September 20, 2006
IMF’s ancien régime must give up privileges
Are we able to make multilateral institutions work effectively? Or is our world now so divided that even those we have inherited are doomed to founder? These questions have been raised in many contexts in recent years, notably in the United Nations. But they are also raised by the debate over reform of the International Monetary Fund. What makes this example disturbing is that it should be a simple case: not only does the institution exist, but it has clear functions on which reasonable people broadly agree. Nevertheless, progress is enormously difficult.
My view of international institutions is pragmatic. States need to co-operate if our increasingly interdependent world is to function. The best way to do so is via multilateral institutions with clear objectives, legitimate governance and professional staffs allowed to exercise independent judgment.
Against these standards, how far do the present reform efforts of the IMF measure up? “Not well enough” is the answer.
The rest of Martin Wolf’s column can be read here (FT.com subscribers only). Discussion from our guest economists is free - click ‘Comments’ below.
Charles Wyplosz: Martin has it right. The voting shares are reasonable, which gives the US, Europe and Japan a majority. There are too many European faces on the Executive Board. The US-Europe informal agreement to share presidencies of the IMF and the World Bank was understandable in 1944, maybe; today it is plain shocking. The Fund’s staff quality makes it the most competent international bureaucracy. The tough question is what conclusions you draw.
It has been agreed at the “reform meeting” in Singapore to make a token gesture towards four arbitrarily chosen emerging market countries and to pledge to review by next year the distribution of votes, presumably based on a new an better formula. This will lead nowhere. Redistributing power is a zero-sum game and none of the big vote-holders shows any inclination to see its power diluted. Since they must approve any change, it amounts to asking them to tie the rope that will hang them.
Nor is there any simple logic to determine what the proper shares should be. The only simple criterion, GDP size, gives some 30% to the US, which makes it politically impossible. The size of exports is an alternative, but then the US would get 10% and lose its veto right; this is a non-starter as well. So you need to combine the two, but how exactly? Any answer is inevitably arbitrary. Then what about capital flows, a crucial concern in today’s integrating financial markets? Problem is that we don’t have any precise measure. All of this means that next year’s “simpler” formula will be far from compelling, which is exactly what the big-weight countries need to reject any substantial reallocation. In truth, there is no allocation that is obviously right. The weight of history will predominate.
This is why the discussion on voting shares is a dead end. The idea of reducing the number of Europeans on the Executive Board is more promising. There is no magical number either, but nine out of twenty-five (counting the Managing Director) is obviously off, as Martin notes. Here again, the incumbent will not hang themselves. They already propose to add new seats, without suppressing any. This will make the already too large Board even larger. Backroom negotiations among a few big voters will continue to run the show. No good either.
There is a simpler solution. We agree that the IMF is a good quality bureaucracy that needs to be made more independent. Why not suppress the Board altogether? The current arrangement leads to micromanagement by the Board. The Board is judge and party: it gives its stamp of approval to all decisions, big and small, and it is the body to which the bureaucracy is accountable. It would be much better to let the bureaucracy run its business and to subject it to serious ex post accountability by the IMF Committee. The IMFC could meet a few times each year and carefully examine the big decisions and potential mistakes. This, along with twitching voting shares, would come close to squaring the circle.
Posted by: Charles Wyplosz | September 20th, 2006 at 11:30 am | Report this commentMartin Wolf: Charles and I largely agree. The idea that the Board’s role - obviously an anachronism that dates from the era of steamships, not the age of the internet - should be drastically reduced was also advanced by the Bank of England’s Mervyn King in an important speech delivered on February 20th 2006 (www.bankofengland.co.uk). Unfortunately, it is very doubtful that this will happen either. But, in the absence of radical reform, to make the Fund more legitimate, the Asians will ignore IMF recommendations (particularly, the Chinese will do so) and continue to make sure that they will never need its money. The Fund will then be unable to contribute anything significant to the resolution of global problems. It will be reduced, instead, to pushing around poor countries and those emerging market economies silly enough to allow themselves to get into difficulties by running large current account deficits and permitting big foreign currency mismatches to emerge within their economies.
