operations division, which is essentially responsible for World Bank lending • The financial operations division, which is responsible for raising and managing the

financial resources of the bank • The policy, planning, and research division, which is concerned with in-depth eco-

nomic studies, analysis, and planning to support the objectives of the bank • The administration and personnel division

World Bank headquarters are in Washington, DC, and there are regional representative offices in many developing countries. The World Bank’s staff, which at the end of 2012 numbered more than 9,000, consists of personnel drawn from more than 150 nationalities and represents a wide variety of professional skills.

International Development Association

The International Development Association (IDA) was established in 1960 to provide long-term funds at concessionary rates to the poorest member countries of the bank. This affiliate does not have a separate organizational structure, and its operations are conducted by the staff of the World Bank. The president of the World Bank is also the president of the IDA. The basic objective of the association is to provide long-term financing to those members who cannot afford to borrow on normal World Bank terms. IDA funds are used to promote long-term, long-gestation development projects.

As member countries grow economically and their per capita income increases beyond a particular level,16 they graduate from IDA assistance and become eligible for World Bank loans under its various lending programs.

IDA loans have long maturities, sometimes as long as forty years, with a ten-year grace period for the repayment of principal. Historically, a nominal service charge of 0.75 percent per annum has been levied, and a commitment fee of 0.5 percent has been charged on approved but non-dispersed credits. IDA funds are raised from member-country subscriptions, repayments of outstanding credits, and allocations from the income of the bank. IDA funds are periodically replenished by member countries.

In fiscal 2012, IDA provided US$14.7 billion in financing for various projects in low-income countries (most of them in Africa and South Asia). The five largest recipients of IDA credits are India, Vietnam, Bangladesh, Pakistan, and Ethiopia. Although in recent years IDA replenishments have led to a certain amount of debate about the amount of contributions to be made by the industrialized countries, there is no doubt that the role of the IDA is critical in providing sorely needed external assistance to many countries with large populations that are at the lowest rung of the global economic ladder.

Co py ri gh t @ 20 15 . Ro ut le dg e.

200 Chapter 6 • Supranational Organizations and International Institutions

International Finance Corporation

The International Finance Corporation (IFC) was established in 1956 with the ob- jective of promoting the development of private enterprises in member countries. The IFC operates primarily through its own staff, but it is overseen by the World Bank’s board of executive directors. The president of the World Bank is also the president of the IFC.

The IFC makes equity investments and extends loans to private enterprises in de- veloping countries. In accordance with its mandate, the IFC cannot accept government guarantees of its loans. The primary role of the IFC, however, is not providing financial assistance alone. It serves as a catalyst to promote private capital flows to the private sector in developing countries. The IFC is never the sole financier in any particular transaction, and its contribution is usually a minor proportion of the total mobilized amount. The corporation also does not accept management positions or seats on the boards of directors of the organizations to which it lends funds. In addition, the IFC provides financial, technical, and legal advice to the companies in which it invests. Advisory services are also provided to companies who do not borrow directly from the IFC.

As a matter of policy, the IFC typically exits from companies in which it has invested as they develop and mature, usually selling its interests to local parties. The importance of the activities of the IFC has grown in recent years, with increasing emphasis on the development of the private sector by the industrialized countries and its growing accep- tance by many developing countries, which are increasingly disillusioned by the lackluster performance of parastatal enterprises in their countries.

Apart from its traditional investment activities, the IFC also plays an important role in strengthening the financial infrastructure of developing countries through its capital markets department. The department provides needed technical and legal assistance to many developing countries to strengthen their financial markets. The IFC provides as- sistance in this area for such issues as framing legal statutes to regulate securities markets and the development of financial institutions, such as leasing companies, venture capi- tal companies, commercial banks, credit-rating agencies, and export-import financing institutions.

The IFC also plays an important catalyzing role in setting up depository institutions; establishing trading, disclosure, and market practice standards; and directing external flows toward developing countries by helping to establish and develop capital markets and financial institutions and by participating in and promoting international investment efforts through pooled investment vehicles, such as country funds.

Although in the past the IFC had funded its investments from its own capital and borrowings from the World Bank, it has also raised substantial amounts on its own by directly borrowing in the international capital markets. The IFC is rated an AAA borrower by major US credit-rating agencies.

