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Robert H. Wade and Jakob Vestergaard, Guest Bloggers

The International Monetary Fund staff and delegates gathered in Tokyo for the Annual Meetings of the Fund and the World Bank have the Eurozone crisis as their biggest headache. But they also have to decide how to proceed with another equally obstinate issue that is even more important for the future of the Fund: the organization’s governance model. In April 2012 Brazil, China, India, Russia and South Africa (BRICS) agreed to commit another $75 bn of extra resources for the Fund, via a channel which did not increase their share of the votes. But in return they made it clear that they want substantial changes in Fund governance, including a larger share of votes on the executive board.

The Indian executive at the IMF, Arvind Virmani, wrote in mid June that “unless the power balance in the IMF changes to reflect the changes in the economic power in the world economy, the IMF will inevitably lose credibility as an ‘international’ institution!” He continued, “rising powers [are] perfectly willing to contribute as much as needed as long as their quota share [which ‘buys’ votes] is adjusted appropriately [but] in the past year I have heard nothing (in the IMF or G20 setting) that would indicate that there is any recognition by the European powers of the need for formula reform (and vote shares) to maintain credibility.”

His sentiments are widely shared among executive directors from developing countries. Discussions at the executive board over the last several years show that there is next to no agreement on how quotas and votes should be changed to reflect demands of the “rising powers”. The big emerging market economies favour a formula with heavy weight to GDP. This has the advantage of being simple, and a rough measure of the capacity of an economy to affect others.

But a formula based largely on shares in world GDP would be a mistake. To see why, start with the existing voting system, in which a fairly small number of North American and European states have a large majority of the votes. This reflects the fact that, until recently, these economies produced the biggest GDPs and also the highest average incomes (with some exceptions at the margins). By 2040, however, it is likely that six of the seven biggest economies by GDP will be relatively poor by average GDP; including China, India, Indonesia, and Brazil. Under an IMF quota-vote formula which gives heavy weight to GDP share, these states would constitute the dominant states in the Fund, together with the US.

The rest of the world would be unlikely to accept such a result. A more complex formula is needed, which balances several criteria for representation. The Europeans at the Fund agree, but they want “openness” and “variability” to be given substantial weights. The problem is that these criteria are hard to specify in a way that precludes gaming the system. Other countries see these criteria as a way for Europe to cling to an unwarrantedly high share of votes.

An alternative voting system for the IMF which has a better chance of winning acceptance across the IMF’s membership might look as follows:

First, a sizable proportion of total votes is classed as “country basic votes” and allocated equally to each member state. The Fund and Bank’s founding fathers in 1945 established basic votes in order to give small and poor countries a guaranteed stake in the organizations; but over subsequent decades the share of basic votes has fallen to insignificance in both organizations. Country basic votes should be restored at least to their original level of 10%.

Second, a sizable proportion is classed as “regional basic votes” and allocated equally to the world’s four main regions: Asia, Europe, the Americas, and Africa (for example, 10% to each region).

Third, the remaining share (50% in this example) is allocated to the four regions on the basis of each region’s share of global GDP.

Fourth, each region’s voting share is allocated to countries within the region on the basis of each country’s share of regional GDP.

A formula with these characteristics best balances economic size, regional representation, and a guaranteed significant representation of small and poor states. In particular, the allocation by regions ensures that the Fund does not become dominated by countries from Asia as Asian countries’ GDPs rise into the top ten. That the Annual Meetings of 2012 will probably make little progress towards an agreed formula should be considered an opportunity to rethink it from the beginning.

Robert H. Wade is professor of political economy at the London School of Economics. Jakob Vestergaard is senior researcher at the Danish Institute of International Studies.

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