Reforming the international monetary fund - Why its legitimacy is at stake

Journal of International Economic Law

Volumn 10, Issue 3, 2007, Pages 443-460

  Torres, Hector R ^a  

^a INTERNATIONAL MONETARY FUND   (United States)

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EID: 34548424592     PISSN: 13693034     EISSN: 14643758     Source Type: Journal    
DOI: 10.1093/jiel/jgm015     Document Type: Article

References (86)

1. The Fund does not technically or legally 'lend' money to its members, although its financial support is normally described as such. The borrower 'purchases' reserve assets from the Fund with its own currency and the repayment is made by 'repurchasing' its currency from the Fund at a determined exchange rate. As this financial support from the Fund is not technically nor legally a loan, this could have relevance if the Fund's preferred creditor status is legally challenged (as it was) by other 'creditors' to a sovereign in arrears, claiming pari-passu treatment. For further understanding of the Fund's financing mechanism, please consult IMF General Department http://www.imf.org/ external/pubs/ft/pam/pam45/pdf/chap2.pdf (visited 5 May 2007).
2. IMF, Article I (v) of the 'Articles of Agreement'.
3. The US is running a current account deficit of approximately 6% of its national income (i.e. it spends far more than it saves). This requires a massive annual lending to the US, much of it coming from developing countries that run current account surpluses (i.e. save more than they spend) and who, rather than using these savings to invest in their own development, buy financial assets mostly valued in US dollars. This massive transfer of capital from the poor to the rich raises the fear of a correction that could, in turn, require raising US dollar interest rates and which could result in economic recession.
4. Martin, Redrado et al, find that in the past ten years there has been 'an explosive growth at global level of international reserves' mainly driven by emerging economies and estimate the current level of reserves at 'a record (...) of 3.8 trillion dollars', Central Bank of Argentina, 'The Economic Policy of Foreign Reserve Accumulation: New International Evidence', Working Paper 2006/13 (September 2006), at 5.
5. Setting aside reserves that normally give a very low return has a clear opportunity cost as savings could be better used to serve development needs. Joseph Stiglitz estimates the cost to developing countries is in excess of US$ 300 billion per year. Joseph Stiglitz, Making Globalization Work, (1st edn, New York: W.W. Norton & Company, Inc., 2006) 249.
6. The most challenging for the Fund is the Chiang Main Initiative, which includes all ASEAN countries (Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam) plus China, Japan and Korea. It was launched in the aftermath of the Asian Crisis, and the volume of reserves accumulated by its most important members (2201 USD billions, circa) could enable them to turn it into an Asian Monetary Fund. Latin America also has a regional Fund, the FLAR (Fondo Latino Americano de Reservas); albeit so far much smaller and limited to a subset of Latin American countries (Bolivia, Colombia, Costa Rica, Ecuador, Peru and Venezuela). The appeal of these pooling arrangements appears to be related to governments' dissatisfaction with Fund lending decisions and the burden of conditionality.
7. Mervin King, Governor of the Bank of England, argues that '[...] the growth of private capital flows and the build-up of massive foreign exchange reserves by many Asian economies have made redundant the idea that the primary function of the Fund is to be an international lender of last resort' (emphasis added). Mervin King, 'Reform of the International Monetary Fund' (speech delivered at the Indian Council for Research on International Economic Relations, New Delhi, 20 February 2006).
8. Rodrigo de Rato y Figaredo, Managing Director of the IMF, Remarks at the Banco de Mexico, Mexico city, 'The IMF's Medium-Term Strategy: Meeting the needs of emerging market members' (23 March 2006).
9. Joseph Stiglitz prefers to categorize this as a 'democratic deficit' that has contributed to the Fund's 'lack of legitimacy, which has undermined [its] efficacy'. Above, n 5, at 19.
10. Article XII, Section 5(a) of the Articles of Agreement states: 'Each member shall have two-hundred fifty votes plus one additional vote for each part of its quota equivalent to one hundred thousand special drawing rights'. This article was never amended.
11. Quotas were increased approximately 37-fold.
12. The basic votes for original members represent 0.5% of current total aggregate voting power. The 2.1 percent figure includes basic votes allocated to members that were incorporated after 1944.
