Reform of Quota, Voice and Governance in the IMF: from the Perspective of Developing Countries

(Script of the presentation at the International Rule of Law Series, UNAM, Mexico City, 15 August 2011 and the 18th Workshop on International Law, UANL, Monterrey, 19 August 2011)

I. Background

The International Monetary Fund (IMF) is one of the most important international organizations, and arguably the single most important international financial organization, in the world. It was established by the Bretton Woods Conference towards the end of the Second World War in 1944, as a response to the collapse of the international monetary system in the 1920's and 1930's, which had partly contributed to the rise of Adolf [ai do f] Hitler in Germany and the breakout the War.

At the time of its formal establishment in 1945, the IMF was essentially jointed operated by the two countries across the Atlantic, the United States and the United Kingdom. Now, there has been more than two-thirds of a century since its establishment. During the nearly seventy years, great changes have occurred in the international political and economic fields.

U.S. and U.K., - the two countries that decisively shaped the postwar institutions - no longer hold a virtual monopoly on international economic policy-making. Continental European countries that were occupied, enemy or neutral countries at the time of the Bretton Woods Conference- such as France, Germany, Italy and Spain - have emerged as major participants in economic diplomacy, either through the European Union or in their own right.

The spectacular rise, first of Japan, then of China, has made those countries essential parties in trade and monetary negotiations. Other Asian nations, such as India, Korea and the members of the Association of Southeast Asian Nations (ASEAN), are now also major economic actors. Key countries of Latin America such as Brazil, Mexico and Chile, have also taken off with market-oriented growth strategies. And with the end of the cold war, Russia and the countries of its former empire have successfully rejoined the world economic system.

In particular, the rise up in recent years of the dynamic emerging market economies represented by the "BRICS" countries has made it clear to the world that it is no longer the time when the wealthy industrialized countries can decide for the rest of the globe. As an example, after the breakout of the world financial and economic crisis, the once hibernating Group of Twenty (G20), in which both China and Mexico are members, has become much more active and played a leading role in managing the crisis and reforming the global financial system.

Despite of the changed and changing international setting, various systems and mechanisms of the IMF have not been reformed and adjusted in a timely manner. This has contributed to its incapability of maintaining financial stability and coping with financial crises in recent years, and has affected its authority and effectiveness as a leading international organization. The G20 summits held since 2009 have explicitly recognized the defects and shortcomings of the international monetary system led by the IMF, and called for substantial reforms. In my opinion, among the issues demanding reform, quota shares, voting power and governance structure stand out sharply, especially for developing countries and emerging economies.

II. Imbalanced quota and voting power

A.Weighted voting and "capital majority rule"

Unlike other major international organizations such as the United Nations or the WTO, IMF has not adopted the "one country, one vote" principle as a symbol of sovereign equality. It is more like a company limited by shares: the voting power of a member in IMF is determined by its shares, or quota, in the organization. The more quota you hold, the louder voice you have. As the starting point, each member has 250 basic votes; beyond that, based on its quota measured by SDR, it will get an additional vote for every 100 thousand SDRs it has contributed to the IMF. The sum of the basic votes and the quota votes will be its total votes.

I am not in a position to question the weighted voting approach itself. It has its historical reasons and perhaps also practical needs, just like the veto power enjoyed by the Five permanent members of the UN Security Council. However, even if we take this voting system for granted, we have to ask whether the distribution of the quota is proper and fair, for it directly determines the total votes of a member.

B.Unfair quota formulas

The IMF Articles of Agreement provide for a general review and possible adjustmentof quotas every five years but do not indicate how quotas should be determined. The Executive Board has neither formally adopted nor endorsed any particular method for determining quotas or quota increases. However, over the years, the IMF has developed quantitative criteria (or formulas) to "calculate quotas," which help determine the initial quota for new members, and serve as a guide in determining increases in quotas for existing members.

Bretton Woods Formula.

The Bretton Woods formula was introduced in 1944 to help derive the initial quotas for the 45 original members of the IMF.