Posted by: FT Forum - Martin Wolf | September 20th, 2006 at 2:56 pm | Report this commentJuergen von Hagen: I find Martin’s and Charles’ analysis agreeable. But their proposals for reform do not touch on the all-important link between the allocation of votes on the Board and the question who is financially responsible for the IMF’s actions (although Martin points to the issue in the analysis). Making the IMF smore independent from the representatives of the “ancien regime” requires a solution that makes the IMF less dependent on the financial resources from the same countries. Otherwise, those who giovern the IMF under the new regime will have no reason to use the Fund’s financial resources prudently.
There are basically two ways to achieve greater financial independence of the IMF. One is to let the IMF float shares in the world capital market. The other is to give the Fund a once-and-for-all financial endowment (a gift from the ancien regime) with the understanding that the Fund will be closed when the endowment has been used up.
Both solutions raise important incentive questions. But it is exactly these questions that must be addressed in a credible attempt to reform the IMF.
Posted by: FT Economist Forum | September 21st, 2006 at 2:04 pm | Report this commentJean Pisani-Ferry: I share Martin Wolf’s conclusions : the IMF needs to regain legitimacy and this requires a significant reallocation of quotas and shares, beyond the symbolic decision taken at the Singapore meeting. I also agree that Europe needs to reduce and consolidate its current overrepresentation. The question is: can it happen?
The European countries’ common interest is to agree on this reduction – in fact, the EU should have taken the initiative to propose it. First, Europe should be ready to pay a price to restore the legitimacy of the IMF because having a smaller vote in a strong IMF is preferable to having a large vote in an institution that would be regarded as alien in several parts of the world and would be challenged by regional initiatives. Second, Europe’s share in the world economy will (hopefully) continue to shrink rapidly. The sooner the Europeans negotiate a new agreement, the better it is likely to be for them. Third and most importantly, the current arrangement is cosy but blatantly ineffective. With one seat and less than two-thirds the European votes, it is the US that sets the agenda at the IMF. As Lorenzo Bini-Smaghi of the ECB illustrated in a recent paper, Europe’s power at the IMF is virtual. Yet a consolidation of Europe’s votes and shares, or even an effective coordination, are unimaginable without a reduction of its weight.
Why is this change resisted, then? Let us put aside the prestige of having a seat around the table and the corresponding career opportunity for civil servants. They may occasionally matter, but after all twelve countries have already abandoned their far more important monetary sovereignty and handed over power to the ECB in Frankfurt. There are two serious issues however: the distribution of votes within the EU and the overall effectiveness of internal EU decision-making mechanisms.
Voting weights within the EU are much more biased towards small countries than within the IMF. Because the criteria for allocating votes in the two institutions are different, Germany’s voting weight within the EU is half its weight among EU countries at the IMF, while Estonia’s weight is ten times larger. Consolidation therefore involves a significant redistribution of power from large to small countries within the EU.
Zero-sum games are notoriously difficult to solve. In principle, it could be argued that the game is in fact a positive-sum game because with a single seat, all (or at least a vast majority of EU countries) would gain from a larger collective influence within the Fund. This is where the second issue kicks in, however: the problem with the EU voting system is its notorious ineffectiveness. The probability of reaching agreement is low because the threshold for qualified majority is high (this was one of the motivations for changing the system in the draft constitution). An EU that would vote within itself before taking position in the IMF Board, but that would not be able to reach internal agreement on most issues, would be a very weak player and all EU members would in fact lose influence as a consequence.
The argument should not be overplayed. Power indexes tell us something but they treat all issues as equal and do not take into account the degree of homogeneity of preferences. Nevertheless, there is a truth in the argument: consolidated representation is the solution, but not with dysfunctional internal EU governance.
Posted by: FT Economist Forum | September 21st, 2006 at 3:34 pm | Report this commentMartin Wolf: I have little to add to Jean Pisani-Ferry’s excellent analysis of the intra-EU imbroglio. I feel that agreeing on a single representation for the EU is going to be impossible, but a unified representation is a logical consequences of the creation of the eurozone.
