October 07, 2010
Some thoughts on the IMF reform debate
Today, we're fortunate to have Mark Copelovitch, Assistant Professor of Political Science and Public Affairs at the University of Wisconsin, as a Guest Contributor. He is also author of The International Monetary Fund in the Global Economy: Banks, Bonds, and Bailouts (Cambridge University Press, 2010).
In the wake of the global economic crisis, the IMF has returned to center stage in the governance of global finance. The Fund’s lending commitments have soared from less than $2 billion in 2007, to nearly $200 billion today, including the large bailouts of Greece, Hungary, and the Ukraine. In response to the Fund’s resurgence, scholars and policymakers have also resumed the debate about reforming IMF governance. At their summit last September, the G-20 countries agreed to shift at least five percent of the Fund’s voting power toward large emerging markets and other developing countries. Last month, the United States pushed further for this reallocation of votes to be linked to a consolidation of the European countries’ seats and a reduction in European voting shares on the Fund’s Executive Board (The Economist’s Free Exchange blog had a nice post on this at the time, available here). Two weeks ago, Germany responded with its own demand that the US give up its unilateral veto over IMF governing rules, which require 85% supermajorities (The US holds just under 17% of IMF votes). On Friday, European Union finance ministers approved a proposal that would share two of Europe’s current seats on the Executive Board, on a rotating basis, with emerging market countries.
As geopolitical theater, this transatlantic back-and-forth is certainly entertaining, at least for those of us who study international relations and political science. Indeed, Alan Beattie of the Financial Times described the ongoing debate last week, with tongue only partially in cheek, as a “Tolstoyan familial saga” and a “Stieg Larsson race-against-time thriller.” The truly important question, however, is whether this reallocation of “chairs and shares” (a term coined by Edwin Truman: see his excellent in-depth discussion from 2006 on IMF reform) within the IMF Executive Board actually matters. In other words, will voting reform actually change the politics and policies of the Fund? Likewise, will reform – as most proponents argue – actually increase the voice of developing countries and enhance the Fund’s legitimacy?
Unfortunately, the short answer to both questions is “not really.” So far, the reforms that have been either implemented or proposed are largely symbolic. They neither fundamentally alter the balance of power within the IMF nor change the basic politics of Fund lending, in which the US and a small group of other advanced industrialized countries exercise de facto control over IMF lending decisions. In order to understand why, it is necessary to delve a bit further into the details of IMF governance. Under the Fund’s current governing rules, the five largest shareholders (the “G-5” countries: the US, Germany, Japan, France, and the UK) hold their own Executive Board seats encompassing approximately 38% of the votes, with the rotating seats held by Canada and other Western European member-states controlling an additional 22% of the votes (see the table below). China, Russia, and Saudi Arabia also hold their own “elected” seats, with a combined 9.5% of the votes. The other 16 Executive Directors are elected and represent regional sub-groups of the remaining member-states; Spain currently holds one of these seats, giving Europe control of 9 of the 24 seats on the Board.
This distribution of “chairs and shares” within the Executive Board gives the US and other advanced industrialized countries overwhelming influence over IMF decision-making. In fact, as has been widely reported in recent media reports on IMF reform, the US holds a de facto veto over many Fund governance decisions (including changes to the Articles of Agreement and changes to the structure of the Executive Board) that require an 85% supermajority of votes. Lost in the current debate, however, is that decisions about IMF lending are not subject to the 85% supermajority rule: Board approval of loans formally requires the support of only a simple majority of votes (not seats). Moreover, the Board rarely conducts an actual vote to approve IMF programs; rather, its standard procedure is to make decisions on a consensus basis based on the Managing Director’s “sense of the meeting” (i.e., “a position supported by Executive Directors having sufficient votes to carry the question if a vote were taken”; on the details of IMF governance, see here, here, and here).
