Daily Archives: June 28, 2011

I remember sitting in a meeting at the International Monetary Fund back in the 1980s, debating the meaning of a small annotation in the margin of a memorandum that had just returned from the office of the managing director. It was just a squiggle; yet we debated possible interpretations for a full half an hour!

This is a small example of what is well known to IMF insiders – the post of managing director is not to be taken lightly in an institution that operates like a well-disciplined army, with staff looking up to the unquestioned general for decisive leadership.

This is why the resignation of Dominique Strauss-Kahn has been so disruptive to the functioning of the IMF. It is also why Christine Lagarde – who following Tuesday’s public backing from Tim Geithner, US treasury secretary, will assume the post shortly barring any legal complications – must move on five key issues in her first few months at the helm.

First, she must restore proper separation between the post and the political ambitions of the holder. This separation has been eroded in recent years by Europe’s decision to appoint politicians (Mr Strauss-Kahn and Rodrigo de Rato before him) and, was essentially eliminated by the widely-held view that Mr Strauss-Kahn was using his position as a springboard to the presidency of France.

To this end, Ms Lagarde must realise that Europe’s perceived entitlement to the top post has left a bitter taste in the mouths of the institution’s membership and anyone who believes in the importance of a legitimate IMF at the center of the global monetary system. The manner in which the entitlement was imposed once again with her appointment has alienated some steadfast supporters of the institution.

With this in mind, she should waste no time in establishing a legitimate selection process for the next managing director that is truly based on merit, not nationality. Rather than repeat the empty European promises that were also made after the appointment of her last three predecessors, Ms Lagarde should improve the institution’s governance by hardwiring a process that emphasises qualifications, meaningful due diligence and true openness to candidates irrespective of nationality.

Second, Ms Lagarde should reinforce her commitment to a meritocracy by eliminating other nationality-based appointments. She should start with the replacement for John Lipsky, the Fund’s first deputy managing director, and an American, who announced his intention to step down just a few days before Mr Strauss-Kahn was arrested. She should let this choice be based on merit, rather than another nationality-based directive – this time from the US Treasury Department.

Third, Ms Lagarde must strengthen the analytical robustness of the IMF’s response to debt crises. This should start with addressing the legitimate criticism that the institution’s role in the peripheral European bailouts was excessively influenced by political considerations, thus undermining its reputation of rigor and evenhandedness. In doing so, she would also enhance its ability to help address other systemic challenges, such as persistent global payments imbalances and deep-rooted structural rigidities that stifle employment creation.

Fourth, Ms Lagarde must prepare the Fund’s balance sheet for the risk of some future financial impairment on account of the massive loans made in the past year, particularly to Greece. The sooner she does this, the less likely that the IMF will fall victim to behavior patterns the ECB seems to be stuck in – that of denying a solvency problem in a member country because too much of the sovereign debt now resides on the bank’s balance sheet. This trap converts institutions from being part of the solution to being part of the problem.

Finally, Ms Lagarde must help restore the public standing of the IMF’s staff. The stunning arrest of Mr Strauss-Kahn has fueled a series of attacks that are inconsistent with the dedication shown by the institution’s talented staff.

In just a few weeks, previously inconceivable circumstances have catapulted Ms Lagarde into the role of presumed leader of the world’s most influential and fastest-responding multilateral institution. With Europe again imposing its will on the rest of the IMF membership, she will need to hit the ground running if her tenure is to be an inspiring story of institutional transformation, rather than one of maintaining a myopic approach to a critical international post.

The writer is the chief executive and co-CIO of Pimco, the world’s largest bond investor.

Response by Eswar Shanker Prasad

The old order has triumphed yet again

Christine Lagarde owes Agustin Carstens a debt for having made this an ostensible contest rather than a choice by acclamation. This may actually strengthen her legitimacy if she can turn the narrative around to having won the top job at the IMF in a fair and open contest. Still, for emerging markets, the selection process that culminates in Lagarde’s victory leaves a bad aftertaste.

