Objectives of Governance Reform

Despite their rising influence and responsibilities, the voice of emerging economies remains weak in global governance. Their voting shares have been disproportionately low in the IMF and the World Bank. No large emerging economy was represented in the Bank for International Settlements (BIS) family, including the Financial Stability Forum (FSF). No emerging economy was a member of the G7 process, and only Russia became a formal member (of the G8) at the Birmingham Summit in May 1998.

The relatively low voting power of emerging economies in the IMF and World Bank has been long recognized. Consider, for example, the voting shares of the PRC (the sixth largest share, with 3.7%), India (thirteenth, 1.9%), Mexico (sixteenth, 1.45%), Brazil (eighteenth, 1.4%), and Korea (nineteenth, 1.35%). These compare with those of the Netherlands (eleventh, 2.4%), Belgium (twelfth, 2.1%), and Switzerland (fourteenth, 1.6%), economies that are far smaller in size (see Table 1 [ PDF 173.7KB | 1 page ], where the top 30 economies in the world are listed according to economic size measured by GDP at purchasing power parity [PPP]). In effect, voting rights in these organizations to a large extent still reflect decisions made at Bretton Woods in 1944.

Against this background, the G20 summit process represents an important shift. It includes large emerging economies in global decision-making and thus also sets the stage for other reforms. But establishing the G20 is not enough; even if this process provides high level leadership, it will need effective complementary institutions to implement its vision. This makes reform of the global economic architecture a high priority. In this section, we examine the progress of the G20 and the four institutions in the global governance system that will be essential for implementing G20 decisions: the IMF, the multilateral development banks (MDBs), the World Trade Organization (WTO) and the FSB.

Emergence of the G20 summit

The establishment of the G20 summit process in November 2008 and its subsequent designation as the “premier forum” for international economic and financial policy cooperation in Pittsburgh in September 2009 fill a major gap in global economic governance. The G20 includes both advanced and emerging economies⁵ and should benefit from much greater legitimacy and effectiveness in tackling global issues than its G8 predecessor. G20 participants account for 83% of global GDP (in PPP), 75% of global trade and 66% of global population.

The first meetings of the G20 summit addressed an ambitious list of actions and institutional reforms, calling for (i) implementing concerted monetary and fiscal policies to support global aggregate demand in the early stage of the recovery from crisis, (ii) achieving balance between growth and the sustainability of public debt in the later stages of the recovery; (iii) restoring the health and soundness of US and European financial systems; (iv) providing further international liquidity and funding for affected developing and emerging economies through financially enhanced international financial institutions (i.e., the IMF and MDBs); (v) preventing trade protectionism and concluding the Doha Development Round; and (vi) reforming global financial governance by expanding the Basel Committee on Banking Supervision⁶ and converting the former FSF into a larger FSB.⁷

But the G20 summit is merely a first step. Though policymakers in each economy can take actions on national agendas—macroeconomic stimulus, debt sustainability, national financial system health, and trade regime openness—and can collectively decide on global agendas, they have no capacity to carry them out. Many of the needed global policy measures would have to be implemented by the relevant international organizations. Thus, an effective global governance system would require additional reforms in existing and new institutions such as the IMF, the World Bank, the WTO, the FSB and other international and regional organizations, as well as an effective division of labor among them.

Macroeconomic stability and the IMF

The IMF is the principal international organization charged with safeguarding global macroeconomic and financial stability. To achieve this, the IMF mainly relies on two instruments: surveillance and crisis lending. The IMF's surveillance mission includes conducting regular macroeconomic consultations with its member economies and now also supporting the G20's “Mutual Assessment Process” of national macroeconomic recovery strategies. But the IMF's ability to identify and mitigate macroeconomic and financial risks remains in doubt. The IMF has been unable to anticipate various past crises, or to propose effective remedies for overcoming them. Notably, the IMF did not foresee or take actions to contain the risks that built up in the US, the United Kingdom (UK), and other European countries in the period leading up to the global financial crisis.

The IMF's lending capacity is potentially a key instrument for managing and containing economic crises. However, the IMF has been criticized for applying inappropriate—and extensive structural—conditionality to its loans in crisis environments, especially during the Asian financial crisis of 1997-98. Responding to such criticisms, the IMF has streamlined conditionality by focusing on clearly macroeconomic-related policy measures, and formulated several new credit facilities designed to be more flexible and less dependent on ex-post conditionality.⁸ The IMF's new lending programs have not been tested in Asia during the global financial crisis so far, but there remains much political opposition in the region to relying on the IMF. Nonetheless, the expansion of IMF resources clearly adds urgency to the need to improve its effectiveness and credibility.

An essential reform is to change the IMF's voting structure and management. As Table 1 indicates, emerging economies are under-represented, while Europe is over-represented in IMF quotas and voting powers. Although the US also appears to be under-represented, it is the only country among the 186 members with a quota above 15%, and under the IMF's charter that gives it veto power over major decisions. In addition, the managing director of the IMF has been restricted, by convention, to European nationals in the past.

In general, the international macroeconomic architecture suffers from serious governance problems. The IMF's inadequate responses in the Asian financial crisis may have been due to the lack of Asian representation in its management. In the wake of the global financial crisis, another set of problems is emerging; given significant macroeconomic spillovers, policymakers in one country may believe that they can avoid taking difficult policy steps while waiting for others to do so. The international system has few tools to manage such conflicts of interest and to encourage cooperation. As is well known, this kind of “game” leads to inadequate cooperation, free riding, moral hazard, and suboptimal outcomes. An alternative, improved system might provide ways for countries to manage cooperation in smaller regional groups if their economies are closely linked.

