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Change is overdue for IMF governance

by Rakesh Mohan

Change is overdue for IMF governance

The world is on the cusp of an epochal change in global economic power, not seen during the past 200-250 years since the start of the industrial revolution.

The centre of gravity of the global economy is shifting back towards Asia from the North Atlantic. Yet there is little evidence of this change being reflected in the framework of global economic governance, where we see a stalemate over the international financial institutions, in particular the International Monetary Fund. The impasse seems to indicate the advanced economies’ reluctance to countenance broader governance changes, despite these momentous economic shifts.

The international financial organisations remain dominated by the advanced economies. IMF reforms have been held up by the US administration’s inability to obtain approval from Congress for doubling the IMF’s quota resources, and changes in its voting and quota structures that the IMF’s board of governors agreed under the 2010 review process (the Fund’s 14th).

This congressional blockage is doubly unfortunate because the US was the principal architect of the 2010 accord. The US has 17.7% of IMF quota shares and hence an effective veto over important decisions that require a ‘super-majority’ of 85% (Chart 1).

The creation of new institutions led by emerging and developing economies,
particularly by the Brics countries (Brazil, Russia, India, China and South Africa), such as the Asian Infrastructure Investment Bank, the New Development Bank Brics and Currency Reserve Arrangement, is indicative of these countries’ dissatisfaction with the framework.

Prospective changes in quotas and voting shares would lead to reduction in the shares of the European countries, which retain disproportionate weights in the IMF despite a shrinking share of global GDP (Chart 2). US leadership of the international institutions remains of great value, and it is important
that the US retains its dominant position.

The Bretton Woods institutions owe their founding to US vision after the second world war. US financial markets continue to be the most dominant in depth and efficiency – and the dollar is the dominant reserve currency
and will remain so for the foreseeable future.

Although the role of the emerging economic powers is increasing, their soft power is not rising at the same pace, underlining the importance of keeping US leadership.

Economic weight shifts

The global economic structure was broadly stable from 1945 until the turn of the millennium. The advanced economies’ share in global GDP was around 60% through that period though there were changes in relative weights among the advanced economies themselves, particularly related to Germany and Japan (Tables 1 and 2).

Change since 2000 has gathered pace, with economic weight shifting from the North Atlantic to Asia. This is expected to accelerate further over the next couple of decades. So changes in global economic governance will have to be more substantive than the current incremental change envisaged.

The global GDP shares of emerging and developing economies is expected to increase from 40% in 2000 to over 60% by 2020 in purchasing power parity terms and from 20 to 40% in market exchange rate terms. The
G7 countries’ share in global GDP (PPP) is expected to fall from about 44% in 2000 to about 30% by 2020, with a corresponding increase in the share of Brics from 19% in 2000 to 33% in 2020 – part of much bigger
changes expected up to 2060 (Chart 3).

The emerging economies’ demand for better representation must be seen against the backdrop of the North Atlantic financial crisis that originated with US sub-prime troubles in mid-2007. The crisis has led to stagnation and weakness in the mature economies, whereas emerging economies recorded strong growth, albeit with some recent moderation.

The Brics countries, particularly China and India, are acquiring large economic weights because of population size, despite relatively low per capita incomes. Greater participation in global economic governance will require greater assumption of responsibility. The transfer of governance roles needs to be tempered by the relative lack of sophistication and size of economic institutions in these aspiring countries. But we can expect that this gap will be bridged before too long.

Financial globalisation is unlikely to be reversed. As the world recovers from the 2008–09 turbulence, other crises will erupt.

As normalisation takes place from the unconventional excessively accommodative policies practised in much of the developed world, and the large debt overhang that exists, the eruption of financial instability in some parts of the world would not be surprising in the near and medium term.

As the emerging economies have grown individually and collectively, and as international financial markets have become more interconnected, resolving successive crises will need large international resources. The IMF is likely to be more not less necessary for its roles in preserving financial stability and as a lender of last resort. To perform effectively, the Fund must have adequate permanent quota resources to retain and enhance its credibility and legitimacy. So it is essential that its quota resources re increased regularly, in line with the expanding size of the global economy and financial markets. Moreover, such regular quota reviews would also ensure that the emerging powers get their rightful share in the IMF’s governance, extending its evolution since 1950 (Table 1 and 2). Decisions on IMF governance and the use of IMF resources can no longer be made in the clubs of the G7 and G10: some of the action has already shifted to the G20.

The IMF’s governance structure has to become more inclusive. The US needs to retain its role, in its own as well as the wider international interest. As US Secretary of the Treasury Jack Lew noted in March 2015: ‘A well-resourced and effective IMF is indispensable to achieving our economic and national security interests, protecting the health of the US economy and enhancing the prosperity of America’s workers.’ 

European countries remain overweight, with the ‘advanced Europe’ group (European Union, Norway and Switzerland) taking a third of board seats, and more than a third of board voting power: the relative constancy of their quota shares is striking, since their share in GDP is falling consistently (Chart 4).

Furthermore, the Bretton Woods institutions since inception have been headed by European nationals in the IMF and US nationals in the World Bank. This pattern has continued for almost seven decades now. It appears that there was an informal agreement that the World Bank would be headed by a US national, and the implicit understanding was that the IMF would be headed by a non-US national; somehow, over time, this got transformed to a European national heading the IMF on a continuous basis.

Thus, nationality has turned out to be the guiding criterion to head the Bretton Woods organisations and nationals of other countries, irrespective of merit, have been excluded. This must be corrected. Other institutions such as the World Trade Organisation have shown the way; there is no reason why the Fund cannot find procedures that could result in the same outcome.

US needs to retake leadership Global economic governance is at a crossroads. The economy has become more complex and interconnected, as international trade has become virtually free across the board as a consequence of multilateral trade rounds, and as capital accounts open further. The best way out of this impasse would be for the US to retake leadership in the IMF and global economic governance through an immediate congressional approval of the long-postponed 14th review. If the US believes that the IMF is important or the smooth functioning of the global economy, in which it has a large stake, it must make it clear that it is in favour of discussions on and consequent approval of the next five-year review (the 15th), which should in normal circumstances have been approved by end of 2015. And the US should support other such quota reviews in the years and decades to come. Further ahead, reviews of IMF quotas and governance need to be more radical – with significant implications for overall quota and voting shares. In addition to the under-representation of the Brics, the country that is most under-represented in relation to its share in global GDP is the US.

Whereas the GDP shares of the US and EU are broadly comparable (16.7 and 17.9% in PPP terms, respectively), the calculated quota share of the US, based on the latest 2013 data, would be 14.5%, compared with 27.6% for the EU (based on the current quota formula).

Correction of this imbalance in favour of the US is important in obtaining congressional approval for future quota reviews. The existing quota formula will need revision to accomplish this. If an appropriate correction is carried out, it would postpone by some years the prospect of the US quota share dropping below the important 15% threshold. This provides a further reason why protecting the S quota share should be a priority – a matter
that concerns not simply the US, but also the entire international community.

Professor Rakesh Mohan is an Executive Director on the IMF Board, representing India, Sri Lanka, Bangladesh and Bhutan, and a member of the OMFIF Advisory Board. Based on Rakesh Mohan and Moneesh Kapur, 'Emerging Powers and Global Governance: Whither the IMF?', IMF Working Paper (forthcoming 2015). The views expressed in this article are those of Prof. Rakesh Mohan and do not necessarily represent the views of the IMF, its Exrcutive Board, or IMF management, or of the authorities he represents.