Co py ri gh t @ 20 15 . Ro ut le dg e.

Financial Organizations 201

Multilateral Investment Guarantee Agency The Multilateral Investment Guarantee Agency (MIGA) was established in 1988. Its main objective is to promote overseas direct investment flows into developing countries by providing guarantees against noncommercial risks that investors face in most econo- mies. Noncommercial risks are generally risks arising out of political actions by most governments, such as confiscation, expropriation, and nationalization of the assets of the overseas enterprise. Other noncommercial risks covered by MIGA include risks arising out of such unforeseen circumstances as wars and civil disturbances.

The Future Role of the World Bank Group The role of the World Bank group has constantly evolved ever since its inception. The next few decades pose several major challenges to the organization as it pursues its fundamental objectives of improving the living standards of people in poor countries by catalyzing greater economic growth and sustainable development. In the past decade, the World Bank has had to deal with a whole new set of issues created by the Asian financial crisis and the flow of much-needed external capital to industrial countries instead of the developing world. Given the significant gaps in the demand and supply of external resources for the developing countries as a whole, the bank will have to make additional efforts to meet the enhanced requirements of its member countries. Further, it will be required to increasingly collaborate with other multilateral institutions, such as the IMF, on the important issue of providing economic and institutional resources to many developing countries with a view to improving their levels of productivity and efficiency. The bank may also increasingly adopt a regional approach to solving difficult problems that need a broader geographical approach than do specific country operations.

Along with the main objective of fighting poverty in many countries across the world, the World Bank is likely to pay increasing attention to fragile global ecosystems and their interrelationships with the consequences of development, particularly in the context of the environmental impact of bank-financed projects. Another new direction for the World Bank is its increasing association with the work of nongovernmental organizations (NGOs) in developing countries. The World Bank has become increasingly involved in the sup- port of organizations such as the International Centre for Settlement of Investment Disputes (ICSID), which has assisted in mediation or conciliation of over 375 invest- ment disputes between governments and private foreign investors since its inception in 1966. The number of cases submitted to this organization has increased in recent years; the group saw thirty-eight cases in 2011 alone.

Internally, there is likely to be an ever-greater need of political and financial support for the bank from member governments, especially those of the industrialized countries.

iNter-aMericaN developMeNt baNk The Inter-American Development Bank (IADB) was established in 1959 with the primary objective of promoting social and economic development in Latin America.

Co py ri gh t @ 20 15 . Ro ut le dg e.

202 Chapter 6 • Supranational Organizations and International Institutions

The bank, headquartered in Washington, DC, has forty-eight member countries, in- cluding twenty-two non-borrowing members that only provide capital and have voting representation.

The main operations of the IADB are focused on providing long-term public financing to member countries. The main areas for which loans are extended include agriculture and rural development, transport, communications, and mining. Since the onset of the debt crisis in the 1980s in Latin America, the IADB has adopted special lending programs that direct financing where it is most urgently needed. Loans are made on a project basis, with proposals initiated by borrowing countries and examined and approved by the bank. The bank also provides technical assistance to the member countries for the preparation of project proposals and their implementation.

Unlike the World Bank, the IADB obtains a significant portion of its funding from member contributions to the paid-in capital of the bank. The United States has the largest contribution of paid-in capital (30 percent), followed by Brazil and Argentina. Loans are made only to Latin American and Caribbean countries, however, and only to governments. Since inception, the bank has loaned more than US$169 billion for over 13,000 projects in twenty-six countries throughout Latin America and the Caribbean. The announced policy of the IADB is to stop lending to a country whose account falls in arrears. In recent years the IADB has borrowed substantial funds in the international financial markets to supplement its resources for financing development in member countries. It continues to be well regarded in the international capital markets, despite the debt crisis faced by many of its member nations in the 1980s.

