Preliminary

Do not quote

17 October 2002

Jorge Braga de Macedo

One year ago, the New Partnership for African Development (NEPAD 2001) contained a call for better governance. Now an African peer review (APR) mechanism is to begin in early 2003. The APR is designed "to help the designated State improve its policy-making; adopt best practices; and comply with established standards, principles, codes, and other agreed commitments"(UNECA 2002). What are the prospects for such an African multilateral surveillance framework to deliver the improvements in economic and political governance called for by the NEPAD?

It has been said that the NEPAD is a road not travelled before and parallels with the in Bretton Woods, New Hampshire in 1944 or with the Marshall plan have been used. The best parallel though is with the conference in Monterrey, Mexico in 2002 where, for the first time, the UN system, the Bretton Woods institutions, and the WTO collaborated not just at the end but throughout the process. Similarly, the analogy with the Marshall Plan only helps if the emphasis is on the peer pressure system set up to co-ordinate the implementation of the plan, because it encouraged a learning process between European nations, which was inherited by the OECD and the EU.

Meanwhile, the globalisation of business and the "information revolution" changed political processes in a way in which "soft power" became more important in relation to hard power. Credibility became a key power resource, giving more open, transparent organisations an advantage with respect to free information. One way to answer the question about credible surveillance with respect to macroeconomic stability – a crucial dimension of multilateral surveillance - is thus to compare the Article IV consultations of the IMF, the Economic Development Review Committee (EDRC) country reviews at the OECD and the EU Broad Economic Policy Guidelines.

Looking at the EU as a more ambitious attempt to promote rules of good conduct among its members certainly helps draw lessons for other countries and regions. But it must be stressed that other international organisations also played a role in spreading the results of alternative policy paths among their member states. The wide acceptance observed suggests that national policymakers stabilised, liberalised and privatised the economy in part because they saw other policymakers do the same.

Definitions allowing the comparison between IMF, OECD and EU are provided in Section 2, following a discussion led by Niels Thygesen (2002) during which it became clear that the appropriate surveillance method varies with circumstances of the particular countries and the topic under consideration. Another conclusion was reached, of particular importance to Africa: the absence of good data poses a considerable challenge to the exercise of surveillance and peer review, just like it would to any other initiative for better governance.

As a lending institution, the IMF has particular clout in the case of program countries – and to some extent in emerging economies too. The OECD has to rely on the quality of ideas and the relevance of comparative policy analysis. Section 3 follows closely Thygesen (2002). Now EU processes go well beyond surveillance or peer pressure, in particular through the evolution of the comprehensive "rule book" and the greater involvement of many high-level national decision makers than at the other institutions. In section 4, which follows Macedo et al. (2001), the European institutional architecture is interpreted in a way that favours schemas of flexible integration, which, like NEPAD, have a voluntary, self selection element.

There has been considerable discussion over recent years concerning how the supervisory role of the Fund might be strengthened. The idea of liberating the IMF from direct pressure, in particular from the larger countries, was been put forward by Eichengreen et al (1999). It may indeed be hard to complain if some countries, by virtue of their having the capacity and the will to undertake analyses of other countries, exert more influence than others. One way of strengthening the Fund’s supervisory role would be to separate the analytical function from lending operations. It is also possible to separate high quality analysis and surveillance and then have the information made available for peer pressure exerted at the regional level, as such pressure is more naturally organised among smaller groups than in the context of global institutions. As I argue in my (2002), this complementarity also reflects the "Monterrey consensus".

Related to the need for adequate data and a well-defined analytical method, there is a cultural challenge for credible surveillance (the requirements of data, analysis and culture are captured by the acronym dac in OECD 2001). The challenge boils down to the effectiveness of peer pressure. Therefore, given the high perception of political risk in Africa relative to other developing areas, greater national capacity and institution building are necessary in order to make the APRs useful for the purposes of better economic and political governance included in the NEPAD (section 5). The concluding section 5 argues that good governance under globalisation is one reason why it is useful to link regional and global surveillance frameworks. Unfortunately, few governance indicators such as those collected in the African Economic Outlook launched by the African Development Bank and the OECD Development Centre (OECD 2002a) are available as yet. The pitfalls of peer pressure under such circumstances must be kept in mind.

In this section, some definitions are provided before a comparison of the main multilateral surveillance frameworks (MSF) in use. The issue of whether peer pressure bring about improved performance has been addressed by Besley and Case (1995) in the context of "yardstick competition", a term coming from industrial organisation which suggests comparing similar regulated firms with each other (Schleifer, 1985). For any given firm, the regulator uses the costs of comparable firms to infer a firm's attainable cost level. Conversely, if the regulator equates the price to the marginal cost of the firm itself, then managers have no incentive to reduce cost. Using the costs of comparable firms (or their average excluding that of the firm itself, which serves like a fictitious "shadow firm") prevents the firm's choice to have an effect on the price it gets. As comparable firms may not exist or be observable, a scheme of yardstick competition may not fully overcome moral hazard problems, but it is certainly preferable to the traditional procedure of comparing current and future costs to past performance.

The peer pressure scheme is thus susceptible to manipulation by participating firms but the difficulty in co-operating to impose collusive behaviour makes this perverse outcome less likely. Note also that in the case where heterogeneity is observable and can therefore be corrected for, Schleifer (1985) shows that a regulatory scheme based on peer pressure should lead to a superior performance. This implies that the regulator can credibly threaten to make inefficient firms lose money and cost reduction can therefore be enforced. When national objectives are at stake, best practices can thus be achieved, rather than allowing a convergence towards the mean. Conversely, when peer pressure is used to stall reforms, rather than to promote them, the outcome is equivalent to the collusive equilibrium and an alternative yardstick must be devised.

