Christine Lagarde, departing International Monetary Fund Managing Director
With the forthcoming departure of Christine Lagarde to the European Central Bank, the IMF’s shareholders are considering possible candidates to replace her. Given the central role the organization has played in recent decades in financial crisis management, a role that is likely to be enhanced in coming years, few of the high-level jobs at the head of international organizations are more consequential than that of IMF managing director (MD). What will be the key challenges facing the new MD? What are the specific reforms and priorities which he/she should push for? And, what are the qualities which the new MD should bring to the job?
On the challenges, there are four that quickly spring to mind. The first one reflects the fairly dramatic shifts in economic and political power which have taken place over the past two decades, with China rapidly emerging as the world’s largest economy. Its contribution to global economic output will have risen from 7 percent at the turn of the century to over 20 percent by 2025. In Destined for War: Can America and China Escape Thucydides’s Trap? Graham Allison (2017) notes that “when a rising power threatens to displace a ruling power, the resulting structural stress makes a violent clash the rule, not the exception.” Allison presents evidence that in twelve of the sixteen cases over the past five hundred years, when a major rising power threatened to displace a ruling power, the result was war, a sobering observation against the background of an escalating trade war between China and the US in 2019. Making peace between the US and China is not in the job description of the new MD, but it highlights the potential difficulties of managing an organization in which two of its largest shareholders have a whole range of unresolved economic and security issues to deal with.
The second challenge stems from the fact that international trade is no longer the engine of global economic growth it has been during the past several decades. The global financial crisis in 2008-2009 and its aftereffects, not only raised fundamental questions about the sustainability of an economic system based on various combinations of liberal democracy and the market but, in the words of a recent editorial in The Economist, the crisis “turbocharged today’s populist surge, raising questions about income inequality, job security and globalization.” Effectively managing the next crisis will be very much part of the MD’s job description (see below).
As I have argued elsewhere, the global financial system today is more fragile than it was in 2007, on the eve of the last crisis. There has been a massive increase in the levels of total indebtedness, with a large rise in the share held by governments. Moreover, the public finances, particularly in the advanced economies, will continue to be under pressure in coming years due to the impact of population ageing, the effects of climate change and the constraints imposed on public expenditures by the quick rise in the share of budgets allocated to debt servicing. Dealing with the next global financial crisis in the context of sharply reduced fiscal space, when the traditional responses to managing downturns (such as reducing interest rates, unleashing fiscal stimulus) will largely no longer be there as weapons in the arsenal of policymakers will clearly be a crucial third challenge. Finally, the persistence of income disparities, long seen as a problem best left to academics has emerged as a central concern of our age. Inattention to the consequences of income inequality risks undermining the stability of our political order and the IMF will have to enter more robustly into this debate and what to do about it, given that, for the foreseeable future, the budget and associated tax and expenditure policies will remain a central tool to create more equitable societies.
Improvements in its surveillance function. One problem with the IMF is that it has very little real leverage to influence the policies of countries not borrowing from it. The process of surveillance of members’ policies is deeply asymmetric. The Fund is able to extract numerous concessions (mainly from developing countries) as part of its loan negotiations, all of them, at least in theory, intended to improve the policy framework and make it more sustainable. However, it is the bigger countries that do not borrow that pose systemic risks to the global economy, as we saw during the last crisis. The IMF may feel strongly that a systemically important country is pursuing unsustainable economic and financial policies, but it has no effective way to induce the country to change course. This, in turn, undermines not only the effectiveness but also the credibility of the organization, as countries internalize the sometimes dire consequences of irresponsible behaviors in the systemically important countries.
One way to make the surveillance process more symmetric would be for the IMF to adopt norms on such variables as current account deficits, real exchange rates, inflation, budget deficits and debt levels, to name a few, and establish thresholds that, if breached, would trigger consultations and various remedial actions. Candid assessments of policy failures in systemically important countries should be made public. In practice these norms would reward countries that stayed within them by, for instance, giving them automatic qualification to various liquidity facilities. As part of this system, punitive measures against countries in breach of them, such as financial penalties, waiving of voting rights, depriving them of their share of SDR allocations (the IMF’s composite currency), could be contemplated, quite independently of whether the country in question was or was not using the Fund’s resources. Obviously, it is not enough to have voluntary or so-called indicative norms.