The role of the bank has been expanded to undertake financing of social projects, such as health, education, and rural development. Moreover, the smaller and economically weaker countries of Latin America have been given the highest priority in the extension of loans. Loans typically have a maturity period of between thirty and forty years. In ad- dition, the IADB assists member states in mobilizing resources in their internal markets, especially through co-financing arrangements.

aSiaN developMeNt baNk The Asian Development Bank (ADB) was founded in 1966 with the objective of pro- moting economic growth and cooperation in Asia and the Far East, including the South Pacific region. Although membership is primarily concentrated among countries of the region, major industrialized countries, such as Japan, the United States, Canada, and Germany, are also members in the capacity of donors. The bank currently has sixty-seven member nations. Traditionally, the president of the bank has been Japanese. Indonesia has been the largest borrower from the bank historically, but Vietnam, India, Pakistan, and Bangladesh were granted the most loans in 2011, taking up 55 percent of the total for the year. The ADB approved 114 loans totaling US$21.7 billion in 2011, for the purposes of 104 projects.17

The ADB provides different types of financial and technical assistance to member

Co py ri gh t @ 20 15 . Ro ut le dg e.

Financial Organizations 203

countries in the region, including guarantees, investment loans, and direct technical assistance. The important areas that receive ADB assistance are agriculture, industry, energy development, transport and communications, development of finance institutions, water supply, sanitation, and urban development. In recent years, the ADB has promoted inclusive growth in Southeast Asia as evidenced by a focus on microfinance programs throughout the region. Additionally, the ADB has partnered with ASEAN in creating an infrastructure fund for improvement in Southeast Asia.

Most ADB loans are long-term, and maturities range from ten to thirty years. Loans carry a fixed rate of interest that varies according to the prevailing rates in the interna- tional financial markets at the time of the extension of the loan, although in recent years the ADB has also started to lend at variable rates, like the World Bank. Repayment and grace periods vary, depending on the per capita income of the borrowing country. Grace periods range from two to seven years.

The ADB has a soft-loans facility known as the Asian Development Fund, in which concessional terms are granted to borrowing countries. This facility is funded by member- country contributions. Loans from this facility are provided free of commitment fees and require a nominal service charge of 1 percent per annum.18 Repayments have traditionally been spread over a thirty-two year period, including a grace period of eight years.

africaN developMeNt baNk The African Development Bank (AfDB) was established in 1963 with the primary objec- tive of accelerating the development process and improving socioeconomic conditions in the newly independent countries of Africa. The bank is headquartered in Abidjan, Ivory Coast. An important characteristic of the AfDB is its strong emphasis on maintaining its fundamentally African character and orientation. In fact, until 1982 non-African countries were not permitted to become members of the bank. Non-African countries are now al- lowed to become members only with certain specific safeguards aimed at preserving the unique African orientation and identity of the bank. Currently, the bank has fifty-three members from Africa and twenty-five non-African members, including the United States, Canada, France, China, and the United Kingdom. Since inception, the bank has funded more than 3,600 loans and grants for a total of UA 60 billion.

The bank is organized into three different affiliates, the largest entity being the bank itself, which lends to the more economically advanced member states and charges rates of interest at a spread over the cost of its own borrowed funds. The second affiliate is a soft-loan window, known as the African Development Fund (ADF), which channels con- cessional assistance to poorer member countries. There is no interest on this assistance, and historically there has been only a nominal service charge of 0.75 percent per year. The ADF receives its resources from the non-African countries, including several industrial- ized countries. The third affiliate is the Nigeria Trust Fund (NTF), which lends funds at rates and maturities that are between those charged by the AfDB and those charged by the ADF. The NTF, set up in 1976, is funded entirely by the Nigerian government. The

Co py ri gh t @ 20 15 . Ro ut le dg e.

204 Chapter 6 • Supranational Organizations and International Institutions

bank raises its resources from paid-in capital by member countries, concessional loans from governments of industrialized countries, and, more recently, significant borrowings in the international financial markets that have been supported by the excellent credit ratings earned by the bank from major US credit-rating agencies.

The AfDB’s strategic plan for the years 2003–2007 included some new methods for reducing the level of poverty on the continent, and ways of improving the governance, environmental protection, and treatment of women in Africa. This included the creation of the Central Microfinance Unit. Microfinance, or lending small amounts to the poorest individuals on an unsecured basis for the creation of small businesses, has been successful in other areas of the world and is seen as an avenue of great opportunity for improvement in Africa. In recent years, the AfDB has focused on the additional goals of creating more solid financial markets in Africa and other strategies to reduce poverty and improve liv- ing conditions on the continent.