Juergen von Hagen raises a bigger issue, which is what should determine power within the IMF. He is concerned that the borrowers should not be in a position to loot the institution. I understand the concern, but am less worried about modest changes in voting weights (and representation on the board) in favour of the potential borrowers. Remember that when the IMF was first set up, the potential borrowers had a large majority (after all the US was then the only important creditor country), but the Europeans and Japanese did not seek to overuse its credit. Today, too, there will be little danger of looting, provided countries have a sense of their own long-term interest. If borrowing countries looted the (rather small) supply of credit available from the IMF (a little over $300bn today), by borrowing and defaulting, they must know it would not be replenished by creditors. Moreover, countries do not wish to default to the IMF, because the signal that sends to the markets is always awful.
Furthermore, many of the countries that could expect larger shares can easily afford to put more money in: China is an obvious example today. Soon, moreover, these countries will have convertible currencies as valuable as, say, the yen or the euro. So I believe a substantial reweighting of today’s shares and votes can be done without any great danger that the borrowers will plunder the Fund.
It is also worth adding that the most important function of the IMF in our new world is supposed to be surveillance. Since the chief deficit country is the US, giving a greater weight to the emerging market creditor countries might well make international finance more prudent, not less. Above all, these emerging countries will not pay much attention to the Fund’s views if they feel it does not pay attention to theirs, as well.
Posted by: FT Forum - Martin Wolf | September 22nd, 2006 at 8:38 am | Report this commentRobert Hunter Wade: I largely agree with Martin Wolf’s views on reform of the IMF and on the desirability of multilateral economic organizations more generally. He is right that the changes in governance agreed to in the Singapore meeting amounted to very small steps, and that those who “think for the world”, inside and outside governments, should keep pressing a more ambitious agenda so that the small steps of Singapore do not become the last steps.
He suggests that the Fund should commit to a tighter focus on exchange rate policies and coordination of global macroeconomic adjustment - or put in other words, the IMF should refrain from being the bag-carrier for other agencies that wish to get their favourite conditions adopted by particular governments via Fund conditionality, and should refrain from presenting itself as a semi-development agency. He stresses a cut-back in Europe’s present gross over-representation to make more room for developing countries which are presently grossly under-represented in relation to most plausible criteria. He notes the need to open up the managing directorship to citizens of the world, not just Europe. And finally, he notes the need for more independence of the managing director and staff to implement the Fund’s mandate.
All well and good. But it is worth keeping a more ambitious agenda “in good currency”, so that when policy windows open these ideas can be brought more into the centre of debate. Here are several items in no particular order.
Under the heading of governance: a double majority (of shares, of countries) voting criterion for certain kinds of issues; an Executive Board which is non-residential, slimmed down from 24 to 15, meets once a quarter, limits itself to strategic, not operational issues (all this would help Wolf’s objective of more independence to the staff); and a balancing of constituencies such that all Excecutive Directors represent between six and 10 countries (rather than, as now, some representing only one, and others 20 or more).
Under the heading of finances: ways of generating revenue which by-pass the Fund’s hard-wired paradox - that its job is to prevent crises but it generates revenue on its lending, and it lends at times of crisis.
Under the heading of macroeconomic surveillance and correcting of global payments imbalances: Fund exploration of bolder measures such as an international clearing union and interest levied on surpluses as well as deficits, capital controls of various kinds, debt arbitration. And the Fund should be actively encouraging regular meetings of senior officials, at ministerial or deputy ministerial level, clustered regionally or by contribution to imbalances; and maybe parliamentarians too. This would give the Fund a role as facilitator of networks as distinct from authoritative designer of solutions.
Posted by: FT Economist Forum | September 22nd, 2006 at 10:37 am | Report this commentLawrence Summers: I am in general agreement with Martin’s views but would add two observations. First, I doubt that eliminating the board is feasible - nor am I sure it is desirable. The board members to no small extent go native and represent IMF staff perspectives to their capitals and push for the integrity of the institution. With the board removed, much of the politicisation on major matters would get worse. Anyone who doubts this should consider the one matter on which the board is de facto impotent: the selection of the managing director. I suspect most informed observers would agree that if the board had more input, the outcomes would be better.