13. Canada, France, Germany, Italy, Japan, United Kingdom and the United States.
14. This does not include the aggregate voting power of the constituencies led by Canada and Italy.
15. USA, Japan, Germany, UK, France, Italy, Canada, Netherlands, Belgium, Switzerland, Australia, Spain, Sweden, Austria, Norway, Denmark, Finland, New Zealand, Portugal, Singapore, Ireland, Greece, Luxembourg, Iceland, San Marino, Israel, Korea and Cyprus (ordered according to voting power).
16. Joseph Stiglitz, above, n 5, at 12.
17. The quotas are calculated using five different formulas. The original Bretton Woods formula was supplemented with four additional formulas and the calculated quota of a member is the higher of the Bretton Woods calculation and the average of the lowest two of the remaining four calculations. All formulas use four variables: GDP at current market prices, Reserves [foreign exchange, special drawing rights (SDRs) and gold], Openness (of current account) and Variability (of current receipts).
18. Abbas Mirakhor and Zaidi Iqbal, walk us along the labyrinth of how quotas are calculated and what variables are used; see IMF, 'Rethinking the Governance of the International Monetary Fund', IMF, Working Paper, WP/06/273 (December 2006).
19. This was explicitly recognized in his memories by Raymond Mikesell, the economist from the US Treasury to whom Mr White (then Secretary of the Treasury) instructed to prepare a formula that would give the US a quota twice as big as that of the UK, a bit more than twice that of the USSR, and more than a bit more than twice that of China. See Mikesell R., 'The Bretton Woods Debates: a Memoir', Essays in International Finance, Department of Economics, Princeton University Intl Economics, N. 192 (March 1994).
20. Germany and Japan were allotted closely similar quotas despite that Japan's economy was much bigger.
21. Joseph P. Joyce, 'The adoption, implementation of IMF programs: A review of the issues and evidence', Wellesley College, Department of Economics (December 2003), at 12, '[...] Fund programs [have] important distributional effects that depend on a country's pre-income situation, with negative consequences for countries in the worst circumstances'.
22. Theoretically, it is the authorities' responsibility to lead the process of designing a program and therefore choose which conditionality should be included in it (see IMF, 'Operational Guidance on the 2002 Conditionality Guidelines'; revised 9 January 2006 - SM/06/14). Unfortunately, things are quite the opposite, as the Fund uses its financial leverage to virtually impose the conditions to which the financial support is contingent [see Ariel Buira, 'An Analysis of IMF Conditionality', Challenges to the World Bank and IMF, Buira (ed.) for the G24 Research Program (Washington: Anthem Press, 2003)].
23. At the peak of abusive use of financial leverage, Indonesia had to accept 140 conditions in its program with the Fund in 1998.
24. Raghuram Rajan, Economic Counselor and Director of Research at the Fund, 'The IMF in A Changing World', keynote address at the International Conference on Global Asset Allocation at the Arison School of business in Israel (17 May 2006).
25. Joseph P. Joyce quotes studies that indicate that only 47% of the programs were successfully complied with, Above, n 21, at 7.
26. Above, n 6, at 12.
27. Governments have to sign 'Letters of Intent' before borrowing from the Fund. Ironically, when the Board reviews compliance with the conditionality there included, the government's 'intent' is read as commitment to deliver.
28. Joseph P. Joyce quotes studies that, not surprisingly, indicate that '[democracies with fractionalized legislatures perform poorly in IMF programs and are more likely to be sanctioned'. Above, n 21, at 10.
29. In its latest program with Argentina, the Fund wanted the Supreme Court to stop 'amparos' against banks (legal actions of depositors requesting banks to return their assets in US dollars). The government refused to accept this condition. For further information, Hector Torres, 'Argentina and the IMF: Learning Lessons from our Experience', Initiative for Policy Dialogue, Columbia University, New York (December 2005) (visited 5 May 2007)
30. Article IV, Section 1 of the 'Articles of Agreement'.
31. IMF, The Framework for IMF Surveillance: Enhancing the Effectiveness of Surveillance in a Globalized World, background document prepared by Fund Staff for a 'Dialogue with High-Level Officials', Santiago de Chile (11 December 2006).
