Wednesday, September 7, 2011

A Simple, Transparent Quota Formula For IMF

There is widespread agreement that a new quota formula for the IMF must be simple and transparent. The simplest and most transparent formula is one with a single variable, the share of country GDP in total GDP.  This will still require agreement on whether we should use GDP at purchasing power parity (PPP), which measures the relative weight of countries' in the real world economy, or GDP at Market exchange rates (MER) which some believe is a better reflection of the financial clout of countries.  A realistic and practical solution to this would be a blend of the two measures with the ratio decided by a tussle between the Low Income (LICs) and Middle Income countries (MICs) favouring PPP, on one side and the High income countries (HICs) on the other favouring MER. A simple calculation illustrates the why!
The impact of a change in the shares of GDP PPP for the four major groupings defined by the WDI (LICs, MIC-lower, MIC-upper and HICs) are shown (for 2009) in the table below:

Table: Shares of countries in total blended GDP (and quota)
Share of GDP PPP in blend=>0%50%100%
High Income countries70.8%62.4%55.4%
Upper Middle Income countries14.0%16.6%18.8%
Lower Middle Income countries14.5%20.0%24.5%
Lower Income countries0.7%1.0%1.3%

Thus in going from 0% of GDP PPP in the blend, to 100%, the Low Income Countrie's quota share goes up by 90%, that of the Lower middle income countries' goes up by 63% and that of the Upper Middle income countries' by 17%. The High income countries' quota declines by 20%.  Consequently the High income countries favour a low proportion of GDP PPP in the blend, while it is in the interest of the rest to have a high proportion. As the rich countries of Europe (with 25% or so of the vote) have a veto on such a major decision, thier willingness to loose some vote power will be critical to the sucess of such a reform!
      The final issue would be whether or not to average the GDP over three years as is done for the GDP blend in the current formula. It is argued that a country GDP may have declined in that year because of a negative shock.  As the averging process delays adjustment to the latest economic position it favours slow growing economies at the expense of the more dynamic economies. A simple practical compromise, that would address both arguments, is to take the higher (maximum) of the 3 year average and the latest year.
    This simple solution could be achieved quickly and without laboured arguments, which everyone can see are designed to favour ones own country, allowing the IMF to focus unitedly on the revived crises in the rich countries (US, Euro area).

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