IMF governance change proposals less than trumpeted

The hoopla surrounding the IMF governance reforms announced by its Managing Director, Dominique Strauss-Kahn, after the October G20 finance ministers' meet in Korea should not delude us into believing that there has been a real shift in its power structure, says Chakravarthi Raghavan.

THE Executive Board of the International Monetary Fund (IMF) on 5 November approved proposals for what has been described as a 'reform package': for increases in quotas and shift in voting power of its member states, and for amendment of its Articles of Agreement to eliminate appointed Executive Directors and instead have a wholly-elected Executive Board.

At the end of the G20 Finance Ministers' meet at Gyeongju in South Korea (on 22-23 October), the IMF Managing Director, Dominique Strauss-Kahn, had announced the envisaged changes and presented them before the media gathered there with much fanfare. He had said then that the changes (in IMF quotas, voting shares and the IMF Articles of Agreement), when effected according to the Fund's charter requirements, would result in a 6% shift of quotas and voting power in favour of the dynamic Emerging Market Developing Countries (EMDCs) and under-represented countries.

The detailed proposals, now approved by the Executive Board, have been sent to the Fund's member countries, and recommended for adoption by its Board of Governors representing the IMF's 187 member countries. They need to be adopted by three-fifths of the membership (or 112 member countries) representing 85% of voting power before becoming effective.

Also, Art. III, Section 2 (d) of the Articles of Agreement provides that 'The quota of a member shall not be changed until the member has consented...'  This thus leaves open the question of whether the developing countries whose quotas and voting shares have been reduced to shift them to other developing countries to enable Strauss-Kahn to claim 'the 6% shift and the revolutionary change', can or may hold up the entire process by not ratifying the proposed amendments through their legislative processes.

The amendments adopted in 2008, and on which the current proposed changes are built, are yet to become effective, since the requisite number of countries have not completed their legislative processes and ratified them.

The present proposals involve completion of the Fourteenth General Review of Quotas, with a doubling of quotas to approximately Special Drawing Rights (SDR) 476.8 billion or about $755.7 billion at current exchange rates. However, to the extent of the increased availability of funds to the IMF from the quota doubling, the current General Arrangements to Borrow will be reduced.

Despite the fanfare with which the purported shift in power structure was announced at Gyeongju, and subsequently in IMF press releases and remarks, a detailed scrutiny suggests that the shift is much less than made out, and involves only about 2% of quota and voting power shifted from the advanced countries to the EMDCs and the under-represented. Much of the balance of change has come by reducing the quotas and voting shares of many developing countries, including so-called over-represented oil exporters but also a number of other developing countries like South Africa and Nigeria.

The IMF management, and Strauss-Kahn (with his eyes reportedly set on the 2012 French elections1), in presenting the changes as a 6% shift, have formulated the changes in a way that resembles the magician's pea-under-the-shell game, and proved Mark Twain's definition of statistics ('Facts are stubborn, but statistics are more pliable'). The announcements and the IMF press releases about the 6% change bring to mind Humpty Dumpty: 'When I use a word, it means just what I choose it to mean - neither more nor less.'

The much-trumpeted 6% shift in voting power and quotas from the advanced to the developing world, from the IMF's own tables, seems to be no more than a little over 2% from the 'advanced' economies to the developing world. The  balance has come by taking away shares from some developing countries and giving them to others, and also by using the GDP data and formula (ad hoc) used for the 2008 decisions. At that time, the Executive Board in fact decided that the ad hoc formula (GDP market value plus compression of Purchasing Power Parity data) would not be used for the fourteenth general quota revision. But the latest proposals and revisions are built on the 2008 changes (which, as mentioned, have yet to become effective).

As the Bretton Woods Project, a UK-based civil society watchdog group, has pointed out, while the IMF has trumpeted these changes as historic, with the 6% figure headlining news reports,  the changes are less than meets the eye or revolutionary. Though Strauss-Kahn has called the recent agreements reached on IMF governance reform 'historic', a closer analysis reveals that the shifts in votes are smaller than claimed. And though the basic power structure of the IMF will better incorporate large 'emerging markets', it will also continue to see dominance of the US and Europe.