europeaN iNveStMeNt baNk The European Investment Bank (EIB) was established in 1957 by the Treaty of Rome, in conjunction with the creation of the European Economic Community. Although the bank is a separate legal entity, it is intimately connected with current EU activities and pursues four objectives:19

• Regional development and economic and social cohesion within the European Union

• Protecting the environment and improving the quality of life in the region • Preparing the accession countries for future EU membership • Community development aid and cooperation policy among member countries

The EIB attempts to implement these objectives by promoting funds for investment in projects that serve these ends. The EIB raises its resources both from paid-in subscriptions by member states and from borrowings in the international markets. Loans are made to finance projects in individual member countries and projects that serve the interest of the community as a whole, for example, projects to develop energy resources or infrastructural facilities that benefit all member states.

Germany, France, Italy, and the United Kingdom are the four largest shareholders of the EIB, and all EU member nations are also members of the EIB. Many of the EIB lend- ing operations are for long-term loans at fixed rates of interest, with maturities varying from seven to twenty years. The bank is operated on a purely nonprofit basis, although it does generate income internally to meet its operating expenses and to build up a general reserve, which is prescribed as equal to 10 percent of its subscribed capital. In 2011 the EIB approved ₣60 billion in new loans, primarily for projects in the European Union. EIB projects included funds for port expansion in Rotterdam, sustainable transport in Warsaw, and small business lending in Croatia.

Co py ri gh t @ 20 15 . Ro ut le dg e.

Summary 205

Support to developing countries is complemented by the operations of the European Development Fund (EDF), which is funded out of allocations made from the budgetary resources of the European Union.

europeaN baNk for recoNStructioN aNd developMeNt The European Bank for Reconstruction and Development (EBRD) was established in 1991 to promote development in eastern and central Europe following the collapse of communism. The bank uses investment and influence to transition formerly centrally planned economies to market-based democratic systems. In 2011, the EBRD invested ₣9.1 billion in 380 projects in thirty countries. The bank is headquartered in London and is owned by sixty countries worldwide, the European Investment Bank, and the European Union. The EBRD has made loans to improve the national railway system in Poland, the municipal water and wastewater systems in Latvia,20 the operations of the oil and gas industry in Hungary, and the efficiency of the pharmaceutical industry in producing non-brand-name drugs in Serbia and Montenegro.

suMMary The increasing interdependence of the nations of the world has increased the need to co- ordinate international actions and policies. Since World War II, permanent international institutions, or supranational organizations, have been formed to serve the vital role of providing economic stability and continuity in the world economy. Some institutions have a global focus, while others are designed to meet more specific regional needs. All of these institutions have the same goals: making the conduct of international business easier and more transparent for business people and the general citizenry.

The General Agreement on Tariffs and Trade, charged with liberalizing international trade restrictions, offers the most-favored-nation clause to member organizations. Eight rounds of GATT meetings were held, resulting in significant reductions in tariffs on indus- trial products. After the creation of the World Trade Organization in 1995, the Doha Round focused on the improvement of the economic performance of the developing countries. The GATT and WTO rounds highlight the differences in perspective that exist between developed and developing countries as negotiators attempt to establish a coordinated, non-protectionist global trade policy that serves the common interests of all parties.

In contrast to the WTO, the United Nations Conference on Trade and Development is a forum for developing countries to communicate their international trade perspectives as a group to the industrialized countries. Although limited in impact, UNCTAD has improved the dialogue between the developing and developed countries.

There are five different levels of economic integration: free trade area, customs union, common market, economic union, and political union. Groups such as the European Union, ASEAN, and the Andean Community have been established to coordinate regional trade policy, with the European Union and ASEAN being the most successful. The IMF and the

Co py ri gh t @ 20 15 . Ro ut le dg e.

206 Chapter 6 • Supranational Organizations and International Institutions

World Bank are international lending institutions, each performing specialized roles in the international monetary system. As discussed in Chapter 4, the IMF focuses primarily on lending for structural adjustments because of balance of payments problems, while as discussed in this chapter, the World Bank, which is comprised of four main agencies (IBRD, IDA, IFC, and MIGA), provides external financing to developing countries at affordable rates of interest. The IBRD, whose main objective is to support social and economic progress in developing countries, offers five major types of loans: specific in- vestment loans, sector operations loans, structural adjustment and program loans, technical assistance loans, and emergency reconstruction loans. The IDA provides long-term funds to the poorest member countries in order to promote long-term development projects. The IFC promotes the development of private enterprises by making equity investments and providing loans. Operating as a catalyst, the IFC exits from an enterprise as it develops and matures. MIGA promotes overseas direct investment in developing countries by providing guarantees against noncommercial risks.