32. There was only one paragraph, out of 54, addressing the Common Agricultural Policy in the 2005 report on the EU economy.
33. At this point, it is worth making a digression. In delivering a positive or a negative signalling with its seal of approval, the Fund's responsibility goes beyond markets. As countries are obliged to provide information to the Fund and hold regular consultations with its staff, the Fund has an informational advantage. Naturally, common citizens give credibility to its approval or disapproval seal. This was evident during the 90s in Argentina when the country was 'touted as a model for other developing countries to follow' (Paul Blustein, And the Money Kept Rolling In (and Out), Public Affairs, New York, 2005), 147. Common citizens in Argentina, guided by their past experience and conventional wisdom mistrusted the sustainability of the fixed peg of the Argentinean Peso to the US dollar. However, the repeated and enthusiastic support given by the Fund to the government of former President Menem (unfortunately) did not go unnoticed when voters had to decide on whether his economic policies were sustainable.
34. Net of scheduled 'repurchases' - reimbursements of credit.
35. There is a surcharge of 200 basis points for borrowing over 300% of quota. The cost of borrowing over 300% of quota (first trimester of 2007) is of 7.38% in SDR. Repayment is normally expected within 2.25 to 4 years (the bulk of the IMF lending is provided under short-term 'Stand-By' Arrangements). This can be compared with the cost of borrowing in private capital markets (Uruguay issued a bond in November 2006 at a cost of 7.525% in US dollars and with a 30 years maturity period and, of course, with no 'conditionality' attached).
36. A country requesting exceptional access has to comply with four criteria: (i) it has to be undergoing 'balance of payments pressures on the capital account, resulting in a need for Fund financing that cannot be met within the limits'; (ii) it has to have a 'high probability that debt will remain sustainable established on the basis of a rigorous and systematic analysis'; (iii) it has to have 'good prospects... to regain access to private capital markets within the time Fund resources would be outstanding and (iv) it has to implement a 'strong adjustment program... [with] a reasonably strong prospect of success, including not only the member's adjustment plans but also its institutional and political capacity to deliver that adjustment (emphasis added). On top of this, before entering in negotiations with a Member requesting exceptional access, the Fund's management has to consult the Board, giving the Executive Directors representing the main creditors the opportunity to set 'prior actions' that the potential borrower should undertake. IMF 'Review of Access Policy in the Credit Tranches, the Extended Fund Facility and the Poverty Reduction and Growth Facility and Exceptional Access Policy' (14 March 2005) Box 1, Summary of Access Policies.
37. In 1995, Mexico had to request borrowing 688% of its quota. In 1997, Thailand had to request borrowing 505% of its quota; Indonesia 490% of its quota (augmented in 1998 to 557%); Korea 1938% of its quota. In 1998, Russia borrowed over 350% of its quota; Brazil 600% (augmented by 2002 to 752%). In 1999, Turkey requested to borrow 300% of its quota and this had to be augmented in 2001 to 1560% of its quota. By 2001, Argentina had to request to borrow 800% of its quota and in 2002, Uruguay had to request to borrow equivalent to 694% of its quota. Ibid, Table 10.
38. Ibid, para 21.
39. The Fund's outstanding credit peaked at 70 billion SDR in 2002 and by the end of 2006 it had fallen to approximately 15.5 million SDR.
40. The Fund's projected income shortfall for FY2007 is equivalent to approximately 17% of its Net Administrative Budget (not counting depreciation for capital assets and IT equipment) and projections for the period 2008-10 bring the red up to 41%!
41. Final Report of the 'Committee to Study Sustainable Long-Term Financing of the IMF', chaired by Andrew Crockett (31 January 2007) http://www.imf.org/ external/np/oth/2007/013107.pdf (visited 5 May 2007).
42. In December 2006, the margin for calculating the rate of charge is of 108 basis points over the SDR (Special Drawing Rights) interest rate.
43. Ngaire Woods and Domenico Lombardi, 'Uneven patterns of governance: how developing countries are represented in the IMF', 499; Review of International Political Economy 13:3 August 2006: 480-515. Global Economic Governance Programme, University College, Oxford, UK.