Therefore, adapting the same reasoning, when there is peer pressure among national policymakers to follow best practices, these are likely to become more and more accepted. Peer reviews have enhanced competition for better macroeconomic and trade policies among OECD members. Similar benchmarking has begun with respect to structural policies, especially those relating to the regulatory framework. The greater complexity of such policies makes them more susceptible to procrastination, and the same problem has been observed in the EU. This hinders institutional change and makes corporate and political governance more difficult.

When applied to corporate strategy, yardstick competition leads to benchmarking exercises which have become common in OECD countries. Business associations such as those gathered in the Business and Investment Advisory Committee (BIAC) of the OECD or initiatives such as the European Round Table of Industrialists have been active in promoting and disseminating comparisons of best practices in various aspects of corporate governance and investment climate. Yet these initiatives remain unusual in developing countries, and especially in Africa.

What is meant by pressure varies with the surveillance framework and the influence of advice might be a matter of managing the process through which the advice is formulated. Moreover, as countries are not just a homogenous block, it is also a question of how the advice is targeted to the different audiences within a country. It would therefore be beneficial to see how target groups can be helped to exercise pressure on their peers within a country.

In the case of the EU MSF, the objectives of the peer reviews are quite clear: the process is really a method of integrating and harmonising policies in order to obtain convergence across countries and ultimately to have a single policy process. In the case of the IMF and the OECD, the objectives and mandates are less clear. A cost/benefit analysis of the review processes should be conducted. There are certainly high costs, among which the political cost of renouncing the ability to introduce policies without prior scrutiny by others. The benefits accrue not only to civil society but also for governments themselves, with the emphasis on a small case g -- not for the governments of today but for governments of tomorrow. If the mandates are not clear, this is difficult to explain to those in power at a particular time.

Defining what is meant by "peer" and sticking to rules once they are defined is important. Size matters very much – political and military importance often determines which countries can lead or block the process. This is again linked to the clarity of mandates. If the objective sought at the end of co-ordination is peace in the world , then the bigger have an interest in playing the game to shared rules.

In addition to identifying external vulnerabilities and supporting international policy co-ordination, surveillance as practised by the IMF may serve as advice, information gathering and dissemination to the public and to policy makers; technical assistance. The core of the policy advice that has been developed over the years though is simply "delivering the message" (Boughton 2001).

Banks and independent research institutes that evaluate policies and monitor economic performance and policies may fulfil most if not all of these surveillance functions. The private sector’s compliance and risk management expertise is particularly strong in making the case for financial liberalisation. More generally, only local actors control the strategic resources – leadership and political capacity – that are essential for governing the policy process. These resources also include particular local knowledge of the nature (complicit or otherwise) of the relationship between the political and business communities, which can be acutely relevant to the policy process. The same can be said about national value systems and how these relate to various policy choices. This is again how data, analysis and culture (dac) affect the credibility of surveillance.

The importance of the knowledge bases that exist in the countries under review notwithstanding, those available in international institutions, in particular certain types of technical or conceptual knowledge remain decisive for credible surveillance. In fact there is a tendency for local analysts to compare the prevailing situation with that of 10 or 15 years earlier when the more relevant and more useful standard of comparison is often the experience of other countries. It is here that the comparative advantage of international institutions resides.

In that sense, there is a complementarity between the national discussion which is enriched by the international analysis and the feedback from the particular circumstances of national discussion which enrich international analysis. In the course of preparing EDRC country reviews, for example, the interactions with national officials, and their assistance in tailoring the analysis and recommendations to reflect their particular circumstances, are extremely useful. The output of the peer review process is not just the final report. It also includes the interactions in the course of its preparation between national officials, the Secretariat and the Committee. The meaningful standard of the effectiveness of advice, surveillance and peer pressure is then the extent to which it positively influences the domestic debate. Sometimes this can be done through putting forward ideas that have yet to be aired in domestic debate; on other occasions it can be by assisting in the penetration of ideas that have been developed by national research institutes or think tanks.

That being said, many commentators have wondered why international organisations are doing projections and macroeconomic analysis given the quality of the work being done in the private sector. In fact, a lot of what private sector analysts say is similar to what international organisations say. The issue is "Who leads?" The work of the private sector would be rendered much more difficult were the IMF and the OECD to cease producing projections. Nevertheless, there is an identification problem in the relationship between the work produced by international organisations and the market. It should be analysed further but the solution will surely depend on the nature of the surveillance exercise.

As implied by the reference to credible MSFs, the effectiveness of the surveillance mechanisms employed by the international organisations is very much dependent on the credibility of the review process. International organisations can add weight to local voices -- even if national think tanks have said something many times, it helps to have a credible external body say it too. Therefore, international organisations must ensure that the analysis and advice presented to the countries is not, and is not perceived to be, either tainted by special interests or weakened by the use of flawed analytical methods.

Thus international organisations have a special role to play because of their comparative advantage and greater experience in some areas of evaluation, notably the international environment and interdependencies, and because they have easier access to data. In particular, aside from "bilateral" surveillance of individual member states, the OECD and the IMF undertake multilateral surveillance, putting things into a global perspective; which clearly adds to the surveillance process. Given the ongoing process of globalisation, this makes their work especially credible for the actors involved in it.