[Incidentally, the term 'emerging markets' was a Wall Street invention of the 1980s (the Brady bond era, when restructured and written-down debt of Latin American debtors was re-branded, mixed with some US Treasuries and sold off) (Frank Partnoy, F.I.A.S.C.O: Blood in the Water on Wall Street, updated paperback edition 2000, pp 67-68). As Partnoy (then a derivatives trader at Morgan Stanley, now Professor of Law and Finance at San Diego University) describes the tricks played, debt issued by sovereign developing countries was commonly dubbed by Wall Street banks as 'emerging': '...It wasn't clear what "emerging" meant, or how these markets might emerge. Still it sounded awfully good, and it helped cloud the fact that the emerging market fund that an investor bought was a Peruvian loan that had not paid any interest since the 1800s...']

The changes will make China the third largest shareholder in the IMF and will vault India, Russia and Brazil into the top ten. However, more than half of the 6% shift will come from other developing countries, which are losing voting share as a result of the reforms. The data table released by the IMF after the Board agreement shows that the voting share of 'advanced economies' will drop from 57.9% to 55.3%, a loss of only 2.6 percentage points.

The IMF's faulty classification of countries also makes the net shift to developing countries look bigger than it really is. Like the World Bank's reforms earlier in the year, the IMF has included South Korea and Singapore in the group of emerging markets and developing countries benefiting from the shift. This is despite the IMF's own flagship analytical report, the World Economic Outlook (WEO), classifying South Korea and Singapore as 'advanced economies'. The misleading classification of now including South Korea and Singapore among the 'emerging markets' has added 0.6 percentage points to the shift. By the WEO definitions, according to the Bretton Woods Project, advanced economies thus experience a net loss of only 2%, far shy of the 6% being reported in the media.

Strauss-Kahn called the November agreement 'the biggest ever shift of influence in favour of emerging market and developing countries', which is again not borne out by the evidence. Even by the faulty classification, the 2008 agreement on governance reform shifted 2.7% of votes to developing countries, a bigger shift than the 2.6% agreed in early November.

The November agreement also marks a formal reneging by the IMF Board on its 2008 promise to reform the IMF quota formula before it was used again. The flawed formula, which was only agreed for temporary use in 2008, has been hotly contested by the G24 group of developing countries as improperly specified. To get over the flaws in the quota formula, this time, it was not applied in a straightforward way to decide who would get shares, with GDP weights and compression factors used to determine the number of countries that would be eligible for increases to achieve the final list of 54 countries that would gain from the process. Developing countries losing voting share include Venezuela, Nigeria, South Africa, Argentina, Cameroon, Algeria, Pakistan and Morocco.

The agreement also leaves in place the US unilateral veto over the IMF's decisions which require members holding 85% of the voting power to agree. The US, with 16.5% of the vote after the November agreement, is the only country that can exercise such a veto, though a number of large emerging markets can get together to exercise a veto as well. In early November, German Executive Director Klaus Stein emphasised that the US veto is 'anachronistic at this point. For one country, no matter how big it is, to have the right to dominate decisions in that unique way is not legitimate anymore. If you talk about legitimacy, that's the major flaw in the organisation.'

The Bretton Woods Project notes that when Strauss-Kahn was campaigning to be selected as Managing Director of the Fund, he had explicitly promised the use of double-majority decision-making at the Board as one of the reforms he would implement. This, the Project says, would be a roundabout way to soften the unique nature of the US veto because it would mean that any group of 28 countries could block a special decision. However, no progress has been made on this promise, and with the current round of negotiations on IMF governance essentially finished, any adoption of this proposal would likely have to wait until 2013 at the earliest.

The agreement by the G20 major economies on Board seats, the Bretton Woods Project points out,  has also been in dispute, since it has been unclear whether Europe will give up two full seats on the Board. The only firm European proposal available to the press was described by Reuters in early October. That report said the Europeans had proposed that Spain would no longer share its seat with Mexico and Venezuela but would move into a European constituency, while Belgium would share the directorship of its constituency with Turkey. That would mean Europe losing the one-third of a seat held by Spain and one-half of the Belgian chair, for a total of 0.83 seats given up by the Europeans. No further details about the restructuring were made publicly available.

