How Traditional Resources Failed Us

Institutions that are one step removed from the immediate action and that are staffed by professionals charged with "surveillance" of the international system are particularly well placed to correctly identify when signals are something more than noise, perhaps even to predict them. Moreover, due to a universal membership and the power granted to them by their articles of agreement, they should play a role in facilitating welfare-enhancing changes in the global landscape.

After all, they are built to reconcile domestic and international considerations. In actuality, however, these institutions have often found themselves better equipped to deal with the challenges of yesterday rather than with those of today and tomorrow. The International Monetary Fund (IMF) has traditionally been considered the most influential of the existing multilateral institutions that are operating at both the country and cross-border levels. Consider some of its attributes:

• It has a virtually universal membership, with 185 member countries as of the end of 2007.
• Through its international staff, it assembles one of the world’s largest populations of economics PhDs to work under one roof, and it exposes them to real-world policy challenges.
• It has unmatched access to countries because, under its articles of agreement, members agree to a number of obligations that include subjecting themselves to a periodic (usually annual) check-up by IMF staff.
• By mandate, it complements its "surveillance" of national policies with multilateral responsibilities.

With these attributes, you would expect the IMF to flourish in the scenarios that have played out among nations in the last few years—namely, lots of national policy uncertainties, new and unusual forms of cross-border flows, and the inability of any one country to deliver an orderly global outcome. Instead, it has languished.

The challenges facing the International Monetary Fund

In commenting on the challenges facing the IMF, its then managing director, Rodrigo de Rato, observed in 2005 that "there is the question of whether the Fund is fully prepared to meet the great macroeconomic challenges that lie ahead." He went on to note that the institution faces "the imperative to stay relevant in a changing world." Others were more direct.

Barry Eichengreen, professor of economics and political science at the University of California, Berkeley, described the IMF as "a rudderless ship adrift on a sea of liquidity." Tim Adams, the former US Treasury undersecretary for international affairs, publicly characterised the IMF as "asleep at the wheel" while he served in his official post. Jim O’Neil, chief economist at Goldman Sachs, asked, "Which of the big countries in the developing world needs the IMF or really cares what they think?"

Adam Lerrick, economics professor at Carnegie Mellon University, added, "Heads of state no longer tremble at the approach of the IMF because they no longer need its money." This echoed a Financial Times editorial that argued, "Since the world’s foreign currency reserves will shortly be 20 times the resources of the Fund, the day when it could dictate to important countries are past."

Sensing the increasing awareness of the IMF’s weaknesses, a growing number of parties have joined the ranks of those taking potshots at the institution. Those ranks have included the two extremes of the political spectrum in industrial countries: those who believe that the IMF is an instrument of western imperialism and postcolonialism and those who believe that the fund interferes with the efficient functioning of markets and the related disciplinary mechanisms. And don’t forget those who feel that national prerogatives should never be ceded to a multilateral body. Those groups have been joined by those—primarily in Asia and Latin America—who still resent the conditionality that they believe the IMF imposed on them.

A vivid illustration of this comes from the ads that ran on Argentine television in October 2007 ahead of that country’s presidential elections. In one ad financed by the leading candidate, a group of children is asked about the IMF. They respond in a way that is familiar to any parent but has nothing to do with the institution: The IMF is a horse; no, a satellite; or is it a country? An offscreen voice then emerges to reassure those watching that "we’re making sure that your children, and your children’s children, have no idea what the IMF is."

Problems at all levels

The IMF’s problems go beyond its inability to respond to the types of challenges that, on paper, speak strongly to its attributes. Like many other entities and activities in both the public and private sectors, the business model of the IMF is ill equipped to deal with the changes that are occurring in the global economy. Indeed, the highly visible and documented case of the IMF contains important insights for many financial firms around the world.

First, and foremost, the IMF has to deal with global issues that reflect the growing interaction between traditional economic issues, where the IMF is strong, and financial innovation, where it lacks sufficient expertise. As such, the IMF is not seen as a credible and knowledgeable "trusted advisor." The resulting loss of influence is compounded by the fact that, the institution is no longer called upon to lend, given the above-noted sharp improvement in developing countries’ external accounts. As a result, the IMF is no longer able to impose the same degree of policy "conditionality" that it did in the past.

Second, the IMF is facing internal budgetary problems. The institution relies on an income model that assumes a high level of lending activity. Consequently, its income has fallen sharply as countries have repaid it. The fund is now running an annual and growing deficit that is slowly eating into its reserves. The result is that just when it needs to learn how to better respond to the new global realities in economics and finance, it must do so in the context of a constant or contracting budget—not an easy endeavor.

Third, the outlook for the global economy is that it will be increasingly dependent on the policy actions of countries that are underrepresented at the IMF. Indeed, it is now widely recognised that the fund’s governance structure is outmoded and feudalistic. How else would Belgium, with a population of just over 10 million, have almost the same voting power (2.13% of the total) as China (2.94%, population of 1.3 billion), Russia (2.74%, population of 141 million), and Brazil and Mexico combined (2.61%, and almost 300 million)? These inconsistencies are stark regardless of what comparison indicator one uses—GDP, trade, reserves, or virtually any other.