Within the EU there is a dynamic process moving EU member countries’ national policies towards close co-ordination and in some cases towards their integration into a single EU policy. In this context, surveillance at the EU level differs from both the IMF and the OECD surveillance exercises. There is moreover a further difference attributable to the binding nature of some EU recommendations. The EU uses different surveillance processes for different policy areas. Its most important surveillance instrument, the Broad Economic Policy Guidelines which set out the general directions that economic policies should follow, is becoming a very detailed policy co-ordination instrument, and includes recommendations for structural policies.

Regionality reinforces peer alignment, the case of the EU being a good example. This regionality aspect is qualitatively important in contributing to the atmosphere in which peer review and surveillance take place. With specific regard to the OECD (of which two thirds of the Members are European), the non-compulsory aspect, which enhances countries’ sense of ownership, also makes an important contribution to this atmosphere.

Part of the "soft" co-ordination that takes place in international fora is information sharing (data produced on a comparable method, details of policies in various sectors and analysis of them). Though it has financial costs, this public good element is not emphasised enough. This is the element that could most easily be transferred from the OECD style of review to others. Some very important objectives could be met by improving information sharing. We need to think how we can improve the bigger players’ understanding of the benefits of such information sharing.

These benefits are evident when it comes to the prevention of financial crises. Were it possible to predict crises, those avoided should be counted as successes. Looking at the phenomenon the other way, prediction is not sufficient when there is political sovereignty -- no matter how much pressure is exerted, that substantial degree of freedom cannot be broken. Perhaps the best gauge of success is the extent to which countries are better equipped to withstand crises and whether this is due in part to the existing MSFs.

The scope of IMF surveillance has expanded greatly since that term was introduced with the revision the Fund’s articles of agreement in the mid-1970s. At that time it was a matter of "firm" surveillance over the exchange rate policies of members in the post Bretton Woods system of floating rates. The focus was on domestic policies in so far as these influenced the economy’s external position. Since then there has been a gradual shift (not only in the IMF, but also the OECD) towards advice on the best use of a wide range of policy instruments, whether or not they have a direct bearing on the country’s external account or exchange rate. The late Manuel Guitian (1992) referred to this change as an evolution towards "the promotion and safeguarding of an international code of good conduct in national economic policy".

The coverage of the IMF (and of the OECD) widened substantially in the 1990s. Some have called it, without intending any criticism, "mission creep" into additional topics, in particular structural policies. The following six themes now have a prominent part in the Fund’s review process (except in the least developed countries): labour market policies; product market reform; privatisation; financial sector regulation and supervision (FSAP); trade policy (notwithstanding the fact that the WTO undertakes reviews in this area); and, the environment. The extension of this agenda comes from:

1. political pressure in member countries (for example in the US Congress which has urged greater liberalisation);
2. the addition of new members (for example, the membership of the transition economies of the former Soviet Bloc has led to the inclusion of new topics on structural reform);
3. the experience of financial crises;
4. the need for additional longer-term lending facilities (it has been argued that an examination of structural policies is necessary for preparing programmes);

The IMF "mission creep" in the structural policy area can also be explained by the shift in the analytical focus in economics over the last 15-20 years to medium-term supply-side issues. Member countries have being going through quite a dramatic paradigm shift which has altered their attitude towards structural policies and the IMF has only accorded a full-scale investment of resources to those structural policy areas which it considers to be important for financial and macroeconomic stability. Examples of this work include financial sector stability assessments, technical assistance for central banking policy and work on tax policy (this latter particularly in developing countries in which the IMF is co-operating closely with the OECD in an attempt to establish which are the best practices); in many other areas, such as privatisation and labour market policies, the IMF’s work has been less systematic than that of the OECD with the focus in particular countries largely dictated by the assessment made by country teams.

When the IMF concludes a consultation process, a Public Information Notice (PIN) is issued by the Board Until the end of the 1990s, the concluding statements were not published. Their publication may have led to a watering down of their content (though this is difficult to ascertain), but staff do retain considerable influence, notably through the publication of a concluding statement at the end of their missions, the content of which tends to carry through to the PIN.

The role of Executive Board is circumscribed by the weight of the overall agenda and the number of Article IV reports to consider: in 2001 there were approximately 130 country reports, with 1½-2 hours devoted to each (the EDRC by contrast spends a full day even on small countries).

Though they do have accumulated experience to bring to bear, the Executive Directors lack the resources to deal adequately with these reports. They depend heavily on comments from capitals which tend to be read out to the letter. As a consequence, there is little give and take in discussions. That said, the countries under examination tend not to exert much pressure to modify the report’s conclusions – the only reason that is readily accepted for such a modification is where "market sensitive information" is involved which could be harmful to the country in question. Indeed, changes are more limited than those in the EDRC at the OECD where the changes made tend to involve the removal of politically sensitive advice rather than market sensitive information.

The group of independent experts on IMF surveillance (IMF 1999) noted a direct negative correlation between the size of the country considered and the impact of the advice. A justification for this could lie in the fact that the larger the country the more civil servants, independent research institutes, banks and so forth there are engaged in examining and analysing the country and so there is less scope for the IMF or indeed any other international institution to say anything new. Examples of direct positive impact are hard to find, even in small countries. The impact is easier to ascertain when a new regime has been introduced following IMF advice, for example, the Czech Republic’s exchange rate policy in the early 1990s, and the introduction by Sweden of an inflation target in 1992-93.