What this means, effectively, is that the current reform proposals on the table will have no meaningful effect on the politics of IMF lending. Indeed, even if the Fund follows through with its 2009 pledge for a further 5% redistribution of voting rights toward developing and emerging market economies, the US and other advanced industrialized countries will retain a sizeable governing majority within the Executive Board when it comes to making decisions about IMF loan size and conditionality. In fact, even a consolidation of European Board seats and a reduction in European voting rights would do little to alter this fundamental distribution of power. To illustrate this point, let’s assume that the 5% redistribution of voting rights would come directly from the G-10’s 62% share of Board votes, and that a consolidation of European seats would not further reduce Europe’s overall voting share. This would still leave 57% of the votes in the hands of the US, Japan, Western Europe, and Canada, even if some of these countries’ seats and votes were reallocated to China, Korea, and other emerging market countries. Under this scenario, it is difficult to imagine that the substance of IMF lending decisions would significantly change, since the newly-empowered countries within the Fund still could not, on their own, summon a majority within the Board. More likely, IMF loans would continue to reflect the domestic financial and political interests of the US and its G-5/7/10 counterparts, just as they have throughout the last thirty years (there is substantial empirical evidence to this effect in the recent political science literature on the IMF; see, for example, here, here, and here). In the absence of more extensive governance reform, there is little reason to believe that this pattern will change in the future.
Therefore, the IMF reform debate, at least on the core issue of IMF lending, appears to be much ado about nothing. Since the current reform proposals do not address the key concern of most developing countries – namely, the fact that IMF lending is politically-driven and excessively influenced by the national interests of the US and other rich countries – they are unlikely to enhance the Fund’s legitimacy in the eyes of its member-states. Even more extensive reforms, however, would not entirely eliminate politics and powerful states’ interests within the IMF. Instead, redistributing voting power from the advanced industrialized countries toward large emerging markets would simply replace Western countries’ national interests and influence with the domestic political and economic concerns of other member-states, such as China and the other “BRICs.” Consequently, just as countries such as Mexico and Argentina received favorable treatment from the IMF in the 1990s, due in part to G-5 governments’ strong financial stakes in these countries, future borrowers might also receive bailouts if they have close ties to those countries with newly-enhanced voting power within a reformed IMF. Simply put, no amount of voting reform will completely purge politics from IMF lending. So long as the Fund’s member states have the final say over IMF policies, their domestic political and economic interests will invariably shape the Fund’s lending behavior. In the long run, this means that the real impact of IMF reform may be the elevation of Chinese (and Brazilian, Indian, and Korean) national interests into the equation, at the expense of American, European, and Japanese interests.
That said, certain other governance proposals do stand to enhance the Fund’s legitimacy and would reduce the degree to which politics shape IMF lending decisions. One such proposal is the idea, suggested by several experts (e.g., Nancy Birdsall, Ngaire Woods, and Eswar Prasad), to require IMF lending decisions to be approved by “double majorities” (a majority of board votes, plus a majority of board members). Under this system, the G-5 countries would require the support of at least eight other board members in order to approve a Fund program. This reform would create incentives for the Fund’s largest shareholders to seek alliances with rising powers such as China and Brazil, as well as with smaller developing countries. Another interesting idea is Jim Vreeland’s proposal to transform the IMF Executive Board into an independent body – akin to the governing board of a national central bank – at least for the purposes individual lending decisions. Finally, adopting a merit-based appointment process for the positions of IMF Managing Director and World Bank president – rather than the current custom of appointing European and American heads – would be an important symbolic step toward enhancing the IMF’s legitimacy in the global economy. Rather than quibbling over modest reallocations of “chairs and shares,” as they have to date, G-20 policymakers should instead embrace these latter reforms, which would meaningfully alter the politics of IMF lending and enhance the Fund’s legitimacy as it faces the uncertainties of the global economy in the coming decade.
This post written by Mark Copelovitch.