The formula contained the following variables: (i) national income as a measure of a country's economic size and ability to contribute to IMF resources; (ii) reserves, also a measure of a member's capacity to finance IMF operations, but with a smaller weight; (iii) merchandise imports as an indicator of possible need to use IMF resources; (iv) variability of exports with a high weight to reflect vulnerability to external trade shocks that could lead to a possible need for financing; and (v) a multiplicative factor that increased the role of exports relative to national income in the determination of calculated quotas.

Although the use of a formula provided a statistical base to the process of determining quotas, the selection of the relevant economic criteria and the weights assigned to them in the formula reflected preconceived notions about the overall size of the IMF and the relative economic size of members. Judging from its effect, the distribution of quota shares based on the Bretton Woods Formula is in the best interests of traditional developed countries.

IMF made some changes to the BW Formula in 1963 and 1983, including introducing four "alternative formulas", replacing "national income" with GDP, expanding "international reserve" to cover SDR and EMU. However, the basic structure of the BW Formula remained unchanged.

The selection, weight and calculation method of the variables in the quota formula naturally lead to a calculation result in favor of traditional developed countries, which fact has not been essentially changed by the two amendments. For example, as the variable carrying the largest weight in the formula, the calculation of GDP is based on market exchange rate instead of Purchasing Power Parity (PPP), and thus inclines towards developed countries.

As indicated by the table above, the total GDP of Brazil, China and India based on PPP was almost four times higher than that of Belgium, Holland and Italy, but when calculated on the basis of market exchange rates, the margin was only 23% percent. What's more, their total votes were even 19% fewer than the latter.

This bias in the quota formula has resulted in an over-concentration of quota and voting shares in developed countries. Most notably, before the reform, the U.S. alone holds around 17% of the total quota and votes in the IMF. As discussed below, this gives it a de facto veto power in the organization's decision-making. Also, if taken as whole, then the European Union holds around 30% of the total voting power, which is far higher the proportion of this region in the world economy. In other words, the United States and the European countries were over-represented in the IMF, while the developing countries, especially the emerging market economies and lower-income countries, are significantly under-represented. As pointed by the IMF itself, now that decision making at the IMF is not based on the principle of "one country, one vote", but "was designed to reflect the position of each member country in the global economy", then the distribution of voting shares must be reformed to "reflect the larger role that emerging market and developing economies now play".

C.Diluted basic votes and de facto veto power

According to the IMF Articles of Agreement, the decision-making methods at IMF include simple majority vote and special majority vote, and the latter further includes 70% majority vote and 85% percent majority vote. There are 21 types of issues that require a 70% majority vote, which mainly relate to IMF's operations and transaction. Another 18 types of issues require a more rigid 85% majority vote, covering IMF's fundamental functions, organizational structure, members' legal status and significant operations. Since the U.S. holds more than 15% of the total votes, it virtually has a de facto veto power on such significant issues as the adjustment of quotas, the sale of IMF gold reserve, balance of payment assistance to developing countries, and allocation of SDRs.

The 250 basic votes were intended to give the small and poor countries with inadequate quota shares an additional opportunity to make their voices heard. As the former IMF General Counsel Joseph Gold pointed out, the purpose of having such basic votes were first to show respect to the traditional principle of sovereign equality, second to avoid being to analogous to a private business corporation, and third to avoid an over-concentration of voting power in one or two member states.

However, two lines of development have virtually suffocated the possible meaningful role of basic votes. First, with the several times of general quota increase, the percentage of basic votes in the total votes have been greatly diluted, from 11.3% at the time of establishment to 2.1% recently. Second, taking the chance of amending the Articles of Agreement, the U.S. and European countries have substantially increased the number of issues that require a special majority vote to decide on. Research shows that at the time of establishment, there were only 9 types of issues which would require a special majority vote. This number increased to 18 when the Articles of Agreement was first amended in 1968, and further increased to 39 after the second revision in 1976. This has further played down the role of basic votes and in my opinion functioned as an indirect dilution.

III. Defective governance structure

A.Executive Board

The governance structure of IMF mimics a company, with a Board of Governors as the highest decision-making body, an Executive Board elected by the Board of Governors to take care of the daily business of IMF, and a Management under the leadership of the Managing Director elected by the Executive Board, which is responsible for conducting the ordinary business of IMF under the direction of the Executive Board.