Other development banks, such as the IADB, the ADB, and the AfDB, have been formed to provide regional assistance in the Western Hemisphere, Asia, and Africa, respectively. The European Investment Bank and the European Bank for Reconstruction and Develop- ment promote investments in the European Union and in eastern Europe.

disCussion Questions 1. Discuss the WTO and its role in international trade. 2. What is the most-favored-nation clause? 3. What trading organization represents the international trade objectives of devel-

oping countries? How do the concerns of developing countries differ from those of the industrialized, developed countries?

4. What is a regional trade group? What are the advantages provided by these groups?

5. Describe the structure at the World Bank and the services of its four main agencies.

6. What types of loans does the World Bank provide? How are these different from loans provided by the IMF?

7. What will the role of the World Bank be in the future? 8. Identify three regional financial institutions and outline their financial services.

notes 1. The ninth round, the Doha Development Agenda, was undertaken under the auspices of the World

Trade Organization. 2. World Trade Organization, “Understanding the WTO.” 3. There have been some temporary exemptions in cases in which preferential agreements had been

signed prior to GATS. These exemptions cannot last longer than ten years, and new exemptions cannot be added or extended.

4. Specific forms of intellectual property are discussed further in Chapter 8.

Co py ri gh t @ 20 15 . Ro ut le dg e.

Globalization at the Crossroads: Whither the WTO? 207

5. The least-developed countries were provided an extension until 2016 for conforming with TRIPS (primarily for pharmaceutical patents).

6. In fact, the name “Mercosur” implies the eventual goal. It stands for Mercado Común del Sur, or “Common Market of the South.”

7. World Trade Organization, “Trade Policy Review: Norway.” 8. Ibid. 9. Ellis, Founding Brothers.

10. Association of South East Asian Nations, “Southeast Asia: A Free Trade Area.” 11. Ibid. Prior to the Asian financial crisis, growth in the region was increasing by 29.6 percent

annually. 12. Association of South East Asian Nations, ASEAN Annual Report, 2003–2004, Chapter 2, “Economic

Integration and Cooperation.” 13. Asia-Pacific Economic Cooperation. 14. Prior to July 31, 1998, the spread was 0.50 percent. 15. World Bank, Annual Report, 2004 and 2011. 16. In fiscal 2004, countries with annual per capita GNI of up to $865 were eligible for IDA assistance. 17. Asian Development Bank. 18. This charge is effective during the grace period; the interest moved to 1.5 percent during the amortiza-

tion period as of December 1998. 19. European Investment Bank. 20. European Bank for Reconstruction and Development.

BiBliography African Development Bank. “Strategic Plan 2003–2007.” www.afdb.org/en/publications/new_titles/

adb_strategic_plan. Asian Development Bank. www.adb.org. Asia-Pacific Economic Cooperation. www.apec.org. Association of South East Asian Nations (ASEAN). Secretariat. www.aseansec.org. ———. Annual Report, 2003–2004. ———. “Southeast Asia: A Free Trade Area.” www.aseansec.org. Bhagwati, Jagdish. Termites in the Trading System. London: Oxford University Press, 2008. Ellis, Joseph J. Founding Brothers: The Revolutionary Generation. New York: Vintage, 2002. European Bank for Reconstruction and Development. www.ebrd.com/pubs/general/6388a.pdf. European Investment Bank. www.eig.org. Inter-American Development Bank, Annual Report, 2005. www.iadb.org/exr/ar2005. World Bank. Annual Report, 2004, 2011. World Trade Organization. “Trade Policy Review: Norway.” September 2004. www.wto.org.Indexmundi.

com. –——. “Understanding the WTO.” www.wto.org.

Globalization at the Crossroads: Whither the Wto? As was shown in Figure 6.1, there has been a rapid acceleration of regional trade agree- ments since the formation of the WTO in 1995. When this is coupled with the lack of progress in the Doha Development Agenda, the question must be asked about the contin- ued relevancy of the WTO in the future. A world without the WTO might not imply a lack of multilateral agreements, but as more and more regional alliances take place outside of the auspices of the WTO, there may be a tacit acknowledgment that the WTO’s place

Co py ri gh t @ 20 15 . Ro ut le dg e.

