It is widely recognized that many of the small economies of the world do not possess the resources to expand demand in order to limit their contraction of output in the face of the adverse gales now blowing. Over sixty years ago the world created an institution (the IMF) intended inter alia to help them act against cyclical downturns. Today most countries do not wish to use it except as a last resort, and so it sits hardly utilized in the face of what some people regard as the most severe shock the world has faced since the outbreak of the First World War.
This is unacceptable. It could be changed by adopting two types of measure.
IMF institutional reform: Chairs, shares, and the Managing Director
The first has already been talked about ad nauseam, and a few months ago all seemed to be lost for the indefinite future on that score. But today there is at least some hope that the Obama administration will not regard itself as locked in to the surrender negotiated by its predecessor, and that a real reform of IMF governance will take place. For unless the countries that need to draw from the IMF come to regard it as their institution (which it is not and will not be under the terms negotiated by the Bush administration), they are unlikely to “go to the IMF”.
My colleague Edwin Truman has neatly summarized the first of the changes as involving chairs and shares. “Chairs” refer to seats on the Executive Board, and “shares” to the percentage of total quotas that determines voting power in the Fund. At present both reflect the world of the 1940s, being dominated numerically by the Europeans, although only one country -- the US, obviously -- has veto power.
A real reform would give the European Union a single Director, with the same voting power as the US, neither of whom would be able to veto changes. This would permit a major increase in both chairs and shares for the Asian countries, which are almost all egregiously under-represented in view of the rapid growth of the region over the past half century. And it would still leave enough slack in the system to allow a reduction in the size of the Executive Board, the already-agreed increase in the size of basic votes (which benefits the small countries), and quota increases elsewhere in the exceptional cases that merit them by virtue of their past economic growth.
Changes in IMF governance need to go beyond the question of chairs and shares, key as this is. They need also to involve adoption of a formal mechanism for appointing the Managing Director when the situation becomes vacant, with the mechanism aiming to appoint the best person for the job in the world rather than giving it to the person nominated by the West European country that regards it as its turn to have the job. And there was great merit in many of the suggestions for reforming IMF governance -- like replacing the International Monetary and Finance Committee by a Council, and directing its Executive Board to focus on strategic rather than tactical issues -- advanced last year by the Fund’s Independent Evaluation Office.
Level of Fund lending
The second type of measure is intended to increase the likely level of lending by the Fund during the crisis. This also involves two types of changes: changing the principles which prompt Fund lending, and increasing the sums available to be lent. Likewise proposals for reforming the principles underlying Fund lending tend to come in two forms. In my view the well-conceived ones are directed at discriminating between countries that wish to borrow as a defensive mechanism because of events elsewhere, and those that are obliged to go to the Fund because of their own policy inadequacies. There should be, but is not, ample scope for countries to borrow of their own volition when their shortage of foreign exchange happens through no fault of their own.
There are also proposals for easing conditionality faced by countries that have to go to the Fund because of their own inadequate policies. I am much less sympathetic to making big changes here. When I ran a conference on IMF lending (way back in 1982), one of the participants summed up our findings as saying that we would all design programs much like the IMF did for any country bar our own. I fear he got it right – self-induced borrowing from the Fund should be painful, for there is a problem that has to be fixed.
Reform should therefore concentrate on enabling countries that have to go to the Fund through no fault of their own to borrow large sums without all the complications and degradations of conditionality. The Fund has already created a Short-Term Liquidity Facility to provide quick-disbursing finance to countries with “strong policies” suffering a liquidity shortage because of contagion in the financial markets. This is useful, but it can at best help a limited number of countries.
Two other proposals might be more helpful in this context. One is to resume SDR allocations, on a far more massive scale that in the past. I am in favor of this, but frankly I am skeptical that much will happen. This is partly because SDRs accrue to the deserving and the undeserving alike; to countries that are short of liquidity and to those that are not, and to those who are short because of their own misguided policies as well as those who have been hard hit by international developments beyond their control. It is also in part because some creditor countries have never been enthusiastic about the SDR.
Conditional Financing Facility
Hence I attach more importance to the second reform, which recently has been pushed by one of my colleagues, Morris Goldstein (see Goldstein 2009, “Dig Into the IMF’s Tool Box to Tackle the Crisis”). This would consist of reviving the Conditional Financing Facility (CFF) that the Fund ran successfully before it was butchered as part of the drive to tighten up Fund lending in 1988. The CFF provided funds practically automatically to countries suffering an export shortfall as compared with a five-year moving average centered on the year in question (with future export levels estimated by the IMF staff). The reasoning was precisely that such an export shortfall is not the result of country policies but of international developments, and therefore it would be inappropriate to require changed policies in the recipient country. A revived CFF would supply finance to many countries, the demands for its services right now would be considerable, but it contains safeguards against giving easy finance to the undeserving. It deserves to be restored immediately.
Accepting this change would add urgency to what is already an important issue, namely increasing the funds at the IMF’s disposal. One can think of a number of expedients, like borrowing from governments under the General Arrangements to Borrow or the New Arrangements to Borrow, or borrowing from the markets, but in my view it would be preferable to go back to first principles and have a big quota increase.
The Fund’s size has not over the years kept up with the nominal growth of the world economy. We are not likely to return to the levels of the 1940s, but it is hardly surprising that the Fund loses influence while it continually shrinks relative to all comparators.
Editors’ Note: Copyright Peterson Institute for International Economics: All rights reserved.
Editors' note: This column is a Lead Commentary on Vox's Global Crisis Debate where you can find further discussion, and where professional economists are welcome to contribute their own Commentaries on this and other crisis-linked topics.