As nominations for a new managing director are collected from the member countries of the International Monetary Fund (IMF), European leaders are closing rank around French Finance Minister Christine Lagarde as their preferred candidate. German Chancellor Angela Merkel put the first stake in the ground soon after Dominique Strauss-Kahn’s arrest for an alleged sexual assault of a New York hotel maid, which led to his resignation as IMF chief on May 18. The way Merkel sees it, as the 24 members of the IMF’s executive board meet to appoint a successor to Strauss-Kahn in June, there are “good reasons” to keep with tradition and have a European remain at the head of the organization as a key broker in helping the eurozone find a way out of its debt crisis. With nearly 36% of the votes at the IMF, Europe holds a powerful hand to win a simple majority.
But there’s a possible hitch to the Europeans’ plan. As the world’s largest economy, the U.S. has been granted the largest voting share of any IMF member on the executive board — at 17% — and could play the spoiler to the Strauss-Kahn succession strategy that many EU leaders want. “It’s not necessarily a done deal,” says Simon Johnson, MIT economics professor and former IMF chief economist. “If someone else [besides France’s Lagarde] emerges whom other countries will back, the U.S. could lend its support.”
If the U.S. is swayed, it would be the first time since the Washington, D.C.-based institution was set up in 1944 that a European has not been at the helm. That would be important for several reasons, say experts from Wharton and elsewhere. Such a change at the IMF, for example, could mark a larger leadership trend promoting developing country high flyers at other intergovernmental organizations, beginning with the World Bank. American Robert Zoellick’s term as president of the Washington, D.C.-based bank ends next year and, like at the IMF, questions are arising about whether candidates from outside the U.S.-European stronghold need to be carefully considered.
While other countries have not coalesced around a consensus IMF candidate, possible contenders from Asia include Singapore’s finance minister, Tharman Shanmugaratnum, and South Korean economist SaKong Il. South African Finance Minister Trevor Manuel has also been mentioned as a candidate, as has Agustin Carstens, Mexico’s central bank governor.
Regardless of who takes the helm of the institution, the success of Asian economies means they “most probably” will have a larger role in setting the rules at the IMF, which has long been the domain of the industrialized countries, noted Nobel Prize laureate and Columbia University economics professor Joseph E. Stiglitz at a conference in April. Ever since the IMF began as an overseer of the economic policies and promote the financial stability of its 187 member countries, it has been run under the heavy influence of the U.S. and the world’s other big, developed economies — Japan, Germany, France and the U.K.Those five members have permanent seats on the executive board, while the remaining members are assigned to 19 groups, with one executive director representing each group. The votes they cast are weighted by the country’s subscription to the IMF, called a quota.
Others agree with Stiglitz that the model is now out of date, leaving countries like China woefully underrepresented. “The practice of treating the IMF position as a hereditary European right must come to an end,” insists Richard J. Herring, Wharton international banking professor. “With the center of economic and financial power having shifted dramatically toward Asia, it is high time to reallocate voting rights in the fund and the bank to better reflect current economic and financial realities.”
The big issue, adds Johnson, is whether the IMF can become “a club where all countries get evenhanded treatment.”
Staying Relevant
Does the organization have any choice but to adjust to the new landscape? “If the IMF continues to be seen as a European institution, it becomes increasingly irrelevant,” says Franklin Allen, Wharton finance professor. The process might have already begun. For some time, emerging market nations have been finding alternative ways to address any financial teetering at home rather than relying on the millions of dollars of loans and aid that IMF provides. One way to help them do that: After the East Asian financial crisis of the late 1990s and the Latin American debt crises a decade earlier, countries in those regions have been building up their capital reserves.
One attraction of holding such large piles of foreign reserves is that it helps countries avoid having to rely on the IMF for loans, which in the past have often come with what many see as onerous conditions attached, such as the austerity measures Greece is being forced to undertake today as part of the “conditionality” of the bailout package put together by the IMF and the EU. China alone currently holds more than $3 trillion of reserves, while this year other developing Asian economies are expected to hold around $1 trillion of reserves and Latin American and the Caribbean economies more than $7 billion, according to the IMF.