It is clear that countries approaching crises have not been inclined to listen to advice. In the cases of: Brazil in January 1999, Czech Republic in 1996-97, Korea in 1997, Thailand in 1996-97, the Fund did offer advice (and attempted to apply pressure) to modify unsustainable policies but this went unheeded

A further complication in evaluating the success of the IMF’s surveillance, in particular in comparison with the OECD, is the absence in most cases of relevant policy makers from the examined country when the report is being discussed by the Executive Board. In so far as the Fund employs analysts who have the confidence of member countries, the whole process may be labelled peer pressure by proxy. To some extent, this has been responded to by increased transparency which has increased greatly with the publication of the PINs and the Article IV reports. There exists in this connection a trade-off between confidentiality and transparency: governments, with good reason, object to public discussion of vulnerabilities.

The uniqueness of the OECD resides in its being a school of international co-operation: the exchanges which take place in the various committees are a unique way of making the several thousand national civil servants who each year attend those meetings aware of the international complexities and the opportunities for improvement that exist; these exchanges create, moreover, a sense of community and thereby confidence in the review process.

The true benefit of the OECD review process lies in its creation of a community of policy practitioners, which allows policy practitioners to bring their local knowledge to bear on the policy review process while also contributing to developing further the conceptual knowledge that they also need. This contribution to meshing conceptual knowledge with local knowledge is key part of the OECD’s value-added and is absent from that of the IMF. This naturally raises the possibility that the IMF has too much clout relative to the rigour of its process.

The OECD peer review process has six distinct advantages over that of IMF:

1. there is more interaction with relevant national policy officials on the basis of the Secretariat’s draft reports;
2. the EDRC’s greater involvement in discussing and modifying reports (as compared with that of the Fund’s Executive Board);
3. the useful element of having two examining countries (which is the closest thing to pure peer pressure that exists in the international system);
4. the subsequent process of revising and approving report, which gives some ownership by the country to the final report (though this redrafting does consume a lot of time);
5. the Organisation’s manageable size (IMF 133, OECD 30) and limited diversity of membership (which is particularly beneficial in that it is difficult to keep up to date in technical areas);
6. the continuity (which is typically around 3 years) and experience of the national officials that countries send as representatives (and examiners) to the EDRC.

The Secretariat plays an important and particular role in the OECD peer review exercises because of the quality and uncommon honesty of the background analyses, which are essential for undertaking the reviews. For this reason, it is important to safeguard the quality of those entities within the Secretariat, in particular those engaged in macroeconomic and structural analysis, which are responsible for the peer review process. Not all countries participate as examiners in each of the individual peer review exercises; this reinforces the importance of the Secretariat’s contribution and of its integrity.

Regarding in particular the OECD peer review process, there is a question "Are there different phases of peer pressure?" The pressure exercised by the published report is much less than the peer pressure exerted in the course of the review process from the visits that the OECD Secretariat pays to each country and, in particular, during the actual examination itself. If this is indeed the case, then perhaps the content of the final report and what the country accepts as recommendations are less important than the advice given to policy makers in the course of the review exercise.

On the other hand, the OECD Secretariat has fewer resources to produce country surveys at regular intervals (for example, IMF missions last at least two working weeks with at least 5 people, much more than the OECD). This is important, for the determinant of the standing of the institution is the quality of the staff’s work.

In order to continue to perform well the OECD must maintain its focus on a small number of key structural policy areas for which an analytical framework can be developed. It must avoid being pushed gradually to purely sectoral issues such as energy liberalisation, under the impression that other institutions such as the IMF and the EU are doing so much in structural areas that there is only scope for this kind of work.

There is a possibility, currently being debated in the trade community, of establishing within the framework of the WTO a new peer review mechanism which would look at trade and competition policy. Over time in that wider forum of 144 members the mechanism has, largely because it permits the identification of technical assistance and capacity building needs, taken on a heavy technical assistance and capacity building role. This was established after the OECD Joint Group on Trade and Competition set out some of the merits of peer review exercises, looked at various OECD country review mechanisms, compared them with the current WTO trade policy review mechanism and in a tentative way identified key strengths and weaknesses of each (OECD 2002c).

The OECD has had a fluctuating relationship with China; one which presents lessons for the way in which international organisations approach countries with the view to offering them assistance. In its initial approach to China, the OECD had mentioned "surveillance" and got a rather cold reception. Following a number of years of developing contacts with officials and institutes, relations improved considerably, to the extent that China is now an outstanding example of a country that knows how to benefit from the work of the IMF, the OECD and other international bodies. It is keener on the concept of "peer example" than "peer pressure" and is constantly looking for analyses and information. The decisions taken by the authorities are well-informed by conclusions reached on other countries’ success and failures (this is borne out, for example, in their caution with regard to capital account and banking sector liberalisation). This shows that the benefits of surveillance and peer review exercises go far beyond the impact of an individual report (such as OECD 2002c). This broader impact, not just for China but for other countries which are considering reforming or rethinking their policies, should not be underestimated.

In considering the issue of countries approaching crisis and their receptiveness to advice, one should also consider whether international institutions have given the correct advice. Taking the case of Thailand, according to Blustein (2001), the IMF had clearly indicated that there were problems. Though it was perhaps less successful in spotting the problems in Korea (the OECD had flagged up its concerns), once the Korean crisis had started the Fund’s analysis evolved and it put forward policies which have helped the country to get out of its problems in a remarkably short period of time.