44. Ibid, at 498.
45. For more on fairness see, Abbas Mirakhor and Iqbal Zaidi, who assess the IMF's governance structure using John Rawls' concept of justice. Above, n 18.
46. The International Monetary and Financial Committee of the Board of Governors of the IMF candidly acknowledged that the effectiveness and credibility of the Fund needed to be 'safeguarded and its governance further enhanced, emphasizing the importance of fair voice and representation for all members'. IMF, Communiqué of the International Monetary and Financial Committee issued in Washington, D.C. (22 April 2006) http://www.imf.org/ external/np/cm/2006/042206.htm (visited 20 May 2007).
47. Resolution No. 61-5 on 'Quota and Voice Reform in the International Monetary Fund', adopted at the Sixty-First Annual Meeting, September 2006, Singapore.
48. Argentina, Bolivia, Brazil, Chile, Colombia, Comoros, Dominican Republic, Ecuador, Egypt, Haiti, India, Iran, Maldives, Oman, Panama, Paraguay, Peru, Qatar, Sri Lanka, Trinidad and Tobago, Uruguay, Venezuela and Yemen.
49. This was confirmed to the author by several colleagues that found that, against their own advice, their governors had been lobbied to vote in favor of the Resolution.
50. Above, n 49, para 4.
51. Above, n 12.
52. Above, n 49, para 3.
53. Such an amendment of the Fund's Articles of Agreement can only enter into force for all of its members if it is accepted by three-fifths of the Fund's members having 85% of the total voting power. As the US holds more than 15% of the total voting power, this means that ultimately the US Congress holds the key of the reform initiated at Singapore.
54. Gross Domestic Product.
55. The sum of total receipts of current account.
56. Ariel Buira shows how combining GDP calculated at Purchasing Power Parity with volatility of movements in commodity prices and capital movements would increase developing countries' participation in aggregate voting. 'The Bretton Woods Institutions: Governance without Legitimacy?' table 4, in: Reforming the Governance of the IMF and the World Bank, G-24 research program, (Anthem Press, Washington: 2005), 23.
57. It should be noted that measured at market exchange rates, developing economies' share of global output is roughly 26% [in 2005] whereas measured at PPP, it is over 50%. The Economist (21 January 2006), 69.
58. Trade within a same currency unit could not bring BoP problems and, therefore, no need for Fund financial support.
59. The US has also hinted that it may be ready to accept a 'blended' measurement of GDP, however, giving PPP a very small weight.
60. The end result of a linear formula which, on its own, would increase the quotas and votes for large economies would be multiplied by a negative number (the 'compression factor') so as to partially smooth-out the resulting disparities. This would be to the benefit of most developing countries and small European countries as well.
61. We are already seeing some of this in South America with the 'Banco del Sur' initiative.
62. Paul Blustein, Above, n 33, at 212.
63. In 2002-03, Argentina arguably lived through its deepest social and economic crisis. More than half of its population was suddenly sent below the poverty line, social unrest was rampant and the country was in political chaos. In that socially volatile context, the transitional government gave fiscal priority to its 'social debt' (rather than to its financial debt). The influential Fund's driven 'Capital Markets Consultative Group' disagreed: 'The rule of law need[s] to be firmly established and the sanctity of contracts honored [in Argentina]', otherwise it viewed a 'risk of "wider" contagion of weakening policies to other countries in the region and elsewhere'. Report from management on the seventh meeting of the Capital Markets Consultative Group, 8 September 2003 http://www.imf.org/external/np/ cmcg/2003/eng/091803.HTM (visited 5 May 2007).
64. For example 'To reduce budget rigidities, it would be crucial to control the growth of the wage bill, including through a renewed effort at civil service reform [...] It would also be essential to substantially reduce [...] government contributions to pensions'. Ecuador, 2005 Article IV Consultation-Staff Report, para. 17 www.imf.org/external/pubs/cat/longres. cfm?sk=19009.0 (visited 5 May 2007). 'The pattern of [public] health spending reflects [...] budget rigidities' Republic of Slovenia (July 2006), IMF Country Report No. 06/250, para. 21 www.imf.org/external/pubs/cat/longres.cfm?sk=19422.0 (visited 5 May 2007).