Although emerging markets lost this round, Ms Lagarde’s victory may well turn out to be a good outcome for them in the long run. She brings to the position an excellent set of strategic and political skills that could make her an effective advocate for emerging markets at the IMF. Ms Lagarde can twist the arms of European countries that have blocked progress on governance issues by arguing that such reforms would be for the greater good of the IMF.

As a well-respected insider in European economic and political circles, Ms Lagarde has the clout and credibility to corral Europe into supporting further reforms at the IMF. Indeed, Mr Carstens may have been less likely to deliver on governance reforms (such as voting rights and representation on the executive board), despite his heart being in the right place, as he would have found it more difficult to overcome European resistance.

The immediate priority for Ms Lagarde, as Mohamed El-Erian notes, is to reset the IMF’s engagement with the debt crisis in Greece in a manner that avoids a blow-up but doesn’t smack of favoritism. Having been embroiled in dealing with the European debt crisis already, it remains an open question whether she can shed that baggage when she comes into the IMF job and can take a fresh and more objective perspective.

Ms Lagarde’s longer-term challenge is to rebuild the emerging markets’ trust in the IMF and make them feel they have a strong stake in the institution. Two factors have heightened the emerging markets’ perception that the IMF subjects them to a different set of rules than it does the advanced economies. One is the selection process for the next managing director. The second is the treatment of European countries in crisis, with the sense among emerging markets that they would not have been given as much rope as Greece seems to be getting if they did not meet policy commitments and targets.

Ms Lagarde will have to work hard to convince emerging markets that she will not let the IMF once again be dominated by European and American views and interests. Otherwise, her legitimacy and that of the institution could be sullied.

How can she do this? First, Ms Lagarde needs to ensure that the shifts in voting shares and executive board representation in favor of emerging markets that were agreed during her predecessor’s regime are carried through fully and quickly. Second, she needs to push for more aggressive reforms that bring representation at the institution more in line with existing economic realities on the ground.

Ms Lagarde takes over an institution that has become central to the global financial system. The way she manages the political, technical and strategic aspects of the job will help determine the IMF’s future legitimacy and effectiveness.

The writer is the Tolani Senior Professor of Trade Policy at Cornell University and former chief of the financial studies division in the research department of the IMF.

The pressure on Lorenzo Bini-Smaghi to resign from the executive board of the European Central Bank is a fundamental challenge to the bank’s independence and to its ability to represent European interests rather than those of individual countries.

When the ECB was being created, European politicians said it would be a truly European institution, making decisions for the benefit of the eurozone as a whole.  As such members of the ECB’s governing boards would be expected to act as Europeans rather than as representatives of their individual national governments.

To reinforce this independence, the Maastricht treaty states that officials of the ECB would not serve at the pleasure of their governments but would have appointments for a fixed term of eight years.  To reinforce this independence, the votes at the ECB are not disclosed, allowing individuals to take votes that favour the overall eurozone economy even when that is contrary to the interest of the member’s own country.

Like other eurozone myths, the goal of ECB independence that rests on the principle of fixed term appointments has now been destroyed. The French government has apparently succeeded in forcing Mr Bini-Smaghi to resign in order to make way for a French appointment to the ECB executive committee.

French president Nicolas Sarkozy has announced that Mr Bini-Smaghi will “voluntarily” resign before the end of the year. The French argue that it is wrong for Italy to have two members on the ECB executive board while France has none. So much for the idea of eurozone solidarity.

President Sarkozy made France’s support for the appointment of Mario Draghi – another Italian – as the next head of the ECB conditional on being able to replace Mr Bini Smaghi with a Frenchman. As someone who thinks Mr Draghi is the best candidate for that job, I find this move fundamentally undermines the ECB as an institution.

