In the EMF Proposal, Chance to Get the IMF Right
Whatever its merits for rescuing European nations mired in crises, German finance minister’s 7 March proposal for a European Monetary Fund (EMF) provides an opportunity for Europe and the United States to get the future of the International Monetary Fund (IMF) right.
The IMF, a creation of the Bretton Woods accords of the 1940s, was saved by the crisis. Only a few years ago fading into obscurity in the thriving world economy, the global lender of last resort sprung back to business. By the fall of 2009, the Fund had committed over $160 billion in new emergency loans to such nations as Iceland, Pakistan, and Ukraine. Policy consensus shifted rapidly, as well. At the US Treasury’s suggestion, the G-20 pledged to triple the Fund’s lending capacity to $750 billion, and asked it manage the wide-ranging Pittsburgh balanced growth agenda.
Notwithstanding its new windfall and duties, the Fund is under debilitating pressures on its legitimacy and effectiveness. One of the challenges is a specter of disintegration of the global financial architecture €“ right when the globalization of financial markets and crises alike calls for strong system-wide management. The epicenter of this issue is Asia. Regional nations scarred by the Fund’s tough policy conditionalities in exchange for loans during the 1997-98 regional financial crisis are wary of the world body, and back at building national reserves and regional financial arrangements so as to wean themselves off the Fund’s influence.
The Chiang-mai initiative conceived in 2000 created a new network of bilateral swap arrangements in Asia among the ten Association of South East Asian Nations members and China, Japan and Korea (or ASEAN+3). The arrangement was paralleled by the Asian Bond Markets Initiative, and paved the way to discussions on a regional IMF, an Asian Monetary Fund (AMF).
Contributing to the regional drive is Asia’s perceived lack of influence in the Fund. IMF’s governance structures are seen by many emerging markets as unfairly favoring particularly the Western European members. The US-sponsored September 2009 G-20 pledge to expand emerging markets’ voting share by five percentage points to 48 percent of the total by 2011 got a hesitant reaction in Europe. It is also unlikely to go far enough to address the grudges of China and India, whose calls for greater representation on the basis of their economic weight are justified.
Asians’ urgency to foster Chiang-mai accentuated as the Great Crisis breezed through. The arrangement was expanded to a total of $120 billion, and it was “multilateralized” €“ made a regional pool for realizing the very same scale economies that the Fund promotes at the global level. The main powers, Japan and China, agreed on equal voting shares. Perhaps observing Asians, also Latin Americans started discussing regional financial response mechanisms.
Thus far, Chiang-mai has had a link to the IMF: borrowers can draw up to 20 percent of their bilateral or multilateral swaps, but then need to agree on an IMF program, including prescribed policy adjustments, to access the remaining 80 percent. As such, Chiang-mai is much more tightly referenced to the Fund than European and US regional rescue schemes €“ Europe’s balance-of-payments facility, Medium-Term Financial Assistance, and the Treasury’s Exchange Stabilization Fund mostly within the Western Hemisphere €“ ever were.
But given EU and US powers in the Fund, their schemes had a built-in consistency with the IMF. Asians, with less weight at the Fund, do not necessarily agree on the body’s policies, and are more eager to go it alone. A gradual divorce between the Asian schemes and the IMF would risk conflicts and gaps between regional and IMF responses in the face of crises, an outcome problematic for global financial stability.
More generally, completely regionalizing the management of global financial stability would be sub-optimal. The IMF’s inherently global projection provides three benefits that cannot be replicated by regional schemes.
First, for any nation believing in the benefits of sound macroeconomic management both at home and abroad, the Fund provides global policy leverage, something a regional fund delinked from the IMF would not give to the outsiders. The Fund’s policy conditionalities, while not perfect, have made a veritable difference. For instance, most studies show that Fund programs, when implemented, improve the recipient’s current account and international reserves. Contrary to its critics, the Fund’s impact on preventing currency crises and reducing macroeconomic imbalances is also positive. Granted, the Fund has made mistakes €“ and it certainly is no magic wand for misgoverned economies or nations that fail to complete its programs. But many an emerging market could well be a declining market were it not for the IMF’s lending and policy advice. Regional rescues not accompanied by similar demands for good governance would perpetuate moral hazard and, at worst, undercut the IMF’s policy advice.
