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American International Group Inc
Societe Generale SA
Deutsche Bank AG
As the Great Recession rumbles on, hitting the old, very rich countries of Europe and North America far harder than the new, somewhat rich economies of Asia and Latin America, the traditional order of global financial governance is looking increasingly frayed. At the Group of 20 summit in Los Cabos, Mexico, on June 18-19, world leaders are expected to issue bold statements about their commitment to reshaping institutions such as the World Bank and the International Monetary Fund to reflect shifts in the economic balance of power. Such declarations have been made at pretty much every G-20 meeting since the first one was held in Washington in 2008.
Thanks to the shortsighted foot-dragging of the U.S. and Europe, however, this goal remains unrealized. For all the talk of reform, developed countries still retain disproportionate voting power inside the halls of the World Bank and the IMF. The U.S. still possesses veto power over major decisions made by those two bodies. The irony is that, by clinging to these prerogatives, the U.S. and Europe are discouraging others from contributing more to multilateral institutions, which in turn has made them less effective at precisely the time when the stagnant economies of the rich world can most use their help.
In 1947, the U.S. took the lead in creating the World Bank and the IMF, as well as the General Agreement on Tariffs and Trade, the forerunner to the World Trade Organization. From 1945 to 1975, average U.S. import tariffs on dutiable goods fell from almost 30 percent to around 8 percent. All this generous multilateralism stemmed from a realization that a robust global economy underpinned by strong institutions of international cooperation was in the long-term interest of the U.S.
If anything, the importance of multilateralism to the U.S. is far greater today than it was 60 years ago. Exports measured as a proportion of U.S. output climbed from 5 percent to 13 percent from 1960 to 2010. The 2008 rescue of was a case study in (AIG) the interconnectedness of modern financial markets. Of the $170 billion in U.S. taxpayer money used to rescue the failed insurance giant, about $37 billion was rapidly passed on to four foreign counterparties—Société Générale (SCGLY), Deutsche Bank (DB), Barclays (BCS), and UBS (UBS).
The U.S. and Europe no longer enjoy economic dominance. From 1990 to 2010, their combined share of global gross domestic product fell from 52 percent to 42 percent, according to Arvind Subramanian’s book Eclipse. The developed countries’ share of global trade fell from 31 percent to 20 percent during the last decade. And both regions are significant net importers of capital. In 1950, the U.S. alone accounted for about one-third of net exports of global capital. Today, America borrows heavily from China, while Europe is borrowing heavily from the IMF. Since 2007 the fund has committed more than $300 billion in loans, most of which have flowed to Europe: Greece, Portugal, and Ireland are its three biggest debtors.
Countries in the euro area now use the potential to borrow by the barrelful from the IMF as a security blanket for investors. In all likelihood, the Europeans themselves will come up with most of the cash (along with new policies) required to avoid a breakup of the currency union, but an IMF with more resources could provide additional security.
Developed countries, and the U.S. in particular, need multilateral institutions not only to help pull themselves out of the current mess but also to ensure that globalization continues on an equitable basis. To cite one example, marshaling international support to persuade China to allow its currency to appreciate requires an IMF with enhanced powers. The more the U.S. loses its status as the sole economic superpower, the more it should embrace multilateralism.
Despite all that, the U.S. and Europe continue to stand in the way of efforts to strengthen the legitimacy and power of the same global institutions they were central to creating. Since 2008, when the G-20 first called for efforts to increase the clout of developing countries, the follow-through has been dismal. In the last year we’ve seen a French woman replace a French man as the head of the IMF and an American man replace another American man as the head of the World Bank, following a tradition that’s held since the institutions were founded. Christine Lagarde and Jim Kim may well be the strongest candidates ever put forward by their respective constituencies. Yet they still got their jobs primarily because Lagarde is European and Kim, American. Not much increase in legitimacy there.
