July 2019 will mark the 75th anniversary of the Bretton Woods system. John Maynard Keynes and Harry White conceived the system during World War II. Their ideas were then adopted at a conference of 44 countries held at the Bretton Woods resort in New Hampshire from July 1-22, 1944. They founded the International Bank for Reconstruction and Development or IBRD, now the largest part of the World Bank Group, and the International Monetary Fund, or IMF, for monetary purposes. Keynes also wanted a third entity to help encourage and regulate trade and commodity markets, but it was not until 1995 that the World Trade Organization was founded.
The World Bank was initially project-oriented, while the IMF was conceived as a global governance institution to oversee the world monetary and exchange rate system. The founders wanted to avoid the competitive beggar-thy-neighbor devaluations that unfolded after the breakdown of the gold standard. In joining the IMF, countries agreed to fixed-but-adjustable exchange rates, with the IMF monitoring their balance of payments and providing short-term financing to counter temporary imbalances.
Over the decades, the IMF underwent many reforms and now plays a vital role in providing guard rails for the world economy, especially when crises hit.
Below, we examine the IMF’s governance structure and suggest ways of improving it to ensure the institution remains fit for purpose.
IMF governance and global governance
In 1945, the Soviet Union, which participated in the work leading to the creation of the Bretton Woods institutions, was invited to be one of the “big five” in their governance system, mirroring the United Nations Security Council. Ultimately, the Soviet Union decided not to join the Bretton Woods institutions. Thus, the IMF started as a de facto plurilateral institution of like-minded nation-states. Case in point: The Republic of China (Taiwan) represented all of China on its Board, until 1980. Only after the fall of the Berlin wall and after Eastern European states and Russia became members in the early 1990s did the IMF (and the World Bank) become truly global institutions.
Any legitimate global governance institution should recognize three realities: the existence of sovereign nation-states; different population sizes of those states; and different national capacities and resources. IMF governance from the start benefited from a voting system based on weighted votes, rather than the one-nation-one vote system of the U.N. General Assembly, as circumscribed by the Security Council and the veto power of the “big five.”
Weighted voting works best for global, or indeed regional, multilateral institutions. A one nation-one vote system gives the same weight to say, India and Vanuatu, which defies common sense, and is in no way democratic, contrary to what its proponents claim. Moreover, weights linked to certain objective variables automatically reflect changes over time in these variables. So long as these variables and the weights given to them are considered legitimate, such a governance system can endure and retain its legitimacy. Compare this to the United Nations Security Council where any one member of the five nation-states that were given veto powers at the end of World War II can block any change, including any move to amend the governance system. How can this be considered legitimate today, as it gives the U.K. and France veto power while it denies it to, say, India or Brazil?
The fact that the Bretton Woods institutions from the start had the benefit of a weighted voting system has helped them. Their governance is nonetheless much criticized—but the justified part of the criticism may be about the size of the weights and the elements used to compute them, not about the principle of weighted voting itself.
Quotas and voting shares
The IMF uses quotas to calculate the number of votes for each country and to determine the institution’s core resources. Each country first gets the same number of basic votes expressed as a fixed percentage of total votes, then receives additional votes based on the quota system described below. Basic votes can be thought of as representing “nationhood,” while quotas represent a country’s economic size as well as balance-of-payments related variables. For countries with small quotas, the basic votes make up a larger proportion of their total votes and the reverse is true for large quota countries such as the United States. About 30 countries have quota shares that are larger than their voting shares.
The quotas are determined as follows:
Quota = (GDP [50%] + OPENNESS [30%] + VARIABILITY [15%] + RESERVES [5%])^Compression factor
GDP: “GDP blend” measuring 3-year averages of GDP at market (60%) and PPP (40%) exchange rates
Openness: 5-year annual average of the sum of current payments and receipts
Variability: standard deviation from the centered 3-year trend over a 13‑year period of current receipts and net capital flows
Reserves: 12-month average of official reserves
Compression factor: Needed to rescale calculated quota shares so they sum to 100.
Quotas also determine subscription—core resources each country provides to the IMF—as well as the magnitude of access to financing.
As the world evolved, so too did quotas and voting power. While quotas as computed by the above formula are the basic starting point in allocating shares, they serve as guidance rather than as a rigid rule, since the IMF’s Board of Governors has full discretion in decisions about shares. There are significant differences between actual and calculated quotas. Notably, for Europe and the euro area, actual quotas are higher than calculated quotas. For China, the actual quota, at 6.4 percent, is only about half of the calculated quota. This discrepancy in particular merits quick correction.
Further revisions to quotas and voting shares are being discussed as part of an upcoming “15th Review,” to take place in October when the IMF Board of Governors meets to consider Fund resources and distribution of quota shares between countries. No big changes are expected, however.