According to the Articles of Agreement, all powers under the Agreement not conferred directly on the Board of Governors, the Executive Board or the Managing Director shall be vested in the Board of Governors, but the Board of Governors may delegate to the Executive Board the authority to exercise any of its powers, except those conferred directly by the Agreement on the Board of Governors. In practice, the Board of Governors has delegated most of its powers to the Executive Board, and only retains the right to approve quota increases, SDR allocations, the admission of new members, compulsory withdrawal of members, and amendments to the Articles of Agreement and By-Laws.

The Executive Board, as the real "center of power" of the IMF, is made up of 24 executive directors, among which Five are appointed by the Five members having the largest quotas (currently U.S., Japan, Germany, France and U.K.), and the remaining 19 executive directors are elected by the remaining member states grouped into 19 constituencies formed on a voluntary basis. The Executive Board normally makes decisions based on consensus but sometimes formal votes are also taken.

Due to the different number of states in a given constituency and their different voting powers, each elected executive director represents a different percentage of the total votes, ranging from 1.56% to 4.92%.

Similar to the distribution of quotas and votes, the major problem with the Executive Board is the imbalance of power between developed countries and developing countries. Currently, among the 19 elected executive directors, Five are from developed European countries (Belgium, Holland, Italy, Denmark and Switzerland), Two from Canada and Australia, Two from OPEC countries (Saudi Arabia and Iran), and the rest Ten from emerging markets and developing countries (China, Brazil, India, Russia, Thailand, Egypt, Chile, Argentina, Lesotho [li'su:tu:] and Togo [tou gou]).

With the Five appointed directors taken into account (all of whom are from developed countries), on the surface developed countries and developing countries run neck to neck on the Board. However, further analysis reveals more. First, European developed countries have Eight directors on the Board, accounting for 1/3 of the total, which is far too disproportionate to their actual position in the world economy. Second, as in the Board of Governors, the decision making process of the Executive Board is not based on the principle of "one director, one vote", but based on the voting power of the member states represented by the directors. In other words, the more voting power the appointing or electing members have, the more voice the director has on the Board. Even when the Executive Board makes decisions based on consensus, it only natural that the U.S. and EU with more directors and more votes would be in a advantageous position.

B.Senior officials

The imbalance of power and representation between developed and developing countries also exist in relation to the IMF management, perhaps to a greater extent. The Articles of Agreement only provide that the Managing Director shall be elected by the Executive Board, and that the Managing Director shall not be a governor or an executive director, without attaching any geographic conditions. However, since the establishment of the IMF, the managing director has always been Europeans and the first deputy managing director been Americans. Even if such arrangement might have some historical justification in the immediate post-War era, over time it is increasingly inconsistent with the international economic reality, not to mention the fundamental principle of democratic politics.

Other problems include the lack of fairness and transparency in the selection of senior officials, and inadequate personnel from developing countries in the management and staff. All these have contributed to the "democratic deficit" in the decision making and operations of the IMF, and undermined its legitimacy, credibility and effectiveness.

IV. Major reforms since 2008

As a result of the global financial tsunami and the mounting calls from developing countries for a more balanced IMF, the Board of Governors passed two milestone resolutions in 2008 and 2010, making significant changes to its distribution of quotas and governance structure. Since both resolutions involve amendments to the Articles of Agreement, in addition to the approval of the Board of Governors, they need to be accepted by 3/5 of the members having 85% of the total voting power to take effect. Currently the IMF has 187 members, which means the two resolutions need to be accepted by at least 113 members holding at least 85% of the total voting power.

It was not until March 2011 that the 2008 Resolution took effect, with the Czech [qie ke] Republic accepted the amendment. The 2010 Resolution is yet to be accepted by the qualified number of members, and the expectation of the Executive Board is for the Resolution to take effect and for the relevant reforms contained in it to be carried out before the 2012 IMF annual meeting.

A.The 2008 Resolution on the reform of quotas and voice (2008 Resolution)

1.Increase of the quotas of the emerging market economies

This part of reform traced back the 2006 annual meeting of IMF in Singapore. On that meeting the Board of Governors decided to begin a two-step reform. The first step was to increase on an individual basis the quotas of the Four most under-represented member states, namely China, Mexico, South Korea and Turkey, the total being 4 billion SDRs.