The EDRC has occasionally experienced the situation of undertaking an examination of a country at the same time as there has been an IMF programme in place. Thinking back to the review of Turkey at the end of 2000, it was clear that the Committee itself would not want the Survey to undermine an ongoing programme or programme negotiations, while recognising that the underlying analysis should point out areas of policy where reform is needed. Turning to non-programme countries, the particular contribution of the OECD resides in its comprehensive analytical coverage, ranging across both macroeconomic and structural policies. The EDRC has requested that the Secretariat place increased emphasis on what it judges to be the key areas of structural reform that countries should focus on, rather than trying to give a comprehensive treatment of all issues.

The success of a review exercise is partly dependent on how the officials representing the examined country before the Committee choose to react to the report. In the OECD’s experience, on those occasions that officials have been defensive and elected to hold the line on all the existing policies the atmosphere has become rather confrontational; it is probably the case that the most useful report does not emerge under such circumstances. We have found that it is when officials acknowledge that the draft report contains politically difficult (in the short term) but ultimately helpful economic advice that the most useful final reports emerge. It would appear indeed that the countries that get the most out of the review process are those that try to toughen up the reports’ recommendations in order to use it as an element of persuasion for improving long-term economic performance, which is the point of the EDRC exercise.

The Brazil Economic Survey (OECD 2001a) has been quite influential in that country. It had found the recent review exercise undertaken by the OECD a very interesting and useful experience, in particular in that it had extended the capacity of local institutions to collect the relevant data.

The peer review process is also a cultural phenomenon -- the regular participation in the peer review process leads to the development of a new frame of mind. This then raises the question, following up that on local knowledge-local capacity, "What if the message from the peer review process is incorrect -- if the collective wisdom is not wisdom at all?".

That there are areas of overlap and complementarity in the work of the OECD and the IMF should not be taken as a criticism with the way the IMF has extended its mandate. The decisive principle governing whether or not this extension is justified is: "Is this element of structural policy relevant to overall economic performance over the time horizon analysed in the report ?". In the case of the OECD, this principle could be relaxed somewhat; this is another source of complementarity between the two institutions. As stated in IMF (1999), its senior officials show a very positive attitude towards collaboration with other organisations. In a recent statement, the Executive Board had requested that the staff make more use of the work of other institutions such as the World Bank and the OECD. More could be done to that effect given the insufficient awareness within the IMF of the work on structural themes being planned for discussion at the OECD. As good bilateral surveillance is an essential underpinning for good macroeconomic surveillance, closer co-operation between the IMF and the OECD is both welcome and feasible.

The quality of the analysis is crucial to the credibility of organisations such as the OECD and the IMF; everything should be done to ensure the production of the best possible quality of work. It is also important, he said, to remain open to new academic ideas and not to bend with the prevailing view of governments.

The EU and Euro area policy review processes are very intensive, with peer pressure based on elements that cannot be replicated in any looser form of international institution. There are elaborate, frequent procedures sometimes based on rules, but mostly on national commitments to which it is the task of the monitoring agencies such as the Commission and at the next level, committees, to keep countries to. This is peer pressure on the basis of commitments. The involvement of high-level officials is much greater that at the IMF or the OECD. In sum, the arrangements in place within the EU give by far the greatest scope for the exercise of peer pressure and supervision.

After the demise of the Bretton Woods system of fixed but adjustable exchange rates in 1973, various continental arrangements to stabilise exchange rates were tried, the last of which was the European Monetary System (EMS), created in 1978 by a Resolution of the Council of Finance Ministers of the Union (EcoFin) and supported by an agreement among participating central banks. The primary objective of the 1986 Single European Act was achieving free trade in goods and services and assets, as well as free movements of people among twelve nation-states. In turn the abolition of internal borders created market pressure for stable exchange rates

Most member states changed their economic regime towards fiscal discipline and stable prices after realising that they could no longer improve export competitiveness by engineering exchange rate devaluations. This followed the creation of the Exchange Rate Mechanism (ERM), with the Netherlands foregoing devaluation after 1982 and France after 1983. Poorer states took longer to be convinced but at the Madrid European Council in 1989, the report of a Committee of Central Bank Governors chaired by the President of the European Commission was accepted as a basis for Economic and Monetary Union (EMU). The single currency was to be achieved in three stages, beginning July 1, 1990. Rather than relying on national reserve currencies, a new currency was chosen. The ECU was renamed euro at the Madrid European Council of 1995).

Over the years, a code of conduct built up as the ERM developed from a mere exchange rate arrangement into a powerful convergence instrument. In addition to compulsory intervention, for unlimited amounts, at the agreed bilateral limits and to the need to reach a consensus for modifying a parity; the Basle-Nyborg Agreement called for convergence to establish and maintain stable exchanges rates. The rules also refer to the creation of ECUs through swap operations, to the provision of currencies for intervention purposes, to the settlement of claims arisen from intervention, and so on. This ERM code of conduct implied the acceptance of the DMark as the anchor of the system and thus the recognition of the leadership of the Bundesbank. It gave a prominent role to co-ordinated interest rate changes in the management of the system and also involved a consensus on crisis management.

Shortly after the first stage of EMU began, the United Kingdom joined the ERM. Sterling appeared to trade its past allegiance to the broad Atlantic standard for a narrower continental bloc. This first experience lasted less than two years but it involved the United Kingdom in the design of a MSF, which turned out to be decisive for the sustainability of the system. The plans for the single currency were agreed upon at the Maastricht European Council in late 1991. The second stage of EMU was set to begin on January 1, 1994. The third and final stage of EMU began in 1999 as convergence had not been sufficiently high after the 1996 revision of the Treaty at the Amsterdam European Council.