Asked at Gyeongju on 23 October (after the G20 meeting of Finance Ministers and Central Bank Governors) on which two European countries will renounce their seats and how this will be done - whether by redrawing the constituencies, or just giving up their seats to members - Strauss-Kahn had said: 'The Europeans will do it, and they have some time to do it. It will be done no later than the implementation of the quota reform. This may take one year, one year and a half, it depends. It's always rather long. And that's the time the Europeans have to rebuild their own system and to decide how they want to give up these two chairs. So there's no immediate answer.'

According to Simon Johnson, former chief economist of the IMF, in a 13 November post on the Baseline Scenario blog, despite the substantial fanfare on IMF governance, in reality there has been a major step backwards.  The Europeans, as Johnson views it, have apparently signalled they are no longer willing to give up the job of Managing Director, and despite the optics they will continue to be over-represented in voice and chairs at the Executive Board.

The Bretton Woods Project also points out that the Board seat controversy had flared up over the summer, with Europeans resisting a move by the US to force them to consolidate their seats on the Board. The controversy has meant that the elections for the Board, which usually happen in October so that the new Board's term can begin 1 November, have been delayed. With the old Board's term expiring 31 October and no formal decision being taken by the IMF Board of Governors, it is unclear on what legal basis they have continued to make decisions.

The Bretton Woods Project said that an e-mail from an IMF official said that 'as the regular election of executive directors was not complete by 31 October 2010, those elected executive directors sitting at that time shall continue in office until their successor is elected. I would note that it is expected the 2010 election will become effective in late November. Until the election becomes effective, the executive board will continue to exercise all of its ordinary functions. Decisions of the board will continue to be posted on the Fund's external website, following standard practice.'  Peter Chowla of the Bretton Woods Project noted the failure of the IMF to make public disclosures about the situation of the Board. 'This complete lack of transparency about the process for the selection of the Board is a bit worrying. In March, the IMF's new transparency policy took effect, but it seems to have no effect on the Fund's operations - despite the supposed "overarching principle that it will strive to disclose documents and information on a timely basis unless strong and specific reasons argue against such disclosure".'

Among the other major agreements to emerge from the Gyeongju meeting of the G20 Finance Ministers and Central Bank Governors, and endorsed by the subsequent Seoul Summit of the G20, as outlined by Strauss-Kahn at his media briefing in Gyeongju on 23 October, is an enhanced role for the IMF and its staff in the so-called Mutual Assessment Process (MAP) - assessment by the IMF of the 'external sustainability on the monetary and the fiscal policy, and finally providing the G20 with advice and policies so that the different questions [that] the global economy is facing can be addressed'.

The IMF is also to formulate a 'financial safety net' that Strauss-Kahn hopes will enable the Asian economies to renew their relations with the IMF and have less reliance on their own reserves. The Seoul Summit has endorsed this.

(The Asian countries, after their experiences with the IMF in the 1997-98 crisis, decided to build their own reserves and rely upon themselves, rather than seek IMF help and accept its unacceptable and draconian conditionalities.)

Despite the 'hopes' voiced by Strauss-Kahn about a renewal of the Asian-IMF relationships, now that  the Europeans have apparently signalled that they are no longer willing to give up the job of Managing Director, as Simon Johnson has pointed out, it is extremely unlikely that anyone outside of Europe will want to rely on the IMF in an emergency.

The G20 Finance Ministers also promised that they will 'move towards more market-determined exchange rate systems that reflect underlying economic fundamentals and refrain from competitive devaluation of currencies'.

In endorsing this decision, however vaguely worded in terms of a timespan and a methodology to achieve it, both the Finance Ministers at their meeting in Gyeongju, and the G20 leaders at their summit in Seoul, demonstrated that they have not learnt any lessons from the crisis of the last three years. As Andrew Cornford of the Observatoire de la Finance points out, 'In a world economy of footloose capital flows there is little reason to assume that market-determined exchange rates will reflect real fundamentals.'