208 Chapter 6 • Supranational Organizations and International Institutions

as a supranational governing body may have peaked in importance. The recent forma- tion of the Pacific Alliance among Chile, Colombia, Mexico, and Peru has the potential of returning Latin America to the “open regionalism” which led to the founding of the Mercosur Accord in 1991. This time, the founding members of the Pacific Alliance are free- market oriented, relatively fast growing economies which have embraced globalization. The Pacific Alliance is trying to resolve the difficulties of the spaghetti bowl of regional trade agreements by agreeing on rules of origin, border procedures, and harmonization of trading rules without WTO involvement.

Questions for Discussion 1. How might the creation of yet another regional alliance threaten the WTO? 2. What does the “spaghetti bowl” of regional trade agreements mean for the notion

of free trade? 3. Should free trade be the goal of international business? 4. What are the potential benefits and pitfalls of a free trade regime with or without

the WTO?

caSe Study 6.1

struCtural adjustMents in MasaWa

Masawa is a small country located in southwestern Africa, with an area of 240,000 square miles and a population of about 60 million. The northern and western parts of the country are hilly terrain, while the southern and eastern areas are plains. Masawa has substantial natural resources: mineral deposits of manganese, copper, and tin in the northern hill areas and large tropical forests in the southeastern parts of the country. The eastern part has most of the cultivated land, and agricultural production, especially cereal crops, is concentrated there. There are some cocoa plantations in the western part of the country; cocoa is an important commercial crop. The main exports of Masawa are copper, tin, and cocoa. Manganese deposits are too small to be commercially viable for export.

The country attained its independence from colonial rule in 1961 and since then has seen a few political upheavals. Emorgue Watiza, a leader of the country’s freedom movement, was the first president. He ruled Masawa for six years before being ousted by the military, which installed General Ramaza, who was assassinated in 1974 and replaced by another military ruler, Colonel Waniki. Colonel Waniki instituted a series of political reforms, and after twenty-one years of power, handed over the

Co py ri gh t @ 20 15 . Ro ut le dg e.

Case Study 6.1 209

reins of government to Dr. Sabankwa, the winner of the country’s first democratic election. Dr. Sabankwa brought excellent credentials to the presidency. He holds a PhD in political science and government from the University of Paris and had been active in the movement for restoration of democracy in Masawa. He enjoyed the almost total loyalty of his tribe, the Waldesi, which is the largest tribe in the country, constituting 30 percent of the population. Besides the Waldesi, Masawa also has three other major and sixteen minor tribes. The three other major tribes are the Mokoti (18 percent), Lemata (15 percent), and Simoki (11 percent). The remaining 27 percent of the population is made up of members of the smaller tribes, none of which individually constitutes more than 5 percent of the population.

Dr. Sabankwa enjoyed considerable support from the Simoki and several minor tribes at the time of his election. After more than fifteen years in office, however, that support has eroded, and rumblings of discontent have been heard, even from Sabankwa’s own Waldesi tribespeople, especially those living in urban areas. Much of the discontent is clearly the result of the economic difficulties the country is fac- ing, which have led to considerable difficulties for both the urban and rural popula- tions. Reactions, however, tend to be more pronounced in the densely populated and politically conscious urban areas.

Most of Masawa’s economic difficulties began before the election of Dr. Sa- bankwa. The country had little in the way of industrial or technological development when it attained independence, and the annual per capita GNP was $160. Much of the agriculture was conducted along primitive lines and was largely dependent on seasonal rainfall, which tended to be erratic. In the initial years of independence, Masawa’s rulers sought to adopt a centralized planning approach to economic de- velopment, assigning a key role to the government in nearly all aspects of economic activity. The public sector accounts for 90 percent of industrial production, and all key infrastructure projects are run by government agencies. Masawa has a large number of highly paid civil servants who administer the wide range of economic and other controls imposed by the government. Although private enterprise is officially permitted, there are a number of bureaucratic disincentives for entrepreneurship. A typical new venture in the private sector needs separate approvals from thirty-two different government agencies and departments.

