Joseph E. Stiglitz
Senior Vice President and Chief Economist
The World Bank[1]

In the aftermath of World War II and in the wake of the Great Depression (surely one of the underlying causes of the war itself),[2] the countries of the world created three international institutions designed to facilitate economic cooperation: the General Agreement on Tariffs and Trade (GATT), the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD). GATT (which has since evolved into the World Trade Organization) was to work on lowering trade barriers among nations and on preventing the beggar-thy-neighbor trade policies that were seen as a contributing factor to the breadth and depth of the Great Depression. The IMF was to provide liquidity and to sustain the international payments system (the gold standard that was reinstituted after the War). And the IBRD, known more generally as the World Bank, was primarily to facilitate the reconstruction of war-damaged Europe, and then to reach beyond that to aid in the development of what later became known as the Third World.[3]

It is now more than fifty years since the creation of these institutions. Over that half-century, they have evolved enormously, especially in response to changing economic circumstances and changing needs. The 1971 abandonment of the gold standard by the United States (and subsequently by the rest of the world) clearly necessitated a change in the functioning and perhaps in the very role of the IMF. The collapse of the Soviet Union posed a new set of challenges to the international institutions – namely facilitating the transition of the former Communist countries to a market economy. The fiftieth anniversary of the Bretton Woods institutions (IMF and World Bank) was marked by criticism from a vocal international group dedicated to the notion that "Fifty Years Is Enough", reflecting a view among certain groups that these institutions had done as least as much or more harm than good. As the World Bank has worked over the past few years to redefine itself, that cry is heard much less often today. Similarly, in spite of considerable hesitancy and a lively debate over the IMF’s role and competence, the U.S. Congress did increase its funding, perhaps in the recognition that if the IMF did not exist, it would have to be reinvented.

As the world moves into the next century, it is appropriate to re-examine how these institutions are and should be evolving. I shall focus my remarks especially on the World Bank, but I shall look at that institution through the broader perspective of the global economic architecture. And I shall look at these institutions through the lens of modern public finance, macroeconomics, and development theory.

Global Public Goods and the Theory of Market Failures

The Bretton Woods organizations are public institutions, designed to facilitate collective action at the global level. At the time the Bretton Woods institutions were founded, there was not as clear a concept of the role of collective action as there is today. Still, Keynes and his compatriots grasped the notion that there were imperfections of capital markets that might impede the flow of capital, say from more to less developed countries. Keynes and his contemporaries were keenly aware that market economies do not always work well—indeed, the Great Depression can be viewed as the most massive market failure that the world had experienced since the beginning of capitalism. He demonstrated how appropriate government intervention could help the economy pull out of an economic downturn. While at the time his ideas were viewed as radical, they were in a sense very conservative, for they maintained a faith in the market economy: beyond maintaining overall macroeconomic stability, government did not have to play any role in resource allocation. Thus, even at the founding of these institutions, there was a curious blend of a recognition of a massive market failure and a faith both in markets and government—or at least in the ability of government to address effectively the key market failures.

Since Keynes, the intellectual foundations of that belief have been subject to extensive scrutiny. Economic fluctuations in general (and the Great Depression in particular) are the tip of an iceberg, the most dramatic manifestation of market failures that are pervasive in the economy.[4] But while we have thus come to recognize that markets are not generally even constrained Pareto-efficient[5], there has also grown a greater recognition of the limitations of government.[6] Government and markets are seen today more as complements, each providing a check on, and facilitating the functioning of, the other.[7] The recent failures in Russia have brought home forcefully the importance of the institutional infrastructure required to make markets work. This includes having appropriate legal and financial institutions, ensuring competition and contract enforcement, providing for bankruptcy, and enhancing the safety and soundness of banks. At the same time, public institutions have also made more extensive use of market mechanisms.

The modern analysis of collective action thus begins with a discussion of market failures, but then moves on to consider whether public interventions can improve matters, and how those interventions can best be designed. It recognizes the presence of agency problems in both the public and the private sector.[8]

We are concerned here with collective actions, and therefore with market failures, at the global level. Here, the concept of global public goods is essential. Following Samuelson’s definition of the concept of public goods (in 1954), it became clear that the benefits of some public goods extended only within a limited geographic region. There thus developed a theory of local public goods.[9] More recently, it has become clear that there are public goods whose benefits extend well beyond national borders to the global level. These are global public goods.[10] Five major examples have been discussed in the literature: economic coordination, environment, knowledge, international security, and humanitarian assistance. Various international institutions have been created to facilitate collective action in each of these areas. As these five public goods overlap to some degree, not surprisingly so do the mandates of the institutions, a theme to which I shall return later in this essay.

In analyzing the evolving role of each institution, it is necessary to identify their core mission, and the market and/or public failure which necessitates collective action at the global level. Why, for instance, might non-cooperative action lead to Pareto-inferior outcomes?

Answering the latter question might not be as easy as it seems. Standard neo-classical theory, for instance, argues that is in the interests of each country to adopt a policy of free trade: what is sometimes referred to as a policy of unilateral disarmament is a Nash equilibrium. But there is considerable evidence that GATT and WTO have played a central role in moving the world towards a freer trade regime (though they have been more successful in reducing tariffs on manufacturing goods, of concern to the industrialized countries, then in removing trade barriers in agriculture, the comparative advantage of the less developed world). To understand that role, one has to move beyond the neoclassical model. But once one does that, a concern for intellectual consistency should make one wary of returning to that model in analyzing trade policies more generally.

Understanding the non-cooperative equilibrium is important in identifying the kinds of interventions that are likely to be desirable at the international level. For instance, McKibbin (1988) concludes his analysis of the role of international macroeconomic coordination in a context in which countries face inflationary pressures by saying:

A comparison of policies under cooperation and non-cooperation clearly shows that the non-cooperative equilibrium is contractionary relative to the cooperative equilibrium.

If that is correct, then international cooperative action should attempt to induce countries to take more expansionary policies than they would of their own accord.[11]