The G20 summit has promised to work to reduce global trade imbalances and maintain them at sustainable levels. The G20 Finance Ministers and Central Bank Governors are to agree on indicative guidelines to assess the nature and the root causes of impediments to adjustment as part of the MAP, while taking into account national or regional circumstances, including that of large commodity producers. The indicative guidelines are to be composed of a range of indicators to serve as a mechanism to facilitate timely identification of large imbalances that require preventive and corrective actions to be taken. The G20 Framework Working Group, with technical support from the IMF and other international organisations, has been mandated to develop these indicative guidelines, with progress to be discussed by the Finance Ministers and Central Bank Governors in the first half of 2011.

However, with the 2010 US Congressional electoral outcomes ruling out any prospects of fiscal stimulus policies, and the US Federal Reserve set to continue its 'quantitative easing', China seems unlikely to move much on the renmimbi, and developing countries will continue to try 'managing' their exchange rates - to the extent they can - along Chinese lines, and aiming for a significant current account surplus (so as to build up foreign exchange reserves).

The G20 Finance Ministers (as the G20 Summit group, created at Pittsburgh) is a self-appointed group and lacks democratic legitimacy even as it attempts to take over the role of the IMF's own more legitimate International Monetary and Financial Committee. (The Executive Council envisaged by the Jamaica Agreement and changes to the IMF charter never came into being, and the IMFC continues instead.) On substance too, the outcomes at Gyeongju and Seoul are nothing more than promises with a self-assessment process on progress - effectively a case of promises kicked down the line until the next summit.

The G20 could have avoided or at least mitigated these outcomes if before the meetings, all of them  (including the US and China) had refreshed themselves with the history of the postwar monetary and financial system and its various travails - starting with the proposals and negotiations between Harry Dexter White and John Maynard Keynes, through the collapse of Bretton Woods I, the Smithsonian accord, the work and report of the Committee of 20 (C-20), and its aftermath.

Most of the history of these efforts (under the Bretton Woods systems), and the documents, are in the three-volume official history of the IMF of that period (Margaret Garritsen de Vries, Vols. 1, 2 and 3; the C-20 efforts and documents are in Vol.3). Some details of the US efforts after the collapse of Bretton Woods I, and how the efforts of the C-20 failed, are in Kenneth Dam's book, Rules of the Game.

In the 1970s, all of the work and proposals from the C-20 were spurned and turned down by the US (in its pursuit of free capital movement and convertibility and ensuring its own unilateral determinism and the benefits flowing from the US dollar as the global reserve and transaction currency and numeraire - with surplus countries having to hold US Treasuries as assets). The patchwork compromises of the Jamaica Agreement resulted in the Bretton Woods II (non-system), which too is now collapsing, if not collapsed. This is forcing the US to seek the same remedies as in 1973-75, but with a weaker hand.

Judging by the Gyeongju and Seoul G20 communiques and documents, and remarks there and on the way home by some of the participants, it is clear that G20 leaders are ignoring the lessons of the last three years (which show up the fiction of the Chicago school's efficient financial market theories). Those at the top of the global economic system are still pursuing what John Quiggin of the University of Queensland calls 'Zombie economics ideas' - the Great Moderation (the macroeconomic stability of the mid-1980s could endure indefinitely), the 'Efficient Markets Hypothesis' (the prices generated by financial markets represent the best possible estimates of any investment), the 'Trickle-Down Hypothesis', and Privatisation (any governmental function can be performed better by private firms).

During the C-20 process and negotiations (of the 1970s), the US had floated the idea of targeting reserves (surpluses or deficits exceeding a percentage) and those with surpluses and deficits adjusting. This idea ran into several problems - among them, whether gross or net surpluses should be the yardstick, and the yardsticks for excesses. All these also involved issues of data and statistics.

Now, instead of focusing on reserves as it did in 1975, the US has focused on the current account balance. By definition, this is the sum of the balance of trade (exports minus imports of goods and services), net factor income (such as interest, dividends and royalties) and net transfer payments (such as foreign aid).

On trade, the available data on goods are on a gross basis, while the GDP data are on a value-added basis. To try to compare them or marry them is an exercise in statistical gymnastics. As for services data, it is perhaps even worse (see Chakravarthi Raghavan, 2002, Developing Countries and Services Trade: Chasing a black cat in a dark room, blindfolded). With financial services accounting for the major part of the world trade in services, and recent continuing disclosures about the unreliability of the audited accounts (revenues, expenses, profits, balance sheets, assets valuation, etc) of financial firms in the US, it will be difficult for any reliance to be placed on them in national or global accounts and balances.