A medium term orientation of macroeconomic policy, coupled with measures designed to improve the functioning of factor markets and of the public sector, is favoured in principle. In transition and developing economies, though, the institutional framework for such an orientation is lacking, so that the rules for monetary stability are not credible. The expectation of EU membership, under conditions of convergence and cohesion, provides this credibility but credible surveillance is needed for geographical peripheries to acquire global reputation. The time it takes for a nation to acquire a reputation for financial probity varies but it typically involves several general elections where alternative views of society may confront each other. The number of years most frequently cited in financial circles is 10. This suggests that it may be better to take time and set on foot a self-reinforcing process of reform than to attempt a succession of overly ambitious and excessively drastic measures that will ultimately fail, damaging policy credibility.

To construct a social consensus domestically, credible signals that the authorities are committed to reform may be needed. If stable democratic governments succeed in implementing reforms which help to achieve convergence between poorer and richer nations and regions, they can set off a self-reinforcing virtuous cycle of stability and growth. On the other hand, there will be a vicious cycle if short-lived governments, fearing the social conflicts associated with reforms, delay implementation and impair convergence.

With high capital mobility, exchange rate stability requires a speedy real and nominal convergence process. The indicators of budgetary discipline have become signals of regime change sustained by the structural reform of the public sector. Given that financial markets tend to exaggerate rather than to dampen such signals, apparent reversions during a relatively rapid convergence are also more liable to misinterpretation. The cohesion objective involves a degree of social awareness that may not be required with respect to the convergence of fiscal variables. In any event, whatever the credibility of national policies, it has been apparent since the first stage of EMU that fast convergence is more difficult with slower growth and that the main macroeconomic costs arise before the main microeconomic benefits are felt.

If, in the final analysis, the exchange rate reflects the credibility of national policies over the medium term, it may do so with considerable noise if the entire parity grid is under attack. This is why little indication about the credibility of national policy could be gathered from the realignments which occurred during this period. Speculative attacks on more vulnerable currency parities will have more negative effects on the system if parities are already locked than if they continue to be flexible. Flexibility within a sufficiently wide band allows speculation not to be a one-way bet. That lesson was learned in the twelve months preceding August 2, 1993 when very wide bands of 15% replaced the normal fluctuation margins. The temporary nature of the move notwithstanding, these new "normal fluctuation margins" eliminated the need for exceptional measures, such as exchange controls, designed to deal with a protracted second stage of EMU.

The 15% wide band was not used by any participating central bank and margins of 2.25% were observed between the Dmark and the Dutch guilder. The basic difference relative to the previously normal fluctuation margin was the absence of one-way bets on parities. The external discipline provided by the grid no longer obtained and each central bank decided whether or not to intervene within the old fluctuation bands. Most decided to do just that, so that the convergence process was not hurt by the decision to widen the band. The lesson from the currency crises is that the largely unwritten ERM code of conduct implied more effective co-ordination mechanisms among monetary and fiscal authorities than expected. Non-compliance with the code of conduct played a major role in the development of the currency turmoil, but the system regained stability after August 2, 1993, thanks to the widening of the fluctuation bands, which limited speculative pressure by eliminating one-way bets and reintroducing two-way risks.

The option to float in order to fix, a kind of financial "cruel to be kind" shows that the set of principles, rules and code of conduct which underlie the monetary union in stage two have proven correct for the euro as well. That the widening of the bands was a positive step towards the euro may be easily accepted nowadays. That you may float in order to fix introduces the earning credibility process explicitly in what is the major lesson from the EMS experience. When the decision to widen the bands was taken, however, many observers and prominent economists stated that the EMS and the euro were dead. The question of credibility is different in EMU members because, thanks to the ERM code of conduct, they are more used to follow a MSF. Since the best indicator of policy credibility is that a MSF exists and is effective, it is the MSF that determines the choice of an exchange rate regime.

The MSF developed among EU nation-states can be adapted to build a global financial architecture resilient to financial crises. To begin with, its intercontinental domain reflects longstanding cultural and commercial ties. Moreover, the EU probes into budgetary procedures and corporate governance standards, in ways that may offend national sovereignty if applied to Washington or Tokyo. In the OECD peer reviews and in the standards agreed upon at the BIS, unanimity is required so that national sovereignty is entirely preserved. The role of the Commission as regulator and that of the Court of Justice help bring procedures closer to a regulatory framework allowing for yardstick competition.

Among the G-7, only the four European states have attempted to deal explicitly with their regional architecture, so that the presidents of the European commission (EC), central bank (ECB) and council (especially the EcoFin) attend the meetings. There is no sovereign national centre equivalent to that of the United States, Japan or Canada (let alone Russia, the 8th member), even though the complexity of the current EU institutional framework leaves substantial room for manoeuvre to the United Kingdom and to the three large members of the eurosystem.

The question of external representation of the EU has been a source of controversy at least since its creation. Due to the fact that the EC participates in the discussions of the G-7 since 1977, the four EU (three eurozone) members tend to ignore their eleven (eight) "peers" when global affairs are on the agenda. The same applies to the OECD, where the EC also participates. At the IMF, like in the G-7, a representative of the ECB addresses all matters directly pertaining to monetary policy.

The ambiguity of the solutions reflects, once again, the complexity of the EU institutional framework. Nevertheless, the strengths of the perspective can be put to good use in the global arena, as long as the procedures underlying the Eurosystem are understood along the lines of the schemes of "flexible integration" discussed next.