The way forward
IMF governance issues are important not just for the Fund, but for principles of global governance more generally. Contrary to what neo-nationalist critics assert, more multilateralism and global governance is needed to regulate cybersecurity, climate protection, gene editing, and more. The preservation of a rules-based global trade system managed by the World Trade Organization (WTO) also remains essential. However, the one-nation-one vote governance of the WTO is problematic.
The governance principles that apply to existing or future multilateral institutions go to the core of ongoing debates about global governance. A system of weighted voting, where weights reflect the functions of an institution and automatically evolve with changes in the world environment, makes sense. Given the sovereign status of nation-states, smaller member countries should be allowed somewhat greater weight in an effort to take nationhood into account. For the IMF, the basic votes do that. For the European Union, this objective is achieved by a double majority requirement: Many important decisions require both 55 percent of the number of member nation-states and 65 percent of the EU population.
There should be no veto power as such, but it makes sense for certain important decisions to require a supermajority, which may give de facto veto rights to one or more large countries. This is the case for the 85 percent requirement at the IMF that applies for certain important decisions. Without such a provision, large and powerful countries, the U.S. in particular, would not allow the system to function. The same may be true for China. However, once the formulas, weights, and thresholds are agreed, it would be better for the sake of transparency and therefore legitimacy, not to allow for discretion in computing actual votes.
Many are calling for an increase in IMF shares of large emerging countries, specifically China, while also protecting the shares of African countries. That would mean reducing the share of European countries.
Based on the principles discussed above, changes in IMF governance that could be considered in the medium term include:
- Adding population as another variable in the quota formula, with a modest weight.
- Combining the openness and variability variables in the quota formula, perhaps into a variable that simply adds current and capital account receipts and payments and has a somewhat reduced weight.
- Considering intra-eurozone trade or perhaps intra-EU trade as internal. The eurozone has a single currency and central bank; the EU has, in addition, a single market.
- Increasing the share of GDP measured in purchasing power parity (PPP) prices from 40 percent currently to, say, 50 or 60 percent. However, the role of GDP measured in PPP is somewhat of a proxy for population size. Given the IMF’s mission, the relevant variable is actually GDP at market prices. If a population variable could be introduced, the need for PPP-GDP would be reduced. This would be an optimal outcome.
- Apply the compression factor, but put an end to ad hoc adjustments in voting shares.
A review of the current resources available to the IMF should complement quota reforms. The IMF currently draws on three main financing sources, of which only one is a permanent feature. Quota subscriptions, the central financial resource of the IMF, currently account for $661 billion representing 49 percent of IMF resources. Two additional funding resources include New Arrangements to Borrow (NAB), which account for $253 billion (19 percent); and bilateral borrowing agreements, which total $440 billion (33 percent).
Cumulatively, total IMF resources amount to $1.35 trillion, or 1.67 percent of global GDP. This may be enough to provide financing for one or several country crises, but it would not be sufficient in case of a systemic crisis. As global GDP continues to rise, IMF resources as a share of GDP will fall. Moreover, by 2022, IMF resources will also decline because non-quota resources (NAB and bilateral borrowing agreements) will expire unless renewed. There has been an overreliance on non-quota sources of funding. This is inconsistent with the IMF’s basic principle that quota subscriptions should be the main source of IMF resources. The reliance on alternate funding sources should be reduced.
The U.S. administration is taking the position that the current level of resources is adequate given “alternative sources of financing available to countries” and might not support an increase. (As of writing, it is unclear whether the U.S. Congress would oppose an extension of NAB resources). In contrast, EU states favor increasing the IMF’s overall quota and preserving GDP and openness as main variables. Both the EU and Japan suggest voluntary contributions made in recent years through NAB should be rewarded in the quota review. Additionally, China favors an increase in quotas and a reduction in quota share misalignment. The G-24 (developing countries) prefers an increase in quotas and a reduction in non-quota forms of financing.
Still essential 75 years on
Prior to the 2008 financial crisis, some questioned the continued need for the IMF. The crisis changed all that. At the 2009 London meeting of the G-20, members of this informal but powerful “Club” agreed to propose a large increase of resources, a proposal that was rapidly adopted by the IMF Board, where G-20 member countries have a majority. The IMF played a key firefighting role in cooperation with central banks and treasuries.
The IMF’s work on monetary and financial sector issues, spillovers, fiscal issues (such as the balance-sheet approach to fiscal analysis), as well as its global economic analysis, have all increased in breadth and depth. When Facebook recently announced its plans to create a global digital currency, the Libra, the G-7 quickly invited the IMF to join it in analyzing the risks that such a currency might create.
Voting reforms should accelerate to reinforce the Fund’s legitimacy; these reforms should go hand-in-hand with an increase in quota based financial firepower so that the IMF is fit for purpose. It is one of the most valuable institutions created with others after World War II to foster a rules-based, peaceful multilateralism. Along with the quality of its analysis and the financial resources it can call on, the legitimacy of its governance needs to be a major source of its strength.