Posted by Menzie Chinn at October 7, 2010 05:00 AMdigg this | reddit
I have been under the impression that the IMF has, in general, been run by pretty competent, well-intentioned macroeconomists trying to bring over-spending countries back to some sort of fiscal sanity. Within its limits, I would consider the IMF something of a success, and not a particularly politicized organization, regardless of voting power.
However, the IMF--like most economists--still operates under a socially conservative (agency) view of the motivation of political decision makers. Thus, politicians are assumed to behave 'in the public interest' with a 'public service ethic'. Asked if this is what they actually observe, I think most IMF economists would readily concede that reality is more complicated.
But ask them how they align incentives...well, that's quite a controversial topic. 'You mean, pay politicians for performance? For optimizing GDP growth and fiscal balance? Like they're...business people? As a condition of fiscal support? Inconceivable." The invisible hand is fine, but not in politics! There (as Jagdish Bhagwati would say) it is nowhere to be seen.
So I perceive that the IMF, like most economists I have talked to, are unwilling to even discuss (and frankly mortified by) tools which, in the private sector, are taken entirely for granted and which have worked well for decades.
If you want meaningful reform, then that's the one you need.
Posted by: Steven Kopits at October 7, 2010 06:13 AM
All thoughts and conclusion aiming at professionalizing the decision process and outcomes of the IMF will be welcome.
A pivot share or a blocking majority is not contributing to this aim.
The same thoughts and process should apply to the World Bank (in 2007 WB loans were made to China at concessionary rates source Bloomberg)
Posted by: ppcm at October 7, 2010 06:52 AM
Mark C. First a small quibble. You said "the Ukraine." Should be just "Ukraine" without the definite article.
I'm not sure if getting help from the IMF is a blessing or a curse. They always seem to be leading the austerity now, austerity forever charge. The IMF has an amazing ability to find a way to make a bad situation worse.
Correct me if I'm wrong, but my understanding was that the IMF's role was to act as a central banker for the world, whereas the World Bank focused more on development loans. In other words, the IMF was all about macroeconomic stabilization rather than economic development. Given this role as central banker to the world and given that most of the world's international currencies are in either dollars or euros, doesn't it make sense that the US and Eurozone should have a dominant voice in the IMF? I can understand the developing world's concerns about US and European dominance of the World Bank, but it's less obvious to me why they should feel that way about the IMF. Thanks.
Posted by: 2slugbaits at October 7, 2010 02:04 PM
From the post:
"More likely, IMF loans would continue to reflect the domestic financial and political interests of the US and its G-5/7/10 counterparts, just as they have throughout the last thirty years (there is substantial empirical evidence to this effect in the recent political science literature on the IMF; see, for example, here, here, and here)."
"Consequently, just as countries such as Mexico and Argentina received favorable treatment from the IMF in the 1990s, due in part to G-5 governments’ strong financial stakes in these countries,..."
I think it would have been more accurate to say that the "strong financial stakes in these countries" are to the benefit of banks in the G-5 nations as opposed to " G-5 governments", but, this an exellent post so I do not mean to sound critical, and... my distinction may not be entirely correct? But some IMF loans are arranged through private banks, but I don't know what %. It is critical to understand though that the austerity tactic is often due to efforts to protect private lenders at the expense of precious financial resources.
Posted by: rayllove at October 8, 2010 09:34 AM
I thought of you a couple of times over the past few days and I just thought I owed you some gratitude for this post. Thanks to you, when I saw headlines such as: 'G20 Inks Pact to Avert Trade War, Seals IMF Power Shift',(Reuters), I had a little chuckle. One such story, I don't remember from which outlet, made the 'power shift' out to be the most significant structural change since the founding of the IMF. Which may be true, but... it was given in a hyperbolic context, as opposed to what I suspect to be the more honest context having more to do with how guarded and inequitable the developed nations have been regarding governance. Clever spin.
Posted by: rayllove at October 23, 2010 09:08 PM