The creation of the eurosystem was followed by a difficult institutional period, which has also delayed the accession calendar. The delay reflects the propensity to procrastinate on structural reforms, rather than the recurrent European debate about whether multiple-speed convergence towards union objectives is possible and desirable. This debate does help illustrate the complementarity between global and regional common good. One extreme position in the European debate draws on the view of a unified constitutional state, for which variable geometry is impossible. The other extreme position calls for a set of contractual arrangements, where common institutions are undesirable.

From the beginning, the European Community attempted to transcend the rigid intergovernmental nature of the OECD or of the G-7 (which does not even have a permanent secretariat) in the direction of supranational institutions like the EC. But the convergence stopped far short of establishing Community-wide democratic legitimacy. As a consequence, the institutional framework became more and more complex, especially after a Union with three pillars, the Community and two intergovernmental ones was created in the 1992 Maastricht Treaty. In the process, flexibility was lost and this is why the debate about multiple-speed convergence towards union objectives has resurfaced. Another reason is, of course, the imminent enlargement.

For any given number of member states, there is a trade-off between the freedom to enter into contractual agreements which include some members and exclude others and the ultimate requirement of "one man, one vote" which would be associated with a new state emerging from the integration of all members. In Figure 1, adapted from CEPR (1996, p. 47), the vertical axis measures flexibility and the horizontal axis measures depth of integration. The origin represents purely intergovernmental co-operation among the same member states. The vertical axis represents economic efficiency and executive performance, or the forces of competition, while the horizontal axis represents legal status and legislative activity, or the forces of co-operation. Each point in the quadrant can therefore be seen as a combination between competition and co-operation.

The highest point on the vertical axis, labelled "a la carte", would be equivalent to a purely contractual institutional design where any combination of subgroups of member states is acceptable, so that the basic intergovernmental principle of equality of member states applies and unanimity in decision making is preserved. During the revisions of the Union treaty in 1996 and 2000, intergovernmental schemes of "reinforced co-operation" have been called for among some member states, as their creation still requires unanimity of all member states and their membership is open to all of the member states who qualify.

These manifestations of flexible integration are consistent with the operation of the principle of proximity (or subsidiarity) mentioned at the outset, according to which further decentralisation is acceptable and desirable. Indeed, CEPR (1996, p. 65) mentions a generalised subsidiarity principle, where decentralisation can go towards groups of states, rather than local and regional bodies within each state.

The horizontal axis would go to the extreme where majority voting applies to the voting population without regard to its national location, labelled "superstate". There co-operation among the (former) member states would cease to be relevant politically, economically or socially. Quite clearly, even in areas where single policies have existed for a long time, such as tariffs, and the EC has an undisputed mandate, the relevance of the member states is always there. The same can be said about monetary policy, administered by the eurosystem.

With respect to the objective of a free movement of persons, it was achieved properly for the first time on 19 March 1995 by the seven member states (Belgium, France, Germany, Luxembourg, the Netherlands, Portugal and Spain) that are parties to the Schengen convention. When the Treaty of Amsterdam came into force on 1 May, 1999, the freedom of movement was extended to all others, with the exception of the United Kingdom and Ireland.

Proximity suggests governance responses at the appropriate level, through the combined action of elected officials and civil society (including business). The common good may thus be provided by regional institutions, as long as the various levels of government are appropriately combined. For these reasons schemas of flexible integration have been proposed, where the principle of proximity is generalised from geography to issue areas. Along the same lines Kolliker (2001) shows that this generalisation depends on the characteristics of the public good being provided. When there are network externalities with exclusion benefits, as is the case with the Eurosystem (also Schengen), then such flexible integration has a "snowballing effect" which may lead initially reluctant states to join in. When there are no exclusion benefits but rather free ride problems, flexible integration does not lead initially reluctant states to join in. This has been observed with respect to common resources (tax or otherwise).

For certain public goods, then, flexible integration recognises national legitimacy and democratic accountability at national level. It also stresses the role of external pressure in bringing about structural reforms resisted by the operation of domestic-vested interests through yardstick competition, as discussed above.

The Euro delivered convergence and cohesion because the "new politics of credibility" overcame financial hierarchy among sovereign risks. Trade unions recognised the perverse interaction between price and wage increases (which hurts the poor and unemployed disproportionately) and public opinion accepted the medium term stance of policy. Yet it took longer to convince voters than markets, and some countries used the Euro to procrastinate on their unpopular reforms, threatening the benefits of the stability culture with the "Euro hold up".

Cohesion countries were reluctant about the proposals for flexible integration made during the preparation for Amsterdam (see my 1995). The Nice treaty made "reinforced co-operation" possible in Community, JHA and even some CFSP areas CEPR (2001). Together with the Convention for the future of Europe, dealing with ongoing "back to basics" issues such as proximity, legitimacy and accountability, this form of flexible integration may bring balance to the European institutional framework.

Flexible integration also stresses the portability of the European experience to countries in different stages of economic and financial development. It may thus facilitate enlargement and a more coherent development policy, in line with the Monterrey Declaration where a new development paradigm may have emerged (my 2002).

The national capacity- and institution-building is decisive because the private sector and civil society in Africa are not organised. Even in so-called "failed states" the state remains an organisation and there is no organisation. in the case of business, of civil society. This is the difficulty about the point of entry when it comes to the private sector and civil society in Africa.

Now the private sector is not only important from a national, regional and continental perspective but also from a local perspective, due to the proximity of business and of civil society to people's specific problems. This is of course the reason why the principle of proximity was mentioned in section 4 as a fundamental in European integration doctrine (even if more flexible integration would make it more important in practice). The local dimension is essential in the credibility of what the private sector may be able to do at national, regional and continental levels.

