The IMF is offering 20th-century solutions for a 21st-century economy.
- By Mohamed A. El-Erian<p> Contributing editor Mohamed A. El-Erian is CEO and co-chief investment officer of global investment management firm Pimco and author of When Markets Collide. </p>
As the world’s power brokers — well, ministers and central bankers from 188 countries — gather in October for the annual meetings of the International Monetary Fund, they will again be confronted by evidence that the IMF is still in need of proper reform. This time, the evidence comes not only in the form of continued global economic malaise and financial instability, but the IMF’s brutally honest self-evaluation of its role in the insufficient Greek bailout (and, by implication, its involvement in other European countries). On the heels of this disappointing performance, one thing is clear: The IMF is still stuck in the last century.
Nearly 70 years ago, the IMF was created for what remains a good and valid reason. Emerging from a world war that had been fueled by a global depression, beggar-thy-neighbor policies, and inadequate economic coordination, visionary leaders recognized that a well-functioning global economy requires a strong, multilateral institution empowered to intervene and rescue countries from disaster.
On paper, the IMF is well-equipped for the job. It commands a virtually universal international membership. It has a highly talented staff and a sizable budget. Its Articles of Agreement give it unique and direct access to policymakers from individual countries. And its executive board provides a confidential forum for frank multilateral discussions and collective decision-making. But it is hamstrung by its masters in Europe over political squabbles and is not nearly representative of the shift south and east in global economic power.
It is far from obvious that sufficient steps will be taken to make the IMF more effective. Despite the obvious, urgent need, officials are still unwilling or unable to pursue the comprehensive revamp that is so critical to the global economy’s well-being.
Five years after the financial crisis that ravaged Western and emerging countries and pushed the world to the edge of a depression, the global economy is struggling again. Growth is anemic, alarmingly high pockets of unemployment persist, and social unrest is on the rise from the Middle East to Europe to Latin America. To make things worse, economic disappointments are no longer limited to weaker countries. Whether it is flat growth in Germany, China’s slowing economy, or less-positive news from recently booming economies such as Brazil and Turkey, even the strong are feeling the malaise.
Global finance is also increasingly vulnerable. Despite many new regulatory reforms to make the system stronger and safer, discomforting instability has returned to markets. Rather than base investment and resource-allocation decisions on sound, fundamental analysis, too many investors rely overwhelmingly on the artificial support they receive from the experimental policies pursued by Western central banks. No wonder the U.S. Federal Reserve’s mere mention a few months ago that it might reduce its monthly securities purchases led to dizzying asset price drops, disrupted markets, and panic. These wild gyrations severely complicate policymaking around the world, adding to the headwinds facing growth and job creation.
Yet this is the type of world for which the IMF’s founding fathers — particularly British economist John Maynard Keynes and his American counterpart, Harry White — created the institution. At minimum, the IMF was built to act as an effective, decisive crisis manager; more ambitiously, it was to serve as a global police force to prevent the emergence or persistence of large imbalances that could imperil the economic and financial well-being of countries, including those behaving responsibly.
IN PRACTICE, HOWEVER, the IMF’s contribution to a more stable and prosperous global economy continues to be undermined by long-standing structural and governance deficits. Perhaps nowhere is this clearer today than in the courageous report that the IMF has prepared on its involvement and failures in the first Greek bailout.
By the IMF’s own admission, the institution allowed itself to be overly influenced — some would say outright bullied — by some of its partners (such as the European Commission) in supporting policies that were inadequately designed and whose implementation was insufficiently owned by Greece. Specifically, the IMF ignored its own assessment of financial viability that pointed to the need for an early restructuring of Greek debt. It lent into a program that was not well-enough financed, and its understanding of the country’s growth and debt dynamics proved incomplete.
Unsurprisingly, Greece is still struggling mightily three years and hundreds of billions of dollars later, after a huge bailout operation and massive austerity program. Anywhere else, such a costly, visible failure would prompt governing boards to conduct serious discussions and pursue reforms. Not at the IMF.
Despite more than two decades of talk about updating its representation and voting, the IMF is still overly influenced by European politicians. Two reasons for this (among many) are that (1) the IMF’s top job is still unofficially reserved for a European, just like it was back in 1944, and (2) Europe still holds about one-third of the seats on the executive board. No wonder European leaders don’t hesitate to push back hard when the IMF offers constructive criticism. As a case in point, within hours of the Greece report going public, European officials rushed to the airwaves to condemn it as "plainly wrong" and neither "fair" nor "just."
Meanwhile, emerging economies seethe — frustrated by Europe’s dominance of the IMF and, more generally, by an institution that still seems stuck in the 1970s. Yet no one really wants to lead the reform movement, especially as this would involve locking horns with some of the developed world’s big bulls (or, perhaps, bears these days). Brazil has, more than once, accompanied its private advocacy for more equitable representation with bold public statements. But to no avail.
Leadership on this urgent matter could — and should — come from within the IMF itself. Yet Christine Lagarde, the IMF’s well-liked and charismatic managing director, has essentially punted on this issue. Rather than signal a steadfast willingness to pursue reforms and take on Europe’s angry, misguided reactions to criticism, she has reverted to diplospeak, noting the IMF’s "very unusual and very exceptional" relationship with European institutions.
We shouldn’t criticize her too much — it is not easy to bite the hand that feeds you. In a selection process that continues to place geography well ahead of merit and inclusiveness, Lagarde owes her appointment to European politicians. And long gone are the days when these politicians would pick an experienced technocrat such as the highly respected Jacques de Larosière or Michel Camdessus. Instead, since 2004, Europe has opted for political personalities for a job seen as a stepping stone to presidencies and prime ministerships at home.
This leaves only one player with the power to turn the tables: the United States. As the world’s most powerful economy, the United States has the largest voting share of any country at the IMF (16.8 percent). And it has been periodically dismayed, if not irritated, by how Europe has handled its financial crisis.
But Washington cannot lead — or even coordinate — a deep, comprehensive reform of the IMF. In normal times, most American politicians are highly skeptical about the role, cost, and effectiveness of multilateral institutions. And given today’s polarized and dysfunctional Congress (not to mention many of its members’ poor grasp of what the IMF does), any attempt by President Barack Obama’s administration to rejigger the IMF’s makeup could easily be misconstrued as selling out America’s European allies to less-reliable developing countries.
Yes, the world urgently needs a more effective IMF that can reduce the global imbalances that undermine growth and jobs in so many countries. But don’t look to the upcoming gatherings in Washington to deliver the needed reforms. Instead, and despite yet another frank and well-documented self-evaluation, it is likely that the IMF will continue to be undermined by political masters who lack courage and vision. Let us just hope that the global economy doesn’t require saving soon — because the IMF is not yet ready.