After the Fall: Re-asserting the International Monetary Fund in the Face of Global Crisis

Introduction

Under the pressure of the current crisis, the international community is carving out a new role for the IMF. But this is not the first time. Every decade or so, the institution has slightly changed the nature of its role in the global system. Almost 40 years ago, in the 1970s, it relinquished supervision of the Bretton Woods exchange rate system and lost its role as forum for global economic coordination.

Ten years later, it assumed the role of manager of the emerging debt crisis. When international financial risks related to the debt crisis waned, the IMF took on the “systemic transformation” in Russia and its former satellite states. That function, too, became obsolete, and the Fund re-asserted itself in the face of the Mexican, East Asian and other financial crises of the 1990s by engaging in large-scale emergency lending. Once that was no longer needed, the institution went through a period of inactivity, leading many to wonder if there was any role at all left for the IMF in the international monetary system.

Now, once again, policymakers are looking to the IMF to define a new, more meaningful role for itself. What exactly that should be is currently the subject of discussion in various groups such as the G-7, and, especially, the G-20. It is also what the Manuel Commission—a group of experts chaired by South African Finance Minister Trevor Manuel—is working on, in its report to be made available shortly.

In what follows, I draw some lessons from the current economic crisis, deduce the implications for IMF reform and, finally, share some concrete recommendations.

Lessons from the Current Crisis

This financial crisis can be attributed to the past seven years of low interest rates and high world growth. While macroeconomic forces were at work in the guise of low interest rates driving investors to seek out returns further down the credit quality curve, the financial system, partly in response to this, came up with new structures and financial instruments offering higher risk-adjusted returns, instruments in fact far riskier than they seemed. It was not long before market discipline fell short, as optimism prevailed and due diligence was outsourced to credit rating agencies.

In this setting, there has been fragmented surveillance with policy debates scattered across various fora such the Bank for International Settlements (BIS), G-7 and G-20, the Financial Stability Forum (FSF), and, of course, the IMF; insufficient cooperation among national financial regulators; and lack of engagement of world economic decision-makers in time to make a difference.

Implications for IMF Reform

Not even amidst the red flags and distress signals was any real system of collaborative global action set in motion. For instance, the disorderly unwinding of global imbalances had long been recognized as a major systemic risk. Yet, collective action in that regard proved less than satisfactory: the IMF’s Multilateral Consultation of 2006-07 produced only the slightest interest of its participants. Once the crisis was in full swing, the policy response remained neither collaborative nor coordinated.

To be fair, this has been pretty much in line with the traditional response of the international community to the episodes of instability affecting the world’s monetary and financial system since the 1980s and for which the response has been conducted on a case-by-case basis, with an emphasis on domestic factors rather than on systemic determinants.

This just happens to reflect well the underlying contradiction in the vision of the IMF that the international community has held since the 1970s, following the end of the Bretton Woods era. On the one hand, powerful members of the IMF have been pushing for the Fund to do more surveillance, yet, on the other hand, these same members have not delegated the institution enough powers to conduct surveillance in ways that might be more effective. They have provided neither adequate authority to the Fund nor effective instruments of enforcement. They have been reluctant to endow the IMF with political capital, making it ineffective as a forum for multilateral solution finding.

For instance, in the latest round of IMF reform in the aftermath of the Asian crisis, the IMF was asked by its key shareholders to devise the Financial Sector Assessment Program (FSAP) with the aim to step up its financial sector surveillance. Yet, to date, neither the US nor China have undergone such an assessment. That same round of reform sought to resolve the loopholes in the financial regulatory regime, prompting the IMF to focus on off-shore financial activity in small, exotic islands, rather than on the toxic assets and financial vulnerabilities being accumulated in systemically-relevant economies.

Though the need for cooperation is now finally recognized, there is no central body to assume leadership for responses to systemic risks in the global economy, while the debate has shifted to smaller and more flexible groups. The Fund has not been effective in this debate so far partly due to lack of a truly representative and effective executive board and the International Monetary and Financial Committee (IMFC).

Reforming the IMF: Recommendations

Against this background, last November in Washington, the G-20 leaders off a process that could lead to a fundamental reform of the world’s monetary and financial system. Given the little time that there is until the London Summit of the G-20 on April 2, it is not clear yet how much they will be able to achieve.

But whatever they will come up with, it has to be assessed against the yardstick of whether or not their decisions provide the international monetary system with a credible institutional anchor, that is, whether or not the IMF will come out of these discussions with an enhanced mandate from its shareholders.

With that principle in mind, there are some proposals that I have had the privilege of discussing with my colleagues of the Bretton Woods Committee. As there is no time to review them in detail, let me flesh out the key underlying principles. The thrust of these recommendations is first to make the decision-making system of the IMF, but also of the World Bank, far more transparent and inclusive. An obvious way to institutionalize this requirement is to introduce the double majority requirement for major decisions. Incidentally, this would end the Euro-American dominance at the helm of the Bretton Woods Institutions, since smaller and poorer countries would have a stronger say in the leadership selection.

Inclusiveness and a greater sense of ownership of the Bretton Woods institutions does also require a more balanced distribution of the voting power between developed and developing economies. In this regard, it is important that the IMF continue to simplify and make its quota formula more responsive to the changing economic realities of the 21st century.

The ensuing reallocation of voting power will then spur a change in the composition of the executive boards, that is, the policy-making organs of the IMF and the World Bank, with developing countries enjoying a broader representation than is currently the case. That said, changes in quotas and representation on the executive board are not mechanically correlated. A more representative and effective board requires one key reform: that European countries consolidate their representation. This could be accomplished in a number of ways such as, for instance, having one chair representing euro area countries and another chair representing all the EU non-euro area members.

The representation of the euro area chair(s) could be entrusted to the European Central Bank and the EU Commission or be a multi-country constituency where the concerned members would agree on their internal representation. Whatever the variant chosen, the two basic premises are that: i) the Europeans must bring consistency in their representation on external monetary affairs, as they have done, for instance, with trade policy, and that ii) France, Germany, and the UK commit, either for Europe or for the world at large, to relinquish the “exorbitant privilege” of holding single-country appointing chairs.

Bibliography

Bretton Woods Committee, Advancing the Reform Agenda—A Proposal to the G-20 on International Financial Institution Reform, March 2009, Washington, DC.

Lombardi, Domenico, and Ngaire Woods, “The Politics of Influence: An Analysis of IMF Surveillance,” Review of International Political Economy, 2008, Vol. 15, No. 5, pp. 709–737.

Lombardi, Domenico, and Ngaire Woods, “The Political Economy of IMF Surveillance,” CIGI Working Paper No. 17, 2007 (Waterloo, Canada: Centre for International Governance Innovation).

Saccomanni, Fabrizio, Managing International Financial Instability, Remarks delivered at the Peterson Institute for International Economics, December 11, 2008, Washington, DC.

Woods, Ngaire, and Domenico Lombardi, “Uneven Patterns of Governance: How Developing Countries Are Represented in the IMF,” Review of International Political Economy, 2006, Vol. 13, No. 3, pp. 480–515.