In the middle of the twentieth century, the United States and Europe were the two major anchors of the global economy. When the International Monetary Fund was born in 1945, that reality was faithfully reflected in the IMF’s structure and operation.
The global economic situation has evolved over the decades to the point where, in the first stages of the 21st century, the map of global wealth has borders unimaginable to those who set up the IMF. The rapid rise of some countries in Asiaand Latin Americahas made the old rules of the game obsolete, and China, India, Mexicoand Turkeywant to take a more active, participatory role.
The people who run the International Monetary Fund (IMF) as well as its 184 member countries agree that, after five years of non-stop systemic crises, there is a “unique and unbeatable” opportunity to tackle a thorough reform of the institution.
Each member country in the IMF is given a quota that measures its voting power in making organizational decisions, the maximum financial resources that it is obliged to supply to the IMF, and the funds that it can borrow in the event of a crisis.
Currently, each country’s quota is determined in a way that basically reflects its economic situation compared with other members. To change the quota, several economic factors must be considered, including gross domestic product, transactions in its current account and its official reserves. At present, the IMF is dominated by the United States, Europe and Japan. Washington has veto power, with its quota of 17.4%, followed by Japan with 6.2%; and then Germany, France and Great Britain.
The economy of China, which is twice the combined size of Belgium and Holland, has voting power of only 2.98%, not much more than that held individually by those two European countries, which have 2.13% and 2.38% respectively. But the problem of under-representation is not limited to China. It extends to the majority of those regions that have grown significantly in recent years such as Asia, the Middle East, Latin America, and even Spain, which has voting power of 1.41% of the total. That’s far behind what its current economic weight would require today. For example, Switzerland, whose economy is practically half the size of Spain’s, has a larger voting power of 1.6%.
Experts say the solution is obvious. The structure of the IMF reflects an economic world that no longer exists. The distribution of votes has to change in order to reflect the fact that such countries as Brazil, Indiaand Chinahave made a giant leap forward in recent decades. “The voice of those countries is under-represented, and their economies are developing very rapidly. If those facts are not adequately reflected, the IMF will not be able to maintain its credibility and legitimacy,” warned Sadakazu Tanigaki, Japan’s finance minister, recently.
According to Wharton management professor Mauro Guillén, “The U.S. and Europe have to lose some of the power that came from their domination of the global economy 50 years ago. Things are not the same today. Spain should gain some quota, especially because of its greater role as an investor.”
Legitimacy and Formulas
Hugo Macias Cardona of the University of Medellín (Colombia) is a member of the Ecolatin Network. Cardona agrees with Guillén, and says the big powers have an obligation to cede some of their power if they want to keep the institution alive. “There is a need to share a little of the power that the Europeans have in the Fund basically because several countries have become independent and have canceled their debts, which has not only delegitimized the institution, but has led to its financial weakening.”
Macias believes that “to rescue the institution, all we have to do is to give away some of the power to those who have distanced themselves from the institution because of its lack of credibility.” He warns, however, that “If the United States and Europe do not manage to seduce those who have distanced themselves, they will put the future of the institution at grave risk.”
Rodrigo Rato, director general of the International Monetary Fund, is aware of the situation. In a recent interview in the Financial Times, Rato guaranteed that there will be an agreement among the 184 members of the institution to address two problems: how to deal with “changes in the weighting of countries” and how to maintain “the representation of the poorest economies.”
Rato expects to receive a clear mandate from the institution to implement a reform plan in two phases, which he says will be complete in two years. The details of the plan, which are still confidential, have already been presented to the executive council of the institution. Agreement on the first phase of the reform has already been reached. It involves a modest increase in the quota or weighting of the votes for China, South Korea, Turkey and Mexico. Those countries are currently poorly represented despite their economic power.
At IMF headquarters, there is a consensus that the current formula for sharing power is not satisfactory and must be simplified. Nevertheless, there is no agreement about the system for establishing the weight for each country. Most members support a new methodology based on GDPand the opening of each economy; or perhaps the sum of other factors.
The United Statesis pressing for a new formula for determining the quota of each country that would be based “predominantly” on the size of each economy. That way, the relative weight of Asian countries would increase at the expense of several small European countries. For their part, those countries argue that the quota must not be based only on the size of the GDP. They criticize the United Statesfor trying to maintain enough weight in the organization to veto key decisions.