But national pressure trumps the Maastricht rules.  The Italian government will offer Mr Bini-Smaghi a suitable alternative job that will allow him to move on from the ECB with dignity. But the ECB will be the worse for it.

The writer is professor of economics at Harvard University and former chairman of the Council of Economic Advisers and President Ronald Reagan’s chief economic adviser.

Response by Lucrezia Reichlin and Charles Wyplosz

The row over Lorenzo Bini Smaghi’s place on the European Central Bank board proves, once again, that only passports matter when choosing Europe’s top central bankers. The problem, however, is not with the individuals involved, but with the process and its unavoidable glitches once nationalism gets in the way.

We have, of course, been here before. Due to a Franco-German deal whereby the ECB was to be located in Frankfurt in exchange for the first chairman to be French, the late Wim Duisenberg was forced to promise to resign to make room for the current chairman, Jean-Claude Trichet, who could not be appointed earlier because of pending litigation. In the end, the ECB’s reputation for independence survived that episode, and will probably survive another.

But as Mr Feldstein writes in his article, this kind of nationalist interference cannot be right. Indeed, this time, arguably, it is worse – Mr Duisenberg made his promise before the appointment was made. The deal was done ex ante. This time we are talking about pressurizing a sitting member of the board to resign.

One could argue that perhaps some extraordinary political haggling was inevitable at the inception of an extraordinary supranational institution such as the ECB. But now it is beginning to look like a bad habit. Sooner or later this will cast a shadow over the bank’s independence. Sooner or later a line will have to be drawn if the principle of independence is to be protected. Why not now?

We do not challenge the idea that elected politicians at the highest levels should have the right to appoint some of the most important non-elected policymakers in Europe. This arrangement fulfills two key democratic principles, namely that important decisions belong to elected representatives of the people and that delegation to bureaucrats is under exclusive control of elected officials.

Even so, this does not justify injecting nationalist politics into the process. It suggests that board members somehow represent their countries, which they explicitly are forbidden from doing. We fail to see what would be wrong if there were two Italians and no French on the board for a couple of years. So what?

Lucrezia Reichlin is professor of economics at London Business School, and Charles Wyplosz is professor of economics at The Graduate Institute in Geneva.

At their meeting last week, European leaders agreed again to “do whatever is necessary to ensure the financial stability of the euro area as a whole”. But they did not say how. Even if Wednesday’s vote in Greece’s parliament averts an immediate crisis, they would be well advised to make use of the long European summer season to turn this unspecified commitment into an action plan. Here are some modest suggestions for their holiday homework:

1. Complete the banking sector clean-up. Financial fragility is heightened by the still-unfinished recapitalisation of the weaker banks. Two years after the US successfully completed its stress tests, Europe is still struggling. The publication of new tests, expected in July, offers a chance to aggressively restore the soundness of banks across Europe.  This may cost public money and political capital, but no political expediency can justify missing the opportunity.

2. Explore options to address insolvency. Last week, the German proposal for a compulsory rescheduling of Greek debt was rejected. But to pretend that an insolvent country will repay its debt is no strategy.  There are only two economically consistent options. One, call it Plan A, is to socialise the Greek debt. It requires lowering the interest rate on official assistance to a level that makes Greece solvent and deciding who, if needed, will bear the corresponding cost – either the banks, through a special levy or, by default, the ordinary taxpayers. Plan B is to make private creditors pay through an orderly restructuring. To make it a viable option, preparations must be undertaken, not least by the ECB, so that when restructuring takes place its financial fallout can be contained. Each plan is anathema to some of the leaders, but one will eventually have to be chosen. The Europeans should make use of the time they have bought to evaluate their implications and choose a strategy.

3. Make better use of the crisis management facility. The recently created European Financial Stability Facility (EFSF) and its successor the European Stability Mechanism (ESM) are potentially powerful instruments to preserve financial stability. But lack of trust and domestic politics have led to attaching too many strings to their use. As they stand they can neither serve to prevent a crisis through precautionary lending nor to resolve it by serving as a backstop to debt restructuring. This is a waste of scarce resources. The EFSF/ESM should be turned into a more flexible instrument to help preserve financial stability.