An adversarial relation between the private sector and civil society and the State is also damaging at all levels. This is why the idea of public-private partnerships becomes so important at all levels. For example, the OECD has a pilot project in Mozambique attempting to enlarge the knowledge base that is accessible to entrepreneurs, very much in line with the Monterrey Declaration-paragraph 24. Such kind of initiatives could be seen as solving the national capacity and institution building in a credible manner because a broader knowledge base benefits private initiative at national, regional and international levels.

On the excessive perception of political risk in Africa, more information and more transparency are needed, as discussed below. In addition to intergovernmental organisations, rating agencies also have a role to play and there is certainly a lot of room for credit rating in Africa. One other important point about perception of the risk is the role of the diaspora in making risk perceptions closer to reality on the ground. There are nowadays a number of African professionals that live abroad and very often they feel a little bit alienated. There is really something that can be done there to increase their visibility at home and the international visibility of their nations or regions.

Both rating agencies and the diaspora can be seen as providing credibility to Africa. Often the lack of credibility comes from ignorance. Greater visibility for African realities would avoid that something that happens in the north of Africa may have completely unjustified ripple effects in the southern part. Of course, this was not uncommon in other continents but it has largely disappeared except in the case of Africa, where confusion is still a source of contagion.

So comparability, visibility and some presence in the media would be a way of going around this excessive perception of risk. And the spread of African risk-sharing institutions, together with rating agencies and the diaspora, will also contribute to earn credibility abroad.

While each MSF serves a particular purpose, the ownership by the country is least in the IMF, whereas the EU is most predicated on the common goal of integration. The mutual surveillance by OECD has the greatest diversity, from overall economic policy to structural and sectoral issues in health, education, corporate governance etc. The EDRC and the Development Assistance Committee (DAC), for example, have different mechanisms, which apply to the different objectives and the different mandates of the respective committees (OECD 2002e. This diversity of models relates to the different mandates and the different degrees of commitment from soft co-ordination to mutual help.

The idea for peer review in NEPAD includes both economic management and political governance. It should be borne in mind in this connection that the lack of data is a major barrier to assisting with policy formulation in Africa; in the European Union Treaty, the one area where subsidiarity does not apply is the compilation of data – it had been recognised that unless there was agreement on the facts under consideration it would not be possible to move discussion on to the next stage. The challenge is therefore how to apply OECD methods when the data are poor.

The already mentioned publication of the African Economic Outlook, modelled on the OECD’s Economic Outlook, presents information on national economies in a comparable manner. It is a first attempt at doing this with respect to economic and political governance (covering the macroeconomic and structural issues). As such, it has been seen as a helpful instrument for the NEPAD peer review process as part of the exchange of views and experience on peer review mechanisms and the requirements necessary for African countries to effectively apply them mentioned in the OECD/NEPAD Ministerial communiqué of May 2002. The idea of launching an exchange network on peer reviews mechanisms is being considered, through which the OECD would share its experience with NEPAD countries in a pragmatic and cost efficient manner.

Peer pressure may hurt good governance when indicators are not supported by data and analytical knowledge on the issues. The importance of comparable data is crucial to peer pressure, otherwise wrong conclusions could be reached. This is why the IMF has provided information to feed peer pressure in a regional context such as that which has taken place among:

1. Latin American finance ministers (notably in the context of the Brazil crisis);
2. ASEAN finance ministers;
3. ASEAN + 3 (China, Japan, Korea).

The same has happened in the context of the Euro Area’s monitoring framework as well as that of the EU as a whole.

The regional framework is promising as peer pressure is more naturally organised among smaller groups than in the context of global institutions. In the NEPAD context, the principle of self selection should help set initial standards that would not compromise the credibility of the exercise.

In effect, many of the available governance indicators are very arbitrary and their use could damage peer pressure instead of promoting it. Actually, the unavailability of data and inadequate analysis are not the only reasons for the danger of available governance indicators damaging instead of promoting peer pressure. There is a third danger, which pertains to culture. The culture of sharing is in Africa's cultural inheritance, and it should be taken into account. The example that is very clear here is the role of the family. Institutions such as the family are very different in different parts of the world. We have to find a way of incorporating them in the new development paradigm coming from Monterrey.

Greater attention to data, analysis and culture (dac) will not be effective if it does not take place at the national, regional and continental levels as envisaged in NEPAD. In fact, the experience with Poverty Reduction Strategy Papers could be helpful in making peer pressure more effective. When they are successful, these programs are done at the national level, taking into account local culture but, of course, have a link with global issues.

The link of the NEPAD to the newly created African Union is yet another way of looking at the link between regional and global issues which is the essence of the Monterrey consensus and perhaps of a new development paradigm. The global applicability of the European experience to the search for the "common good" hinges on the European Union being a community of nation-states. This may be enough justification for the emphasis on the EU MSF, which, in turn, derives from a particular institutional architecture now being looked at in the Convention for the future of Europe.

The emphasis on security after 9/11 has brought back hierarchy, even among like-minded countries, but also the "globalisation of solidarity". The importance of legitimacy is also evident in the Convention and this is certainly required but multilateral surveillance frameworks also require efficiency and this can only be achieved through flexible schemas. Once again, a single MSF does not apply to diverse circumstances. Yet peer pressure has shown remarkable resilience the fact that it is at the heart of the NEPAD bodes well for the credibility of APRs.

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