What about voting control? At April’s meeting of the IMF, donors from Japan, South Korea, India, Saudi Arabia, and China, among others, agreed to lend the fund $430 billion to help it contain the euro crisis. The organization has resorted to borrowing this money rather than increasing quota contributions—its equivalent of shares—for the simple reason that quotas are the basis for voting power on its board. Emerging countries and oil producers have the cash to commit and want to play a greater role in the IMF, but Europe and the U.S. don’t want to relinquish their voting shares.
This unwillingness to give others more seats at the table is all the more stunning when you consider that the U.S. and Europe have previously pledged to do so. At its 2010 summit in Seoul, the G-20 agreed to undertake a “comprehensive review” of the IMF’s quota formula—the system that decides voting shares in the institution. Under current rules, the IMF assigns each member country a shareholding based in part on that country’s power in the global economy. The size of the quota dictates the country’s share of votes on the fund’s board. The U.S. has a 16.75 percent voting share, giving it veto power over major IMF decisions, which require a supermajority of 85 percent.
The Seoul reforms called for doubling the IMF’s resources and shifting more of the funding burden to emerging powers such as Brazil, Russia, India, and China; that would translate into greater voting powers for the BRICs as well. The new arrangement would not require any increase in financing from the U.S. (resources that it has already lent the IMF would be converted into quota shares) and would still leave it with veto power. And yet the Obama administration hasn’t even submitted the legislation to Congress.
The result is the perpetuation of a system that is laughably anachronistic. Under the current arrangement, the European Union, with about 7 percent of the world population and about 20 percent of the world’s GDP, accounts for one-third of the IMF quota and therefore controls an equal proportion of seats on the fund’s board. Even if the reforms outlined in Seoul are implemented, voting shares will remain disproportionately tilted toward the U.S. and Europe. The BRICs as a whole will have 14 percent of the voting power on the fund’s board, compared with 29 percent for the EU—even though, according to measures of GDP that account for being able to buy more for your money in developing countries, the BRIC economies are considerably larger.
The developed world’s lame-ostrich strategy of being too weak to commit additional resources, but too fearful to give up votes, can last only so long. The BRIC countries are now specifically linking their responses to the IMF’s loan appeals to progress on reform. Indian Minister of Finance Pranab Mukherjee announced that his country would not contribute money to the new euro firewall fund at all until U.S. and EU officials agreed to further quota reform. Brazil’s finance minister said, “We conditioned the money to the completion of the IMF’s quota reform so that emerging countries have larger representation.”
It’s not only the IMF where the U.S. is trying to remain host of the party while contributing less than its share of resources. In 2010 the country pledged just 12.1 percent of total funds to the World Bank’s soft-loan arm, the International Development Association. The U.K. contributed 12 percent and Japan 10.9 percent. Canada, with an economy about one-ninth that of the U.S.—smaller than California’s—gave 4.1 percent, the equivalent of a threefold-larger contribution per dollar of GDP. And that’s not to mention the multilateral negotiations over reducing global greenhouse gas emissions, where the U.S. has shown the strength of global leadership usually associated with San Marino or Brunei.
The longer leaders from developed countries wait to reform international institutions, the more likely that change will be imposed on them. Bolstering the IMF’s capacity to respond to the euro crisis and beyond, for instance, will require serious revision of the fund’s quota system. Such a revision would better account for both economic weight and the rights of the poorest countries to have their voices heard. And it may mean stripping the U.S. of its veto power, immediately or very soon. The IMF may well find a way to prevent a euro collapse by borrowing enough money under the old quota system and working with the forthcoming $1 trillion European Stability Mechanism. But what about the next crisis? This is a game of chicken which is almost as stupid as the U.S. federal debt ceiling debate—and involves some of the same cast of characters.
For Europe, giving up some power on the IMF board in return for help saving the euro should be an obvious bargain. The case is almost as clear for the U.S. It’s possible that the threat of losing worldwide economic dominance has left American policymakers too scared to engage in building up global institutions. But having a smaller share of worldwide GDP is no threat to long-term U.S. economic performance or quality of life. On the other hand, failure to reform global financial governance threatens not just recovery in the U.S. but the world as a whole. It is time for the country to return to the bold decision-making of the 1940s—and realize that, more than ever, what is good for the rest of the world is good for the West, too.