Tuesday, July 17, 2012

Reforming The IMF Quota Formula

The IMFC and G-20 meetings of April 2012 and June 2012 directed that work should proceed on simple and transparent quota formula that better reflects members’ relative positions in the world economy and that any realignment is expected to result in the increases in the quota shares of dynamic economies in line with their relative positions in the world economy, and hence likely in the share of EMDCs as a whole; and that steps shall be taken to protect the voice and representation of the poorest members (IMFC, April 2012-emphasis ours).  This was elaborated in the G- 20 Leaders summit declaration at Los Cabos which “stated that the distribution of quotas based on the formula should better reflect the relative weights of IMF members in the world economy, which have changed substantially in view of the strong GDP growth in dynamic emerging markets and developing countries” and regarding “the importance of protecting the voice and representation of the poorest members”.
This requires a re-evaluation of the existing variables in the Quota Formula.
 The only conceptually sound measure of the real share of an economy in World GDP is its GDP measured in Purchasing Power Parity Prices. Thus, this variable best captures a country’s contribution to and its stake in the Global economy.  It must therefore be the core variable in the Quota formula, with a dominant weight.  It has been clearly shown in numerous simulations that the greater the weight of this variable in the Quota formula, the higher the CQS of the Low and middle income countries. However, because of the long history of the use of GDP at market prices and as a possible indicator of that part of the IMF’s mandate that is not already captured by GDP PPP, the GDP blend has been accepted as a compromise by a plurality of IMF members. It remains a potential consensus candidate for the simplest, most transparent (two variable) formula.
  The openness variable has been justified as a measure of inter-connectedness and the stake of countries in the global economy.  Much of the interconnectedness that this openness measure captures is the interconnectedness of countries within the Euro Area / European Union.  It is not clear whether intra-EU interconnectedness has any relevance to the rest of the World.  To the extent that interconnectedness implies a stake, it only mirrors the European countries stake in the Euro and the EU.  Thus Intra-European ‘openness’ may be relevant for the ECB or a “European Monetary Fund” but appears to have little relevance to an ‘International’ institution.  The limited relevance for the rest of the World becomes starkly clear when we compare the share of ‘openness’ of the EU27 with that of the USA.  The USA’s 13.1% share of the ‘openness’ variable is less than 1/3rd of the 41.1% share of the EU27.  The argument for ‘openness’ implies that the EU has more than three times the US stake in, or commitment to, the World Economic or Monetary system.  This defies both reason (logic) and common sense!
    Financial Openness is even more problematic.  Besides sharing the anomalies and biases of the current openness variable, it has additional problems.  The problem of tax havens has already been noted (By definition tax havens imply openness to tax evaders and avoiders).  The large financial sectors of the ‘financially open’ economies are a threat not only to their own economy and peoples, but also to the growth and well being of the rest of the World.  This has been amply demonstrated by the continuing financial crisis.  The inclusion of financial openness in the quota formula would be analogous to appointing financial capitalists (as against real entrepreneurs) as financial regulators. The consequences of regulatory negligence and capture are still being exposed: Namely, (a) Government bailouts paid for by the general public (moral hazard). (b) Exorbitant profits and salaries attained by exploiting asymmetric information and cozy monopolies, through actions bordering on, or crossing into, fraud. (c)  Dutch disease, sudden stops and periodic liquidity freezes in the rest of the world (negative externalities).  If we have learnt anything about moral hazard, asymmetric information and negative externalities, it is that external risk creating economies, with large open financial sectors, should be penalized not rewarded with quotas.
Financial Contribution
     Financial contribution in an equity based organization must be related to the quota formula, which simultaneously determines vote share and contribution share.  Foreign Aid is an obligation of the rich countries, accepted by the people of these countries since WWII. Consequently, any reward for rich contributors to subsidy programs for the poorest (e.g. PRGT) must come at the expense of rich non-contributors. A transfer of these obligations from the high income to the middle and other low income countries through the quota formula is unacceptable.
    Temporary funding, in the form of unsubsidized loans from member governments to the IMF cannot be equated to permanent equity funding and permanent vote share.  The rules for temporary funding and its use can be framed to give a greater say in the use of these specified funds to the contributors, without permanently distorting the formula.  An alternative, even better solution would be to raise such temporary debt funds directly from global financial markets, in which case the issue is moot.
 Measurement and Format
    Implementation of the IMFC and G20 decisions requires simulations designed to give voice and representation to the poor developing countries.  There are several choices: (i) A compressed population variable (suggested by Ralph Bryant). (ii) The share of the poor or weighted poverty ratio (suggested in IMF WP/11/208). (iii) A scaled and capped variability measure (suggested by the G24 secretariat). Further the interests of the small open economies, particularly middle income countries, could easily be safeguarded by a compressed and capped version of this variable.  Such a procedure would also reduce anomalies that have been repeatedly pointed out over the past decade, such as the ridiculously high share of Luxemburg in openness.  The practice of averaging, which delays adjustment of CQS to economic changes, also requires a thorough reassessment.  

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