Motives of regional financial institutions:
There are mixed motives for the donor countries to provide development assistance to developing nations. While a desire for poverty alleviation may genuinely be present, there is also narrow self interest, as is sometimes seen in the case of tied aid. There are also foreign policy interests. But we can still look at the advantages and disadvantages of alternative institutional arrangements for development assistance.
One case is bilateral assistance. In this case the donor country's ‘taxpayers' can closely monitor their aid in the developing country. The disadvantages also arise from this same source-domestic political processes in the donor country, and domestic distributional struggles, affect and influence the nature and composition of development assistance. This is seen in the various pressures that come on a government to tie its aid to purchases from its own suppliers.
We turn to the issue of whether a group of donor nations should come together multilaterally. In principle, a pooling of resources in a rich donors' group should have considerable cost advantages. However, pooling of countries in turn introduces the problem of differences in preferences of the different members on how the resources should be used. Whatever consensus is reached, it will always be unsatisfactory to some countries' preferences as donors. The cost advantages therefore have to be balanced against this disadvantage. Therefore, a rational response for each donor country will be to diversify, to have some of its development assistance flow through bilateral channels and some through channels that group together rich country donors. This argument has not as yet provided a rationale for RFI's, since it discusses groupings of donors, not groupings of recipients. What are the costs and benefits of grouping recipients into groups that are defined by geographical region? The cleanest argument comes from a consideration of cross-border externalities and multi-country public goods. When development in or actions by one country have an impact on other countries, an impact that is not mediated by competitive markets, the presence of such an externality can lead to sub optimal policy outcomes for the group of countries encompassed by that externality.
The above argument suggests a demarcation of tasks: regional externalities to be dealt with by regional institutions, global externalities by global ones. In other words, RFI's should supply regional public goods (RPG's), and GFI's should supply global public goods (GPG's). Of course the division is not clear-cut.
There are five policy suggestions that have been made regarding regional financial institutions. First, the responsibility and resources for region specific public goods should be gradually and increasingly shifted to the RFI's. To the extent that the RFI's do not have the capacity to deliver on these just yet, a purposive programme of building up these capacities should be developed. Second, global issues such as green house gases, financial contagion, global spread of diseases, etc., should remain the domain of global institutions. But these may not be explicitly financial institutions.
Third, on country specific operations there should be a presumption in favour of donor resources flowing through RFI's rather than the World Bank. This does not necessarily mean that the World Bank end country-specific operations. Fourth, there should be a presumption that the lead role in interacting with a government in developing and monitoring conditionality should fall to the RFI's rather than the GFI's. And finally, in certain situations, a case could be made for sub-regional financial institutions for further improving the division of labour.