4. Devise an adjustment and growth strategy for southern Europe. Fiscal consolidation is of paramount importance but ultimately, what will matter most is whether southern Europe can return to growth. So far the joint European Union and International Monetary Fund programmes have, with some success, focused on the fiscal front. But unlike Ireland, southern Europe has not started reducing the real exchange rate misalignment resulting from a decade of excessive inflation, and growth prospects remain remote. The EU should now move on this front. A first and simple step should be to make better use of the money it spends in Greece and Portugal. Both countries are major beneficiaries of structural transfers, but EU money is both under-spent and badly spent (because guidelines set long ago are at odds with current priorities). The EU should pass special legislation to speed up the disbursement of aid and, as long as assistance programmes are in place, allocate it to supporting their growth component.

5. Address the underlying weaknesses of the euro area. Euro area surveillance reform, about to be completed, will help diminish the risk of future crises. But nothing has been done to remedy the lethal correlation of banking and sovereign crises. Sovereigns should be better protected against the failure of their banks, through the centralisation of supervision and the creation of an insurance scheme akin to the US Federal Deposit Insurance Corporation. By the same token banks should be better protected against the failure of their sovereigns, through diversification of their bond portfolio. Today, any meaningful restructuring of the Greek debt would wipe out the capital of the Greek banks. As long as this concentration of risk persists, sovereign restructuring will remain more dangerous that it needs to be. This is the most potent justification for introducing Eurobonds, because they would offer a natural diversification instrument.

Throughout the crisis the European leaders have consistently demonstrated a strong commitment to the euro. But as Winston Churchill once said of the US, they can be trusted to do the right thing only after having exhausted all other possibilities. This behaviour is too costly to be sustained. The leaders should now move ahead of the curve and take initiatives.

The writer is a French economist and director of Bruegel, a Brussels-based think-tank focusing on global economic policy-making.

Response by Anand Menon

The political implications of the eurozone crisis must not be ignored

Jean Pisani-Ferry’s suggestions for addressing the crisis in the eurozone make a lot of sense. Strikingly, however, they relegate politics to mere observer status in the quest for efficient solutions to Europe’s economic woes. Thus, restoring banking soundness ‘may cost public money and political capital, but no political expediency can justify missing the opportunity’. Meanwhile, domestic politics helped attach ‘too many strings’ to the EFSF and ESM. In the world of economics, politics is often viewed as an unwelcome distraction. In the real world, however, ‘political expediency’ tends to take centre stage.

The European Community’s institutional structure was designed with an eye to the promotion of internal trade. The theory was that this would make everyone richer. Therefore, there was no need for the kind of democratic institutions necessary to legitimise large scale fiscal transfers.

As a result, there is no European mechanism for reconciling or legitimately choosing between the increasingly polarized attitudes of European publics. While German voters resent transfers to spendthrift Greeks, protestors in Athens rail against austerity measures imposed by unelected foreign technocrats. Hence, the kinds of steps proposed by Pisani Ferry are, at best, politically hugely problematic.

As important as the current economic crisis is, so too are its potential political implications. Voters are increasingly dissatisfied with responses to the crisis. This resentment is amplified by their inability to hold European decision makers to account in the way they can national political leaders. The result will doubtless be an increased sense of alienation and cynicism on their part, which their national leaders will be anxious to avoid.

Such public sentiments, moreover, may well spawn an increase in the popularity of eurosceptic parties (as in Finland) and an erosion of public support for European integration. Riding roughshod over domestic public opinion in a quest for optimal economic solutions will merely intensify such trends. As well as disillusion with national leaders, the results could be an equally serious political crisis for European integration.

The writer is professor of west European politics at the University of Birmingham and author of ‘Europe: The State of the Union’.

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