And the fallback position for the needed data (on services trade) is the Extended Balance of Payments statistics of the IMF (which, however, only record transactions between residents and non-residents, and thus do not cover services transactions among residents, whether national or foreign).

As a result, the BOP (balance-of-payments) data which the IMF could use, underestimate the services transactions data, and also the US royalty incomes on intellectual property, which are often routed through tax havens to hide real incomes and profits.

In the runup to the G20 Finance Ministers' meeting, the US (as also host country Korea) promoted the idea of targeting current account balances, and suggested a 4% target (those in excess or deficit by 4% to change currency values and adjust). Since the US trade deficit is less than 4% of GDP, and the Korean surplus less than 4%, the two conveniently don't need to adjust. The US-Korean proposal, and numerical targets, understandably ran into opposition from Germany and Japan, among others.

As Strauss-Kahn noted at his media briefing at Gyeongju, a specific target has advantages, but also problems. And since it involves balances as a proportion of GDP and exchange rates, this creates further problems vis-a-vis the euro-zone and its constituents.

Running through all these are the issues of asymmetry and adjustments (by the surplus and deficit economies) within the system, and the incompatibility of simultaneously working for 'market-determined exchange rates', 'trading money' across frontiers and free movement of capital and convertibility and maintaining an open rules-based multilateral trading system.

Having spurned (at Dumbarton Oakes and Bretton Woods) Keynes' attempts at symmetric adjustments (with both surplus and deficit countries having to adjust), by the time of the Smithsonian agreement for currency revaluation by the G10 countries and the setting up of the C-20, the United States began to work for adjustment by the surplus countries - but also for free convertibility of capital and the ability to trade money internationally.

As for IMF surveillance and the guidance principles it can evolve, in relation to its surveillance role (Art. IV consultations), in November 2006, an IMF research department paper (for the Consultative Group on Guidelines for Exchange Rate Arrangements), approved by then IMF chief economist Raghuram Rajan, suggested three methodologies to provide complementary perspectives on exchange rate assessments.

The paper said these three, taken together, and combined with additional country-specific information, can help staff reach informed judgments about medium-term real exchange rates and current account balances, weighing the relative importance of a number of economic factors affecting these key variables.

The paper added a qualification that while adopting different empirical methodologies goes some way towards strengthening the robustness of exchange rate assessments, it should be recognised that such assessments are unavoidably subject to 'large margins of uncertainty', due to a number of factors, such as the potential instability of the underlying macroeconomic links, differences in these links across countries, significant measurement problems for some variables, as well as the imperfect 'fit' of the models. 'Some of these problems,' the paper added, 'may be more severe for emerging market economies, where structural change is more likely to play an important role and where limitations in terms of data availability and length of sample are more acute.'

And if persistent intervention in currency markets by China is to be viewed as currency manipulation, the US Federal Reserve's quantitative easing (by printing dollars and buying up bonds) also has the result of devaluing the dollar vis-a-vis other currencies - already seen in foreign exchange market quotations.

And the IMF's own surveillance activities and Art. IV and other consultations with member countries, while effective with deficit emerging market countries, have long been ineffective against the strong, a point conceded by Strauss-Kahn in his Gyeongju briefing. As other commentators have noted, it has been more so vis-a-vis the US, where in the meetings, Treasury officials give a polite hearing but do nothing. The IMF's 'multilateral surveillance' process in vogue for the last two years has been ineffective, and to think that the MAP will prove any better may prove to be wishful thinking.                                   

Chakravarthi Raghavan is Editor Emeritus of the South-North Development Monitor (SUNS). The above is based on his articles in SUNS Nos. 7026 (26 October 2010) and 7039 (12 November 2010).

Note

1. According to several observers of the French scene, if he is the nominee of the Socialist Party and runs against President Sarkozy's bid for a second term, Strauss-Kahn will easily win.

*Third World Resurgence No. 242/243, October-November 2010, pp 4-8