Second, the Fund’s surveillance and research on the global economy is something regional funds would not and could not replicate. Yet, that crises all too easily globalize requires system-wide monitoring and policy recommendations. The Fund is the only instance in the world to credibly serve as a systemic police patrol and alarm bell.
Third, the Fund imparts a further benefit: it economizes bailouts. Pooling resources and rescuing nations multilaterally makes for smarter policy than hoarding reserves unilaterally or structuring rescues bilaterally, or, given the global spread of crises, rescuing only regionally. That the Fund distributes the burdens of emergency insurance across its 186 members prevents free-riding on the main lenders. Fund expert Randall Henning has found that US contributions to the Fund are matched more than four-fold by other states. Global insurance pooling also makes sense also in that crises do not respect borders: a global fund is required to put out rapidly spreading fires. While regional funds can be an excellent complement to the IMF, managing global surveillance or rescues by relying on them alone would be inefficient and risky.
To be sure, concerns about a world split into regional schemes might be premature. While Asians may have a sufficient kitty for an AMF or a larger Chiang-mai, they are not ready for a separation from the Fund. First, Asia is still much more integrated with the US and European financial markets than intra-regionally. The region’s global exposure calls for multilateral engagement. Second, the regional pool, unless augmented, is still small and untested. Hit rather hard in the current crisis, Korea and Singapore turned directly to Japan and China, and Korea performed its largest, $30 million swap arrangement not with Asia, but with the US Federal Reserve. Third, politics stand in the way. Beijing has grown increasingly enthused about the AMF and made the case for an Asian Currency Unit, but Japan has a large stake in the IMF and wants to continue playing the role of a leading power in Asia. Even if Tokyo and Beijing collaborated seamlessly, political divisions not unlike those at the IMF could erupt between the Sino-Japanese-dominated financial schemes and other nations in the region.
In light of their disenchantment with the IMF and the uncertainties surrounding the regional pool, the first-best strategy for Asian nations for now is unilateral reserve accumulation €“ even if it de-economized the provision of insurance that the IMF is designed to economize, and unnecessarily diverted funds away from regional investments in, say, education or infrastructure.
The EMF debate, if advancing, will have implications on the dynamics in Asia. It will likely inspire Asians, just as the euro and European integration have done in the region. But by necessarily entailing consideration about the link to the IMF, the EMF discussion also presents an opportunity for the EU, along with the Fund’s leading shareholder, the United States, to set a precedent for a constructive complementary relationship between regional funds and the IMF €“ one that can be referenced and leveraged with Asia. This notion should be prioritized over any European urges to completely distance the EMF from the IMF: a Chiang-mai-type link should be viewed as being in the broader interest of Europe in the world economy.
Even if the EMF idea did not prosper, regional initiatives will unlikely go away. The issue requires more thorough discussion. Three steps could be taken.
First, working particularly with Japan, China, and Korea, Washington and Europeans should in the G-20 context fashion a clear set of principles to guide the relationship among the IMF, regional financial facilities, and bilateral arrangements. Money confers influence, but, as President Roosevelt understood in the 1940s, influence can be exercised in a fashion constructive to long-term viability of the global economy. Emerging nations, many with money, will now need to be tied into this paradigm.
Second, US and European support to Asian financial integration should be conditioned on a continued 20 percent link to the IMF. A range of further, non-zero-sum mechanisms can be deployed to foster synergies between Asian schemes and the IMF. One idea is that Chiang-mai members gain voting shares in proportion to their Chiang-mai contributions for Fund decisions concerning the region.
Third, giving emerging Asia and especially China more power in the Fund would unlikely €“ and ought not €“ undo plans for a regional fund. But it would provide Asians greater incentives to hone the multilateral financial system and build complementarities between the Fund and their regional arrangements. The ball is now on Europe’s court. The first step is to give emerging markets the 5 percent share increase, not because it is necessarily the best or the only solution, but because it has already been agreed upon.