To specify, the quota percentage of China was increased from 2.98% to 3.72%, vote percentage from 2.94% to 3.65%; the quota percentage of Mexico from 1.21% to 1.45%, vote percentage from 1.20% to 1.43%; the quota percentage of South Korea from 0.77% to 1.35%, vote percentage from 0.76% to 1.33%; and both the quota percentage and quota percentage of Turkey from 0.45% to 0.55%. As the second step of the reform, the resolution requires of the Board of Governors to make further rules on quotas and voice by 2008.

On that basis, the 2008 Resolution adopted a new quota formula. The new formula has four variables, expressed in shares of global totals, namely GDP, openness, variability, and reserves, with weights of 50 percent, 30 percent, 15 percent, and 5 percent, respectively.

The GDP variable is a blend of GDP at market exchange rates and GDP at PPP rates, with weights of 60 percent on market rate GDP and 40 percent on PPP GDP. Accordign to the IMF, this approach captures the central role of quotas in its financial operations, for which GDP at market exchange rates is the most relevant, as well as the its non-financial activities, where PPP GDP can be viewed as a relevant way to capture the relative volume of goods and services produced by economies.

Based on this new formula, the Board of Governor further increased the quotas of 54 members (mainly emerging market economies), with a total of 20 billion SDRs. According to the IMF, taken together the actions in 2006 and 2008 have increased the quota percentage of the beneficiary members by 4.9%.

2.Increase the number of basic votes

Another major content of the 2008 Resolution was to greatly increase the number of basic votes, from 250 votes to 750 votes. This was the first time for the IMF to increase basic votes ever since its establishment. Besides, after this increase the proportion of basic votes to the total votes would be locked, that is, if the total votes are increased as the result of general quota allocation, then the basic votes must be increased accordingly, in order not to be diluted.

B.The 2010 Resolution on the reform of quotas and governance (2010 Resolution)

1.Quota transfer

In response to the mounting calls for reform in the aftermath of the global financial crisis, the G20 Pittsburg Summit in September 2009 decided to transfer 5% of the IMF quota shares from over-represented developed countries to under-represented developing countries, especially those dynamic emerging market economies by the end of January 2011. Since the work is quite complicated and time-consuming, the G20 financial ministers and central bankers meeting in October 2010 once again decided to finish the transfer of quotas by 2012, and increased the percentage from 5% to 6%. On November 5, 2011, just before the commencement of the G20 Seoul Summit, the IMF Executive Board approved the package on the reform of quotas and governance. The Board of Governors passed the resolution accordingly on December 15, 2011.

Basically, the 2010 Resolution decides to double the total quotas of IMF from 238.4 billion SDRs to 476.8 SDRs, so as to increase its lend resources, to enhance its crisis-managing capacity, and to effect the transfer of quota shares.

The Resolution also decides to transfer 6% quota shares from over-represented members to under-represented members. Thus, together with the 2008 Resolution which has already taken effect, the total transfer of shares to dynamic emerging market economies and developing countries would reach 9%. Half of the transferred shares come from developed countries, mainly European countries; 1/3 come from OPEC countries; only less than 20% come from other emerging market economies.

Meanwhile, a special committee will be established to take care of the quotas of the poorest countries (with a per capita annual income of less than $1,135 in 2008), and to make special increases to their quotas on an individual basis when circumstance so require.

2.Reform of the Executive Board

The 2010 Resolution made substantial reform to the composition and election of the Executive Board.

First, the size of executive directors (24) will remain the same, but the number of directors representing advanced European countries will be reduced by 2, who will be elected by emerging market economies and developing countries.

Second, after the reform package takes effect, the composition of the Executive will be reviewed every 8 years.

All the Executive Directors will be elected, ending the category of appointed Executive Directors. The Board of Governor will further make regulations to govern the conduct of the election, so as to avoid an excessive concentration of voting power in multi-country constituencies on the one hand, and to allow for adequate flexibility to enable members to form constituencies on a voluntary basis on the other hand.