To his credit, say some observers, Strauss-Kahn had acknowledged the need to address the imbalances at the IMF, where he oversaw a staff of 2,400. Under his watch, which began in 2007, reforms were approved to adjust the quota system, for example. An upshot of that change is that China’s voting share is set to increase from 2.9% to about 6%. The IMF has also softened the “conditionality” of its assistance that made it so highly unpopular in the countries receiving its assistance in the 1980s and 1990s. Meanwhile, the organization established more flexible credit lines for countries considered to have sound economic policies to qualify for IMF financing before a crisis hits. And according to a report it published this spring, the IMF has made a break with its past views and now agrees with policy makers of various emerging economies that capital controls can at times be more beneficial for a nation than strict adherence to open capital flows.
Morale Boosting
Amid all the controversy, the IMF’s new managing director will take over a different organization than the one Strauss-Kahn inherited. Strauss-Kahn’s reforms of IMF governance, loan conditionality and capital flow policy helped restore its legitimacy in the eyes of some of the organization’s fastest growing, emerging market member countries. Being a vocal supporter of government stimulus spending after the 2008 world financial crisis and subsequent management of the eurozone debt crisis have also raised the IMF’s profile.
“The most important [challenge for Strauss-Kahn] was that the IMF was a bit demoralized because of its declining reputation as an effective and fair organization, given what happened in 1997 in Asia and then in Brazil, Russia and Argentina between 1998 and 2001,” says Mauro Guillen, international management professor at Wharton. “It was also an organization that was trying to redefine its role in the new global economy with rapidly growing emerging economies.” How much fallout and reputational damage has been caused by Strauss-Kahn’s downfall remains to be seen. But the new IMF chief will need to take further steps to bolster the institution’s legitimacy, according to Guillen.
Perhaps most important will be what measures the IMF’s new chief helps put in place to the prevent another global financial crisis. It will also mean getting involved in the ongoing global debate over exchange rates. For example, the IMF has come out in favor of the view that China should allow its currency to appreciate and float more freely against other currencies. Experts say that while a European successor would be likely to maintain that view, someone from an emerging market may be more willing to give China greater flexibility in how it controls the renminbi in recognition that a low renminbi continues to be key to the country’s, and in turn the world’s, growth, notes Yukon Huang, a senior fellow at the Carnegie Endowment for International Peace in Washington.
Over the medium term, the possible decline of the U.S. dollar as a global reserve currency will also be a hot topic. A new World Bank report titled, “Multipolarity: The New Global Economy,” predicts that by 2025, the renminbi will join the U.S. dollar and euro as the world’s reserve currencies. An emerging market leader might be more willing than a European to promote policies that elevate the renminbi’s presence as a reserve currency, perhaps even working with China’s central bank to encourage other countries to use the renminbi in their foreign exchange reserves, says Shen.
Crisis Zone
As a change of leadership looms, are the Europeans justified in digging in their heels by insisting on maintaining the status quo? Chancellor Merkel argues that the eurozone crisis necessitates a European chief, not least to continue the work of Strauss-Kahn, a former French finance minister who helped put together the €110 billion bailout of Greece and a separate €750 billion fund for other struggling European economies, both paid for by other European countries in partnership with the IMF.
Others disagree. “That position flies in the face of logic,” argues Lex Rieffel, non-resident senior fellow at the Brookings Institution, a nonprofit public policy organization in Washington, D.C. By that same token, he says, “when there were problems in Asia, there should have been an Asian managing director, and during the Latin American debt crisis, a Latin American managing director.”
A European in charge of Europe’s debt woes can lead to a conflict of interest, adds Wharton’s Allen. “The reason [Europeans] didn’t make private sector investors bear the burden [of Greece’s debt] is because the head of the IMF wanted to look after Europe,” he says, noting that Strauss-Kahn, up until his arrest, had been considered a favorite to win France’s upcoming presidential elections. Meanwhile, the European Central Bank and the European Union have continued resisting calls for a restructuring of Greek debt out of fear of causing a meltdown of the region’s banking sector. (France’s Lagarde, however, has now expressed a willingness to accept Greek debt restructuring.) As Greece staggers along to meet the terms of its bailout package, naysayers to restructuring are “delaying the inevitable,” according to Robert E. Litan, a senior fellow at the Brookings Institution.
In contrast, says Bing Shen, a retired Morgan Stanley executive director and former World Bank economist, an emerging market country leader is less likely to soft-pedal a solution to the eurozone debt crisis. “The real Gordian knot in the Greek debt situation is the unwillingness of banks to take a ‘haircut,'” and not receive the full amount of money promised under the original terms of the debt, notes Shen. “If Greece wants additional help from the IMF, someone from an emerging market country may be willing to put their foot down.”
