Reform or irrelevance for the IMF?

The world needs an effective International Monetary Fund. Countries have become heavily indebted in the wake of the COVID-19 pandemic, and the risk of further shocks is increasing as the world warms and new pathogens emerge. Protectionism (sometimes cloaked in security interests) is on the rise, impeding traditional development paths. As economies falter, no one wants to absorb the desperate people braving dense jungles or boarding rickety, overcrowded boats in search of a decent livelihood.

We need an honest broker to help countries negotiate fair rules for international trade (including, most immediately, rules on subsidies), call out wrongdoers, criticize bad policies and step in as a lender of last resort to those in need . Unfortunately, the IMF, despite the high quality of its management and staff, is increasingly ill-positioned to carry out these tasks.

The institution’s problems lie in its anachronistic governance. Most key decisions, including on the country’s loans, are made by the Fund’s executive board, where G7 members hold most of the power. The United States has a de facto veto power, and Japan’s voting power exceeds that of China, whose economy is larger than Japan’s. India’s vote share is much lower than that of the UK or France, even though its economy is larger and growing faster than both.

As the world’s dominant powers refuse to budge, the underrepresentation of fast-growing emerging economies persists. At the same time, it is no longer clear that the old powers always have the global interest at heart. In the immediate postwar era, the United States, as the sole economic superpower, could be trusted to enforce the rules of the game and generally stay above the fray. But as his worries about being outplayed grew, he switched from referee to player. Once a champion of the idea that openness benefits everyone, he increasingly wants openness only on his own terms.

The quality of the Fund’s lending decisions is also likely to deteriorate. Whenever the Fund lends, it is natural that well-connected countries in economic distress tend to get more relief on easier terms. While there have always been political influences on the Fund’s lending, it has been more likely to succeed in the past due to outside assistance from powerful board members – think, for example, of the Mexican. crisis in 1994, where the US contributed a large part of the bailout package.

With fiscal resources tight, even in the G7, the IMF will increasingly have to risk capital as powerful board members with relatively little skin in the game, lending directly to friends and neighbors. Worse, such special treatment may not even help borrowers, many of whom need some tough love.

In conclusion, the governance structure of the IMF will increasingly affect the activity of the Fund. But won’t redistributing IMF voting shares to reflect the current distribution of economic power lead to chaos? Won’t China block loans to any G7-related country and vice versa? Isn’t dysfunctional governance better than absolute paralysis?

Perhaps, which is why any reform affecting countries’ voting power should be accompanied by a fundamental change in IMF governance. The executive board should no longer vote on operational decisions, including individual lending programs. Instead, the Fund’s top management should be free to make operational decisions for the benefit of the global economy, with the board setting broad guidelines and periodically reviewing whether those guidelines have been met.

Specifically, the executive board should become a governing board, just like in the case of corporations. It would set the operational mandate of the organization and appoint and change management and monitor overall performance; but would not control day-to-day decisions. All operational decisions should be depoliticized. Indeed, this is what John Maynard Keynes would have preferred to see when the Fund was established. Fearing undue American influence, he proposed a non-resident board, which in those days of poor communications and steam travel meant a non-executive board and empowered management.

There are some predictable objections to this proposal. The first is that powerful countries will refuse to commit their taxpayers’ resources to the Fund if they cannot exercise full control over their use. But that’s exactly what the ruling board powers already expect the rest of the world to do. What is good for the goose…

Another objection is that emerging powers such as China may not agree to a change in the structure of the Fund now that they are on the verge of gaining power themselves. But if they don’t accept any change, neither will the old powers. The recent 16th general revision of quotas brought little change in the distribution by the power of the plate. Expect more of the same, unless the old powers and emerging powers make a big deal.

Finally, countries would be uneasy that fiscal resources are being spent by unelected leadership who may be insensitive to the needs of the people of the world. But political considerations will still play a role. Board directors, appointed by governments, will appoint top IMF executives and give them broad marching orders based on their governments’ policy assessments. For example, the rules governing credit can become more relaxed if directors feel it is necessary. The difference is that the rules will be applied uniformly in all countries. Strong friends of the needy can still help, but they will have to do so outside of the Fund’s program rather than by bending the rules.

Eight decades after the creation of the IMF, the world can—and must—watch a grand bargain to reform its governance structure and meet emerging challenges. The alternative is to do little and watch the institution fade into irrelevance.

Raghuram G. Rajan, former governor of the Reserve Bank of India and chief economist of the International Monetary Fund, is professor of finance at the University of Chicago Booth School of Business and co-author (with Rohit Lamba) Breaking the Mould: India’s Untrodden Path to Prosperity (Princeton University Press, May 2024). Copyright: The project union2024, published here with permission.