3. What will happen after it takes effects?

Remains to be accepted by a qualified majority of members

Once it takes effect, the quotas and voting power of the emerging market economies and developing countries in the IMF will be further increased. For example, China will have its quota shares and voting shares increased to 6.394% and 6.071% respectively, and will become the third largest shareholder of the IMF, next only to the U.S. and Japan. Furthermore, all the BRICs Four countries will be among the top 10 shareholders of the IMF. Together with the four largest European countries (France, Germany, Italy and U.K.), as well as the U.S. and Japan, the top 10 shareholders will really represent the top 10 economies in the world; the ranking of the countries will be more close to their ranking in the global economy.

Meanwhile, the transfer of two chairs in the Executive Board from advanced European countries to emerging market economies, as well as the ending of the category of appointed directors, help to improve on the democracy and representation in this daily decision-making body of the IMF.

V. Achievements and limitations of the reforms

A.Achievements

Although the IMF, as a international financial organization based on the "capital majority rule", is different from many other international organizations, it is indeed an organization made up of sovereign states. Therefore, it must respect and observe the recognized principles of democratic politics and international rule law, and must represent and protect the rights and interests of all its members as widely as possible. Or else its legitimacy and fairness will unavoidably be questioned; it might even fall into the mouthpiece of a club of wealthy countries or certain superpowers.

In fact, even the business corporations under the private law are required to have in place a reasonable corporate governance structure to protect the rights and interests of minor shareholders, to prevent excessive control or manipulation of the corporation by major shareholders, and to embody the spirit of fairness, equity and equality before law. As an international organization under public international law, there is simply a much stronger argument for the IMF to improve on its internal governance, so as to ensure that each of its members "enjoys the rights inherent in full sovereignty", as announced by the Declaration on Principles of International Law.

In this sense, the reforms made through the 2008 and 2010 Resolutions are definitely a significant step in the right direction. In the words of the former managing director Strauss-Kahn, the 2010 reform package "is the most fundamental governance overhaul in the Fund's 65-year history and the biggest ever shift of influence in favor of emerging market and developing countries to recognize their growing role in the global economy".

B. Limitations

Even if this round of reform has great or even milestone significance to the IMF, it has not resolved all the problems relating to the voting power and governance structure. Most notably, even after the 2010 reform takes effect, the U.S. will still have more than 15% of the total voting power, and continue to enjoy its single veto power on core issues of IMF. Also, the mixed method of calculating GDP, with market exchange rates have the lion's share, manifestly falls short of the expectation of developing countries.

Another deficiency in this round of reform is that it fails to make specific provisions for the selection of IMF senior officials including the managing director. Considering the insufficiencies in the representation and selection of the IMF senior officials, the G20 Toronto Summit pledged to strengthen the legitimacy and credibility of IMF, and to ensure the open, transparent and merit-based selection of the IMF management. However, the 2010 Resolution said nothing specific in this respect.

As a matter of fact, after the resignation of Mr. Strauss-Kahn, we have expected to have a new managing director from non-European countries. However, Europe once again prevailed. The French lady Christine Lagarde defeated her Mexican rival, Mr. Agustin Carstens in the competition for that position. In addition, the first deputy managing director will continue to be an American (David Lipton to replace John Lipsky). This means we have to wait for at least another 5 years to see a real change to this traditional power structure.

C.Comments and Suggestions

Further reform might include the following:

?First, to set up an automatic quota adjustment mechanism on the basis of the current quota formula and periodical reviews.

?Second, to make a thorough review of the Articles of Agreement, reduce on a reasonably possible basis those issues which require a special majority vote, especially 85% special majority vote to decide, so as to lessen the excessive control of the IMF by certain superpowers.

?Third, to establish and maintain a really open, transparent and merit-based selection process for the management, and meaningfully break the European monopoly over the leadership of the IMF.

In my opinion, this round of reform is to a great extent pushed by the crisis, which has undermine the economic strength of traditional developed countries, especially the European countries, and placed the emerging market economies at the front stage. Although developed countries as a whole have been forced by the circumstances to make some concessions to the developing countries, they are not in a position to compromise their core interests in the IMF. In terms of reforming and reshaping the IMF, the international society still has a long way to go.

In this process, Mexico and China, both as significant dynamic emerging market economies, ought to, and indeed are able to, play a more important role.