The route to democracy at the IMF

Kenneth Rogoff, Project Syndicate

Emerging market countries from Chile to China have been arguing for some time that the International Monetary Fund -- the nerve center of the international financial system -- needs to become more "democratic." They want more policy influence the next time the Fund decides to bail out a fellow emerging-market country like Argentina, Brazil, Indonesia, and Turkey. (Unfortunately, benign as current market conditions may seem, there will surely be a next time for some countries.) In the meantime, as a new "Washington Consensus" of best-practice economic policies inevitably emerges, developing countries want to feel that they helped design it, for better or worse.

I couldn't agree more. The IMF's perceived "democratic deficit" is a serious challenge to the Fund's political legitimacy and to its ability to effectively stabilize crisis situations. But let's recognize that real democracy is only going to come when middle-income developing countries are prepared to back up their lofty rhetoric with hard cash.

Right now is precisely the time to do so, given that the United States has become, without rival, the world's most reckless borrower. The U.S. is draining a whopping 75 percent of the world's surplus savings. Today, even formerly bankrupt governments from Korea to Russia to Mexico are awash in dollars. Why not put some of those dollars to good use?

These countries need to understand that calls to cut rich- country voting shares at the IMF, unless they are backed up by real money, are naove, if not downright hypocritical. At the end of the day, as long as the IMF is in the lending business, it needs to keep its creditors happy. Otherwise, they will pull up stakes, and the Fund (and its sister organization, the World Bank) will have a debt crisis of its own. Right now, the U.S., Europe, and Japan put up the lion's share of the capital, so they have disproportionate power.

It doesn't have to be this way. Many middle-income countries' central banks are hoarding dollars today in order to prevent their currencies from appreciating too much against the sinking dollar. China alone, with over $600 billion in reserves, holds more than enough dollars to recapitalize the IMF four times over. Even Latin American governments now hold enough dollar reserve assets to buy out Europe's shares in the Fund.

It may seem strange to make middle-income countries pay for their own bailout insurance, but it isn't. They have much more at stake in IMF policies than do rich countries.

Many people have forgotten that the Fund was originally conceived as a cooperative -- it bailed out England only a few decades ago, and almost had to bail out France. People forget these episodes because the Fund's resources have not kept pace with the explosion of global capital markets so that today, the IMF lacks the capacity to bail out an Italy or a Japan (though the issue may well arise one day.) So, if the Fund is to resume its identity as a cooperative, it makes sense to shift its center of gravity.

Would middle-income developing countries actually change things if they were big creditors at the Fund? I wonder. Admittedly, no developing country ever seems to vote against a big bailout for one of its brethren, no matter how ill conceived. But would such indiscriminate largesse persist if middle-income countries knew that their votes really counted, and that they were spending their own money? I doubt it.

On the whole, I expect that the bailout policies of a more "democratic" IMF would look much as they do now. After all, the laws of economics are always going to force prodigal debtor countries into adopting austerity measures. If a country that has been borrowing like a drunk suddenly sees its credit dry up, it will tighten its belt -- raise taxes, cut spending, or do both -- with or without an international lender of last resort. Perhaps the IMF's bedside manners would improve, perhaps not.

In any case, greater political legitimacy would likely make the Fund's crisis leadership smoother and more credible, potentially shortening crises and minimizing their pain.

The big question is whether the rich countries that have long ruled the roost at the Fund would actually surrender some of their power. They might, and they should, even if global financial markets take time to adjust to a slightly smaller role for the dollar. They really have little to lose and much to gain.

So there is an upside to today's massive U.S. fiscal and current account deficits. The structure of global imbalances, with the U.S. the big borrower and emerging markets the creditors, presents a rare opportunity to finance a change in governance at the IMF. Let's do it now before the chance slips away when the next round of crises hits.

The writer, a former chief economist of the IMF, is Professor of Economics and Public Policy at Harvard University.