It would also seem desirable to separate the Fund’s surveillance activities from its decisions in respect of lending, so that glaring conflicts of interest might be avoided. Former British prime minister Gordon Brown’s call for a “more transparent, more independent and, therefore, more authoritative” Fund is certainly a step in the right direction.
Boosting its lending capacity. The IMF’s “lending capacity” is equivalent to around US$1 trillion, consisting primarily of IMF quotas and multilateral and bilateral arrangements that the IMF has negotiated with member countries and official financial institutions to provide so-called second and third lines of defense, to supplement quota resources. Since the late 1990s, the IMF has been forced to substantially relax its long-standing parameters that established the extent of a country’s access to Fund resources. Following the onset of the Asian financial crisis in 1997, there has been a growing number of examples of very “large access” IMF programs, such as Korea in 1997–1998, Turkey in 2000–2001, Uruguay in 2001 when the country received the equivalent of 16 percent of GDP, a similar program for Greece in 2010, and more recently Argentina, receiving almost 13 times its quota in 2018.
While US$1 trillion may seem large, equivalent to about 0.4 percent of total global debt and 1.2 percent of world GDP, it is, in fact, a relatively modest sum, adequate to deal with a handful of crises in a few middle-income countries, but possibly a puny amount in the middle of a global financial crisis. As part of its efforts to improve global liquidity management, the IMF should be allowed to mobilize additional resources by: tapping capital markets; issuing bonds dominated in SDRs; doing emergency SDR allocations under considerably more streamlined procedures; and expanding its program of loan/swap arrangements with key central banks. An alternative and possibly more promising approach would give the Fund the authority to create SDRs as needed to meet calls on it by would-be borrowers. The IMF Articles envisaged the SDR to ultimately emerge as the “principal reserve asset” in the global economy. There are at the moment about US$280 billion outstanding in SDRs, or less than 0.4 percent of world GDP. Thus the SDR has not fulfilled the promise that it held at the time of its creation.
Hence the need to overhaul and simplify the system under which the Fund may issue SDRs under exceptional circumstances, such as times of crisis. When this idea was first put forward, in the early 1980s, concerns were raised about the possibly inflationary implications of such liquidity injections, but then international inflation was a serious problem in ways that it clearly is not today, and measures could be introduced to safeguard against this.
Voting shares. IMF members’ voting powers have been updated from time to time, but with the rapid pace of economic growth in emerging and developing countries such as India and China in recent years, a sizable gap has emerged between the relative weight of particular countries in the global economy and their voting share within the IMF governance structure. The gap has been particularly glaring in the case of China, whose voting power is less than 7 percent (compared with 17.5 percent for the United States), even though by 2018 the GDP gap had virtually disappeared and China was well on its way to overtaking the United States as the world’s largest economy. The risk of allowing this problem to fester—quite aside from the inequity issues it raises—is that China may well opt for creating separate funding structures in Asia that would compete with the IMF in some way, and undermine its global nature. Indeed, some argue that the creation of the Asian Infrastructure Investment Bank (AIIB) in 2016 is already an indication of this.
Desirable attributes in a new MD
Ms. Lagarde, whose tenure is judged to have been a success, showed that “relevant experience” is important, but that one need not define it in a very narrow way. Being able to consult widely, to tap into the organization’s vast reservoir of expertise, and to delegate when needed may be more important than having familiarity with the technicalities of monetary policy. Ms. Lagarde gently pushed the organization into an examination of the linkages between financial stability and such non-traditional concerns as climate change, corruption and gender inequality, and for this she deserves considerable credit. To be willing to push for a change in the culture of an inherently conservative/cautious organization that failed to anticipate the last global crisis is a sign of enlightened leadership. So, the new MD should also be broad minded and open, ready to see the global economy in a more holistic way. Intellectual courage is obviously key: the willingness to speak truth to power, particularly at a time when the current international order is under threat from various infantile forms of populism and nationalism. He/she should come (mentally speaking) to serve a single, five-year term, lest excessive concern for being re-elected create a conflict of interest or curtail the enthusiasm to take positions that might ruffle the feathers of the powerful. Finally, but no less importantly, the new MD should be a person of unimpeachable integrity. The MD is also the head of the staff; few things are more discouraging than having to work for a boss with a cloud hanging over his head and the timidity and fear that inevitably accompanies it.