Development finance and the MDBs

The multilateral development banks—the World Bank⁹ and regional development banks—aim to help developing countries achieve sustainable economic development and poverty reduction. They typically perform three related functions: lending, providing knowledge, and delivering public goods.

The World Bank provides market-based and concessionary loans for development-oriented investments. Capital-scarce poor countries have few alternatives to this kind of financing, and even some middle-income developing countries benefit from it due to their limited access to international capital markets. World Bank loans are guided by Country Assistance Strategies that identify key development challenges, especially with regard to poverty.¹⁰ As knowledge banks, MDBs provide economic analyses, policy advice, and technical assistance. Finally, the MDBs also generate international public goods, such as fighting communicable diseases, protecting the environment, mitigating the impacts of natural disasters, and containing conflict.

The World Bank's governance parallels that of the IMF. Its work is augmented by four regional development banks: the African Development Bank (AfDB), the Asian Development Bank (ADB), the European Bank for Reconstruction and Development (EBRD), and the Inter-American Development Bank (IDB). These are further complemented by smaller sub-regional banks.

While the MDBs are not as much in the center of the storm as the IMF, their operations have been criticized for being guided more by public opinion in developed countries than by the development needs in poor economies. In a thorough study of the World Bank in the US, the Meltzer Commission (Meltzer 2000) envisioned an especially large role for the regional development banks—eventually handling all lending while the World Bank focused on its knowledge and public goods functions—but noted that current activities often overlap. The G20 has agreed on larger general capital increases for the regional development banks than for the World Bank,¹¹ perhaps signaling a longer-term increase in their relative role in global development finance.

Trade liberalization and the WTO

The WTO and its predecessor, the General Agreement on Tariffs and Trade (GATT), have promoted liberal, non-discriminatory and multilateral trade and have contributed substantially to growth in advanced as well as emerging and developing economies. But as the scope of trade liberalization has expanded from tariffs on manufactured products to non-tariff measures, agricultural products, and services, global trade liberalization has become more complex. In addition, the WTO has brought emerging economies directly into the negotiations, and has revealed key points of difference between developed and emerging economies on the future directions of liberalization. So, after eight successful trade rounds, the global negotiating framework is at an impasse, and the current Doha Development Agenda enters its tenth year of negotiations with little sign of breaking the deadlock.

Meanwhile, bilateral and plurilateral free trade agreements (FTAs) have proliferated. Although FTAs must theoretically comply with provisions set by GATT Article XXIV,¹² most have been made outside the WTO's purview. There are now major trade agreements in Europe, North America, Latin America, the Gulf countries, and Asia. Many Asian countries participate in a “hub and spoke” network centered on Association of Southeast Asian Nations (ASEAN), with overlapping FTAs. The WTO has been silent on the proliferation of FTAs, but could play a more proactive role. Baldwin (2006) argued that there are benefits from consolidating regional agreements into a coherent global system, and this is an area where the WTO could make major contributions.

Unlike the IMF and the World Bank, the WTO is member-driven and consensus-based. It has a small Secretariat, much of which supports administering existing obligations, including especially the Dispute Settlement Body. Most of the WTO's work is done in councils and committees by its member governments. Thus, the WTO is inclusive and representative, but its major weakness is in effectiveness; the unwieldy negotiating framework and the requirement for consensus make it difficult to achieve breakthroughs that might be acceptable to its membership.

Financial stability and the FSB

An important factor that led to the global financial crisis was the lack of an international financial regulatory/supervisory framework that is capable of regulating, monitoring, and supervising the cross-border activities of systemically important financial institutions and internationally connected financial markets. Ideally, a new global financial regulatory and supervisory body should be created—with the participation of key emerging economies—to internationally harmonize supervision, regulation and resolution. To this end, the G20 agreed to strengthen the BIS Basel Committee and to upgrade the FSF into a more powerful FSB. The FSB is mandated to collaborate with the IMF to provide early warning of macroeconomic and financial risks and to take actions to address them.

This move has been supported by the US efforts to upgrade its financial regulatory and supervisory structures.¹³ Major emerging economies' participation in global financial supervision is also a welcome development as this allows their views to be reflected in, and their practices to be overseen by, the FSB. But the hard work still lies ahead: the resources and human capacity of the FSB are limited relative to its expanded mandate, and since the reform of the regulatory system is largely national in scope, much depends on the willingness of countries to cooperate through the FSB.

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Comment(s)

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1. Sritanu Chatterjee
   (posted 12 August 2010 / 12:31:26 PM)
   
   Dear Sir,
   
   The suggestions put forward in the paper are quite pertinent in today's scenario. In a multipolar world, regional institutions will have much bigger and responsible role to play.The paper would be more interesting if the shortcomings or problems of having too many regional institutions had been mentioned. Decentralisation leads to many benefit - increasing bureaucratic efficiency, localisation of knowledge base and global institutions gaining more confidence while taking decisions. But the problem lies in the implementation of the idea. In India, decentralisation or "panchyati raj" started in 1980s. But very few states have been able to implement it properly till date. For some states, it has aggravated the problems. Therefore, I think if more intense thought is given on the idea of implementation then it would expedite the process of formation of regional institutions.
   
   Thanks & Regards,
   Sritanu