Second, I think it is important to distinguish between new potential creditor countries in the IFIs (eg china) and those who are likely to be borrowers from the Fund and Bank. The principle that lenders set terms of loans seems to me compelling. And I worry that - as the experience of the UN system demonstrates - too much power devolved to borrowers/aid recipients could over the long term diminish major country support for the institutions. Martin caricatures the concern as “looting”. I would ask: could a tilt towards borrowing-country leverage lead to insufficiently strong conditionality in programmes, or the creation of unsound contigent facilities, or special drawing right imprudence? I am not sure that the issues here are more than symbolic but I do think the distinction between new creditors and old borrowers is salient.
Posted by: FT Economist Forum | September 22nd, 2006 at 10:46 am | Report this commentCharles Wyplosz: A comment on the looting issue. When the IMF was created in 1944, there were no borrowers and no lenders. It was meant to be, and in effect it was, a “fund”, pooling reserves among countries for each member to use in case of emergency. There was no looting.
The separation between lenders and borrowers is the natural result of history, which lenders now use to claim control of an institution of which they have no use, except for imposing conditions and playing politics. Sometimes I wonder whether the lenders should not just leave the Fund to its potential users and thus restore its initial logic and purpose…
Posted by: Charles Wyplosz | September 22nd, 2006 at 3:00 pm | Report this commentMartin Wolf: Larry Summers is (almost) always right. So let me propose a compromise on the question of the board. The reconstituted board should continue to meet at regular intervals, though less frequently than now. It should focus its attention on general policy issues, but not be involved in every decision the Fund makes. The managing director and staff should decide the content of surveillance reports, including the World Economic Outlook and similar documents. But since Fund lending must involve the shareholders, a resident board then serves as a useful interlocutor between the staff and the capitals.
If the IMF is to carry out its global mandate, the big concern is the effective inclusion of what Larry calls “the new potential creditor countries”, particularly in Asia. They must be given a suitable weight in the institution if they are to regard its strictures on their policies as legitimate, since they do not have to do as they are told.
As Charles Wyplosz notes, the division between creditors and debtors was not a part of the original design of the IMF, since it was conceived as a revolving fund on which all could draw and to which all would contribute. In such an institution, the bifurcation that Larry stresses would not exist. In practice, as I mentioned in my response to Juergen von Hagen, the likely borrowers did have a majority in the original Fund. Yet it worked quite well. The drawback of giving countries that will never borrow total control over the IMF is that those who might borrow, but prefer not to do so, choose to self-insure, instead. This has lost us the initial purpose of the Fund.
Conceptually, one could envisage the creation of two distinct organisations – one an insurer against liquidity crises and the other responsible for surveillance. If there were two organisations, they could have two systems of governance. But there are not – and will not be – two institutions, at least at the global level.
A compromise solution might be to increase the voting weight of the new potential creditors, while allowing borrowers sufficient say in Fund policies to make use of its credit domestically legitimate, without scaring away suppliers of credit and emptying the institution of resources. That must be a tricky balancing act.
Asian countries could also go further towards developing their still modest regional revolving fund (the Chiang Mai Initiative). That could remove their demand for funds from the IMF. This would then allow a rebalancing of the votes without threatening a feared take-over by likely users of the credit.
That point brings me to Robert Wade’s interesting remarks. We are in agreement in several areas. The Fund does need a source of income, other than crisis lending. If it were a proper insurer, it would charge fees for its services. But it is not, because many of its members never need to borrow. So there must be some other source of revenue. Some suggest sale and investment of the proceeds of its gold stock.And I agree with him on the Fund’s role as a facilitator of networks.
I disagree with Robert in two important areas.
First, international institutions have to reflect power in the area in which they work. Otherwise, they will enjoy a formal rather than an effective existence: the UN General Assembly is the model to be avoided at all costs. So I oppose the double majority. But I do accept that constituencies need to be reconfigured, to allow better representation of small countries.
Second, I see no point in discussing a clearing union in current circumstances or in suggesting the levying of interest on surplus countries. I don’t think these are relevant proposals in today’s world of freely moving capital. In any case, they will never be agreed. As for capital controls, they are already permitted.
Posted by: FT Forum - Martin Wolf | September 22nd, 2006 at 5:13 pm | Report this comment