65. The report was issued on February 2004. The Commission was created by the ILO. It was co-chaired by H.E. Ms Tarja Halonen, President of the Republic of Finland and H.E. Mr Benjamin Mkapa, President of the United Republic of Tanzania. Commissioners included former Prime Minister of Italy Guliano Amato, Former President of Uruguay, Julio M Sanguinetti and Nobel Prize Winner Joseph Stiglitz. http://www.ilo.org/public/english/fair-globalization/report/index.htm (visited 5 May 2007).
66. 'Core Labour Standards' are internationally agreed fundamental human rights recognized for all workers, irrespective of whether they toil in developed or developing countries. They are defined by the ILO conventions that cover freedom of association and the right to collective bargaining (ILO Conventions 87 and 98); the elimination of discrimination in respect of employment and occupation (ILO conventions 100 and 111); the elimination of all forms of forced or compulsory labour (ILO conventions 29 and 105); the elimination of all forms of forced or compulsory labour (ILO Conventions 29 and 105); and the effective abolition of child labour (ILO Conventions 138 and 182).
67. Joseph P. Joyce quotes studies that indicate 'that labor's share of income is lower in countries with IMF programs'. Above, n 5, at 12.
68. 'Rich Man, Poor Man', The Economist, 20 January 2007, 15.
69. 'A Survey of the World Economy, The New Titans', The Economist, 16 September 2006, 6.
70. Guscina, Anastasia, 'Effects of Globalization on Labor's Share in National Income', IMF Working Paper, WP/06/294, December 2006; in researching on the reasons that made labour's share of national income in industrial countries steadily decline in recent decades, finds that 'by making capital more mobile, globalization may have decreased the bargaining power of the less mobile factor - labor' (ibid, at 5). Moreover, she also finds what should be pretty obvious for the Fund, that 'a higher degree of employment protection benefits labor more than capital, resulting in higher compensation and labor share' (13).
71. According to the Financial Times (12 January 2007), 3, 'Wages gap "undermines support for free trade'") Tim Geithner, the president of the Federal Reserve Bank of New York, stated that sustaining support for further global integration 'may be the most important economic challenge of our time' and warned that rising inequality and economic insecurity (of workers) was undermining support for open markets.
72. IMF, Articles of Agreement, Article I, (ii).
73. Just to cite a few of the latest examples; in 2006 it opposed increase in Chile's minimum wages (IMF, 'Chile-Staff Report for the 2006 Article IV consultation', SM/06/245) and 'high' minimum wages in France (IMF, 'France- Staff Report for the 2006 Article IV consultation', SM/06/329) and the 'excessively rigid' collective wage bargaining system in Spain (IMF, 'Spain-Staff Report for the 2006 Article IV consultation'SM/06/174). It also opposed the introduction of minimum wages in Germany, as we will see next.
74. 'Beggar Thy Neighbour', The Economist 27 January 2007, 73.
75. Ibid.
76. IMF, 'Germany - Staff Report for the 2006 Article IV Consultation' (13 November 2006), SM/06/370, para 16.
77. Ibid, para 17.
78. IMF, Articles of Agreement, Article IV, Section 1, General obligations of members.
79. Article I, (v), Purposes. Above, n 2
80. Article I, (ii), Ibid.
81. Ibid.
82. The US holds 16.83% of the votes.
83. The European Union countries act individually, but coordinately. As Woods and Lombardi note the EU countries form a coalition with a Brussels permanent Sub-committee on the IMF. Ibid. Together they hold 32.18% of the votes.
84. The most important decisions require a qualified majority of 85% of votes.
85. Above, n 17, at 279.
86. Ngaire Woods, and Domenico Lombardi, ibid, find it astonishing that there are virtually no mechanisms to hold accountable elected Directors (those representing 'constituencies' of countries that gather to have a seat at the Board). The situation for appointed Directors (those appointed by countries that enjoy their own seat at the Board, i.e. US, Japan, Germany, France, the UK, China, Russia and Saudi Arabia) is somewhat different, as in some cases (e.g. the US) their appointment has to be approved by the legislature.