As in many other countries of the developing world, the state-owned industrial enterprises of Masawa have had losses for a variety of reasons, including inef- ficient management, overstaffing, administered prices of products, and outmoded technology. The government has guaranteed most of the debt taken on by the enterprises and has had to resort to substantial deficit financing to make good on these obligations.

(continued)

Co py ri gh t @ 20 15 . Ro ut le dg e.

210 Chapter 6 • Supranational Organizations and International Institutions

Case Study 6.1 (continued)

The government of Masawa has faced a major budget deficit every year for the past eleven years; for several reasons, the deficit has become a permanent feature of the government’s finances. Government expenditures have been rising rapidly in five areas: defense, oil imports, administrative expenses of the government, subsidies to industrial enterprises, and price subsidies for essential consumption items, especially food. On the other side, revenues have been stagnant, principally because of the absence of strong measures to secure better tax compliance by the vast majority of taxpayers. The government has, therefore, resorted to large-scale deficit financing, which has pushed the inflation rate progressively higher every year. In 2011, Masawa experienced 93 percent inflation, and there were indications that this number would increase by another 40 percent in 2012.

Imports have been increasing steadily over the past seven years, while exports are stagnant, because the world market for Masawa’s principal exports continues to be sluggish. The exchange rate of Masawa is overvalued by about 70 percent, and there is a large premium on the black market for foreign currencies. The country has suffered considerable flight of capital as wealthy industrialists lost faith in the political and economic stability of Masawa.

The external debt of Masawa, largely to official creditors, is well above the level considered dangerous for sustaining the debt-service schedule. The country has no access to the international capital market, having defaulted on the amortization of earlier loans, taken primarily by state-owned corporations. Foreign exchange re- serves are at a dangerously low level and are sufficient to finance only two weeks of imports.

Dr. Sabankwa calls a meeting of his cabinet to discuss the question of accept- ing an International Monetary Fund structural adjustment loan in order to tide the country over the immediate problems on the balance of payments front and to im- prove future prospects. The finance minister briefs Dr. Sabankwa and the cabinet ministers on the pertinent issues.

The IMF is willing to extend a $3 billion loan to Masawa under its structural adjustment lending program, but it wants Masawa to draw up a set of concrete economic measures to restructure the economy. Although several measures have been recommended by the IMF, five are the most important:

1. The government should initiate a phased reduction of official subsidies on food.

2. Masawa should devalue the exchange rate by 40 percent. 3. The government should take steps toward privatizing state-owned enter-

prises.

Co py ri gh t @ 20 15 . Ro ut le dg e.

Case Study 6.1 211

4. The level of imports should be reduced. 5. The government should reduce its administrative expenses by cutting the

government staff and salaries.

While these measures seem sensible and useful, effective implementation of them would create many practical difficulties. First, cutting food subsidies would be an extremely unpopular measure that might spark civil disturbances, especially in the urban areas. Those most affected would be the urban poor, who are already under great economic hardship. Devaluing the exchange rate also has ominous implications. Politically, it might be viewed as a weakening of the economy, pro- viding another reason for opposition groups to attack the government’s handling of the economic situation. Further, the costs of imports would rise and contribute to an increase in the already high inflation rate. Privatization would also be difficult, since there are few people in Masawa with the managerial or technical expertise to take over the operations of these enterprises. Further, there is bound to be strong opposition from the trade unions to any move for privatization.

Reducing the level of imports would be a feasible option, but it would hurt the growth rate considerably, because imports of essential industrial equipment and machinery would have to be curtailed. A very large cut in imports might not even be possible because of the inelastic level of defense and oil imports. Reducing government staffing may create ill feelings in a crucial time.

Dr. Sabankwa fears that these steps, if implemented, would generate political unrest that would lead to the fall of his government. As he mulls over these issues, he wonders whether a compromise solution can be found.

diScuSSioN QueStioNS 1. What would be your position if you were a member of Dr. Sabankwa’s

cabinet? 2. Should Dr. Sabankwa accept the IMF plan as it exists or should he insist on

some modification? If modification is needed, what changes should he sug- gest? What arguments can Dr. Sabankwa make to convince IMF officials to agree to these modifications in the structural adjustment plan?

Co py ri gh t @ 20 15 . Ro ut le dg e.