Bundesbank, Germany’s central bank, does not support the idea of precipitously giving away capital and voting rights in the IMF to developing countries. “We must find a solution that is transparent and which involves equitable representation for all countries in the IMF,” declared Axel Weber, the president of the Bundesbank. “The partners of the European Union must not agree to any arrangements that involve the aspirations of other countries in the anticipated way,” Weber explained to Handelsblatt, the German daily.
Germany prefers that the GDP and the degree of economic openness be the decisive variables in calculating each country’s quota, to the detriment of its foreign exchange reserves. That way, such countries as Germany, Spain and Ireland would be [currently] underrepresented in the international organization. Guillén supports the notion that the variable for measuring the weight of countries “should involve considering several factors: the size of its economy, its ability to export, [the level of] foreign investment and the strength of its financial system.”
Far from talking about indicators of wealth, Macias supports the concept of “creating an organization of developing countries that represents the interests of its members.” He also supports the idea of giving them “real negotiating power within the Fund.” That way, “the countries of Latin America, as well as those from Africa and even some from Asia, could participate.” For Cardona, “the most important thing is that countries take regional positions; Latin America must make an effort to participate in a unified way to avoid systematic errors committed by the Fund.”
Positions on the IMF’s executive committee will also be a topic of discussion within the reforms. The countries of the EU occupy eight of the 24 available seats [on the committee], but they could wind up having as many as nine seats – those that belong to Germany, the United Kingdom and France, plus two seats that permanently represent Belgium, Italy, Holland, the Nordic countries [Scandinavia] and Switzerland. Spain will join those eight countries in November when it takes the baton from Mexico and Venezuela, with whom it has shared a rotating position [on the committee].
On this question, the U.S. argues that the European states should give away one seat or even that the euro zone should be represented jointly in the IMF. This seems unlikely because it would mean that France, Germany and Italy would give up power. Already, several voices have spoken out against such measures, arguing that Europe would have to be much more closely integrated.
Beyond discussions about power sharing and organizational structure, the IMF reforms involve its very essence. The organization must analyze its current role in the international financial system. Guillén emphasizes that the main goals in the reform of the IMF must be “to correct the imbalance in terms of the weighting of countries. But it must also make the institution focus on its key mission, which is to facilitate problems in international payments and imbalances in the balance of payments.”
Today, the IMF’s function as a moneylender to emerging markets has been relegated to a secondary level as a result of increased private capital flows and the growth of central bank reserves, especially in Asia. Rato has already noted that the main task of the Fund involves supervising, but not granting, loans.
“The main goal in the reform of the IMF must be to recover its legitimacy, which has been seriously wounded, especially in developing countries,” notes Macias. “This institution, which was created during negotiations that brought the Second World War to an end, has reached a key point for restructuring itself and redefining itself. That is because so much has changed since it was created.”
The proposals on the table argue that the organization should establish “multilateral” management of those “systemic” problems that have a regional or global impact. At the same time, these measures would involve careful observation of the impact that national economic policies of big countries have on the global economy. They would also emphasize policies for exchange rates and test those policies’ “consistency” with global economic stability.
“Today, the main global problem is the enormous concentration of incomes, and that’s where there should be the major programs of the International Monetary Fund,” says Cardona. Adds Macias: “The institution must do more when it comes to considering the local realities of those countries where it establishes its programs, so that there is a higher probability that it will succeed there. There are many examples of IMF programs that not only have failed to achieve their proponed goals, but have wound up damaging – in some cases seriously – other subsystems of the local economy. In addition, the IMF must guarantee a predictable external environment for those economies that are on the road to development.”
Work on designing a “new” IMF and designing a more equitable formula for quota sharing will begin before the end of the Singapore summit on September 19 and 20. However, Rato has warned against any expectations that the meeting at Singapore will mean meaningful progress in resolving the international economic imbalances that result from the new process of multilateral consultations that the IMF launched last March.
According to Rato, the consultation process is still in its initial phase. The IMF recently completed a first round of bilateral contacts with the United States, China, the euro zone countries, and Saudi Arabia. Soon, group consultations will begin. It is anticipated that multilateral discussions will be completed at the end of this year. “We will talk about it at the IMF meeting in March 2007,” said Rato, who was formerly Spain’s economics minister.