The Great Disconnect: 21st Century World Economy, Postwar Multilateral Institutions

The BRICS statement on the selection of the next head of the IMF is an appeal for reason and proportionality. International multilateral institutions should reflect the world they claim to represent.

On Wednesday, France’s Finance Minister Christine Lagarde officially declared her candidacy to replace Dominique Strauss-Kahn as managing director of the International Monetary Fund.

A day before, the executive directors of the BRICS (Brazil, Russia, India, China, and South Africa) noted that the selection of the managing director on the basis of nationality undermines the legitimacy of an international Fund. The unwritten convention that requires the head of the IMF to be from Europe, they concluded, is “obsolete.”

What is needed is not a head that is European or Asian, but a strongly qualified person who is committed to the reform of the IMF so as to adapt it to the new realities of the world economy.

Global world, pre-global rules?

“As we learned from the crisis, global problems require global solutions,” John Lipsky, the IMF acting managing director, said recently. Today “greater policy cooperation in enhancing systemic stability and in preventing crises” is more important than ever.

At the same time, several advanced economies have been pushing for a European candidate for the next IMF managing director.

Last year, the 27 countries of the European Union accounted for some 27 percent of the global GDP. By future projections, this share will shrink by half, in the next two decades – to 14 percent.

If, instead of global GDP, the focus would be on global growth, the relative role of Europe would be even less impressive.

The IMF describes itself as “an organization of 187 countries, working to foster global monetary cooperation.” However, if the world economy is more globalized, it can no longer be led by rules that predate the rise of the large emerging economies.

The birth of the IMF stems from July 1944, when the representatives of 45 governments met in the Bretton Woods, and agreed on a framework for international economic cooperation.

The formal launch in late 1945 was preceded by the Yalta Conference where the winning nations of the World War II sought to ensure dominance in the postwar world.

Over time, the number of the IMF member countries has more than quadrupled to almost 190 countries, due to de-colonization of many developing countries, and the implosion of the Soviet Union.

Despite dramatic shifts in the world economy, the statutory purposes of the IMF remain pretty much the same as when they were formulated in 1943. Reforms came only after the global financial crisis, when they could no longer be avoided.

Economic vs. voting power

In October 2010, the ministers of finance of G-20, which govern most of the member quotas, agreed to reform IMF and shift 6 percent of the voting shares to major developing countries.

That, however, can only be the beginning.

In September 2005 the IMF’s member countries agreed to the first round of ad hoc quota increases for four countries.

In March 2008 – only half a year before the onset of the global financial crisis – the IMF executive board shifted quota and voting shares from advanced nations to developing countries.

Still, even today, the G-7 countries continue to enjoy more than 50 percent of the quota of the special drawing rights and of the voting power. The European Union alone still has over 32 percent of the votes.

Conversely, the role of the BRICS and other emerging economies (Saudi-Arabia, Mexico, South Korea, and Venezuela) is less than 20 percent.

These shares do not reflect the proportions of the most advanced economies and the large emerging economies in the world GDP.

And they reflect even less the contributions of these two sets of countries into global growth.

European exceptionalism?

In the ongoing rivalry for the next IMF managing director, several European countries have argued that, as the Euro zone is currently facing great debt pressures, the leaders of such economic powerhouses as Germany and France need to feel trust in the management of the IMF.

The argument is flawed. After all, few Europeans saw the need for a Latin-American to cope with the crisis of the 1980s and 1990s; or for an Asian to overcome the Asian financial crisis of the late 1990s.

Conversely, in 1997, Japan introduced the idea of an Asian monetary scheme, which was vetoed by Washington. At the time, few Americans saw the need for an Asian to really understand the depth of the financial crisis in Asia.

The argument on European exceptionalism introduces an element of moral hazard; that is, a situation in which one person makes the decision about how much risk to take, while someone else bears the cost if things go badly.

If the idea of moral hazard in this context is hard to digest, it should not be forgotten that currently some 80 percent of IMF credit outstanding is to European countries.

Europe enjoys credit that is highly disproportionate to its share in the world economy. In the coming years, it is likely to need much more credit. As a result, it is hardly surprising that the large emerging economies may feel somewhat uneasy with the implications.

For all practical purposes, it is the poor of the world – at least measured by GDP per capita – who are expected to bail out the wealthy of the world.

Representation matters

In IMF, major decisions require an 85 percent supermajority. At the 2009 G-20 Pittsburgh summit, the United States, which has the largest share of votes (17 percent), suggested that some European countries would reduce their votes in favor of increasing the votes for emerging economies. Neither France nor Britain complied.

At a subsequent IMF meeting in Istanbul, the then-IMF managing director Dominique Strauss-Kahn noted that, in the absence of a significant shift in voting power, “we’ll have the recipe for the next major crisis.”

After all, the most under-represented countries of the IMF (relative size in the world economy/IMF quota share) are China, U.S., India, Brazil, Mexico, Turkey, and Russia – mainly large emerging economies. Conversely, the most over-represented countries are Saudi-Arabia, Germany, Belgium, France, Netherlands, UK, and Switzerland – mainly European nations.

As global growth will be driven by the BRICs, the most powerful economies will no longer be the most prosperous ones. It is hardly a surprise that these nations expect their voice to be heard. Moreover, despite their great diversity, the political manifestation of the large emerging economies – the BRICS (BRIC + South Africa) – recently moved to another stage.

In mid-April President Hu Jintao met with Brazilian President Dilma Rousseff, Russian President Dmitry Medvedev, Indian Prime Minister Manmohan Singh and South African President Jacob Zuma. The third formal meeting of the BRICs (Brazil, Russia, India, and China) included South Africa for the first time.

One of the most remarkable aspects of the rise of the BRICS is the severed tie between total GDP and GDP per capita; that is, the economic power of nations and the average prosperity of their citizens. In the past, the two used to go hand in hand; in the future, that will no longer be the case.

In the 19th century, Britain was the growth engine of the world, and British citizens enjoyed relatively high GDP per capita on average. In the postwar era, the United States was the strongest nation, while Americans were the most prosperous people on average.

Until recently, the world was led by the multilateralism of the few in the West. In the future, it will be led by more inclusive multilateralism of the many.

However, international multilateral institutions remain in the postwar era, while the world economy is in the 21st century. These institutions should herald the future – not run behind it.