IFI governance

Analysis

IFI governance reform

Short-changing developing countries?

28 September 2010 | Briefing

Much as developing countries have often taken the approach that “no deal is better than a bad deal” at the WTO, a strong joint negotiating position would leverage larger gains in the IMF governance reform process due to be concluded by the end of 2010. Possible gains from a tough negotiating position include a rewriting of the IMF quota formula, double majority voting, more developing country seats on the board, and an end to the US veto. Limited change at the Bank highlights potential pitfalls.

IMF board size and composition: time for change

In July, the IMF released a paper examining non-quota aspects of governance reform,i which seemed to indicate low impetus for change, in part because of unhappiness with wrapping these reforms into quota discussions.  However, by early August a fight erupted between the US and European countries over the number seats at the board. Maintaining the board size at 24 requires an 85 per cent majority vote every two years, giving the US a veto. Having previously only threatened to veto, the US finally vetoed the decision, meaning the IMF board will shrink to 20 seats at the next election slated for autumn 2010.

This outcome only came about because European countries continued to obstruct deeper changes to IMF governance that the US desired. The move could hurt developing countries since the four smallest chairs (in terms of voting shares) are held by Brazil, India, Argentina, and Rwandaii. However, it will also put significant pressure on the Europeans to finally consolidate their seats the board as well as give up more voting share.

The US-European fight shows that there are also opportunities to make gains in terms of board composition, including ending the practice of unelected board seats. Germany, France and the UK currently sit in such appointed seats, and are thus obstacles to European consolidation, which is the key to freeing up seats for developing countries.

IMF quota formula needs changing

In 2008 the IMF governors made a commitment to re-examine the quota formula before further reform. This commitment needs to be defended. As a paperiii by Ralph Bryant of Brookings shows, using the current formula would mean a decline in quota shares for low-income countries and also for emerging market countries like India. Current proposals in a July IMF paper, and August Australian government non-paper for the G20 all result in shifts to emerging market and developing countries of less than 3 per cent. A 5 per cent shift, even if it all went from developed to developing countries, would leave the IMF dominated by wealthy countries, which currently hold almost two-thirds of the vote.

Further, previous G24 analysisiv has shown that a population-based formula and increasing basic votes are effective ways of giving developing countries fairer representation. The current formula continues to use poorly specified variables that bear little relation to the purposes of the IMF.v

The 2009 IMF annual meetings promised a “shift in quota share to dynamic emerging market and developing countries of at least 5 per cent from over-represented to under-represented countries.” However, those with the most to lose, particularly Europeans, continue to block deeper reform. As a March IMF board progress reportvi says, the question of “whether the targeted shift should be to dynamic emerging market and developing countries, [or] all under-represented countries” is still under discussion. At the moment, the latter interpretation would mean some rich countries such as Spain, Ireland and Luxembourg might benefit, as they are ‘under-represented’ compared to their quota entitlements. Additionally, according to the existing formula, some emerging markets such as India, South Africa and Argentina are considered ‘over-represented’.

If developing countries can forge and maintain a united position in favour of reforming the quota formula and a larger shift in votes, it will be very difficult for wealthy countries who are trying to block reform to not give way – particularly if those wealthy countries also face internal pressure for reform from civil society organisations.

Other IMF governance reforms

Other serious reforms to address the Fund’s democracy and legitimacy deficits, such as the use of a double majority voting systemvii, continue to be vital to keep on the table. While there was a commitment to protect the voting share of low-income countries, this is insufficient. A double majority system would introduce a much stronger voice for low-income and small countries. It would also strengthen the need for coalitions and consensus-based decision making that would necessitate the agreement of large developing countries before any major reforms.

Finally, the commitment made by both the G20 and at the last IMF annual meeting to “an open, merit-based and transparent process for the selection of IMF management,” appears to be under pressure. It was already damaged last October by the appointment of a new Japanese deputy managing director without such a process. The executive board progress report praises the 2007 procedure for selecting the managing director, despite the fact that it saw no change in the practice of the Europeans installing their candidate. This anachronistic practice must end.

Quota reform also opens up the issue of what size the Fund should be. At the annual meetings in 2009, the G24 pushed for a doubling of IMF quotas in total. As well as expanding the Fund’s capacity to lend, and increasing the amount that each country could borrow, this would also reduce the power of richer countries. This is because it would reduce the likelihood of the IMF having to use the ‘New Arrangements to Borrow’ (NAB) – a device which wealthier members can use to maintain influence at the Fund in exchange for additional ad hoc resources. 

World Bank reform

The recently completed World Bank governance reforms are a model for an incomplete process that produced little change. It failed to resolve the Bank’s democratic and legitimacy deficits. Despite rhetorical claims to deep reform from Bank management, an independent analysis shows that the changes still leave rich countries overwhelmingly in charge. Averaging across the three main arms of the World Bank Group (IBRD, IDA and the IFC) the latest round of reforms means that high-income countries still have over 60 per cent of voting power, middle-income countries around one third and low-income countries just 6 per cent. viii

No further reform is on the table at the Bank for five years. There are plans to develop a formula to calculate voting shares in IBRD and IDA, which would take into account countries’ economic weight, donations to IDA, and contributions to the Bank’s ‘development mission’. However, the latest reforms placed a heavy emphasis on economic weight (75 per cent), followed by countries’ contributions to IDA (20 per cent) – both criteria which favour high-income countries. The development element was accorded just 5 per cent, and was also partly defined by IDA contributions.

For real progress to be made, efforts to gain a genuine commitment to achieving parity will have to be stepped up.  Parity will need to be more clearly defined and future formulas will have to be readjusted to give far more weight to developing countries, and to ensure that they are compatible with parity. Different arms of the World Bank Group may also need to be treated separately in their definitions of parity.

Conclusions

The reform completed at the World Bank this year shows the peril of not holding out for thorough governance changes. IMF governance reform negotiations are not yet complete, and there is still time to insist on comprehensive reforms that will not again short-change developing countries.

European countries can be put in a position of weakness by a tough approach that demands quota formula reform, double majority voting (both past commitments) and consolidation of their seats on the board. Complementing these reforms with things the Europeans have traditionally liked, such as an end to the US unilateral veto and greater transparency at the IMF, would soften the diplomatic fallout and could allow a grand bargain beneficial to developing countries to emerge.