Time Is Running Out to Rebuild the Fund, Mr. Paulson

Op-ed in the Financial Times

July 12, 2006

Dear Hank Paulson,

Congratulations on your installation as the 74th secretary of the US Treasury. The Treasury is a vital institution, guiding the US economy and financial system for more than 200 years. As you enter your handsome corner office, many issues will demand your immediate attention, including the US fiscal situation. I write about a related concern: reform of the International Monetary Fund (IMF), another vital institution.

The IMF has shaped a prosperous global economy and stable international financial system for more than 60 years. It is in eclipse. Time is running out to reform the Fund. At your first IMF annual meetings in Singapore in September, you face this big challenge. If you and your colleagues fail to address it, the adverse consequences for global economic and financial stability could be enormous. The Singapore meetings should produce concrete progress on a three-part package: meaningful governance reform, significant steps in policing the policies of the systemically important countries and a strengthened IMF role in crisis lending.

On governance, the US position is forward looking. Enhancing the IMF's legitimacy requires a redistribution of voting shares and executive board chairs. IMF voting shares have stagnated for three decades as the world economy evolved. At least 10 percentage points should be redistributed from relatively slow-growing, industrial countries toward faster-growing ones. The latter are primarily the emerging market countries, principally in Asia. The quota formula should be revised to reflect the economic and financial facts in the 21st century. It should be based predominantly on some measure of gross domestic product and exclude intra-eurozone trade.

The configuration of the IMF executive board has been largely unchanged for more than four decades. The disproportionate representation of Europe in 10 of 24 seats and its dominance in eight of them cannot be justified. The Europeans should begin consolidating their representation in the Fund.

On multilateral surveillance, the US position is incomplete. The core objective is to police more effectively the policies of those countries that affect the global economy. The managing director has initiated multilateral consultation on the resolution of global imbalances. The content and timetable of these consultations are insufficiently ambitious. They must be grounded in an acceptance that Fund members have obligations under the IMF articles not to prevent effective balance of payments adjustment and that the managing director has the responsibility to act as the overseer of the system.

The global adjustment process has been under way since the US dollar peaked in February 2002 and has so far been unbalanced. But more than changes in exchange rates are required. The United States should not hide behind a modest improvement in its irresponsible fiscal position that has been driven by economic recovery. From 2003 to 2007, the US overall, underlying fiscal balance is projected to narrow by only half of 1 percent of GDP and to remain close to 4 percent. That is insufficient to ensure the health of either the US or the global economy. Mr. Secretary, this is where you need to exert leadership at home to achieve results abroad.

On crisis lending, some reactionary and short-sighted policymakers and critics want to close down the IMF as a significant lending institution. The United States has been sympathetic to these views. That position is inconsistent with the fact that liberalized global financial markets can be dangerous to countries' economic health. Perceptions of those dangers and a weakened Fund have contributed to a doubling of foreign exchange reserves over the past five years, creating a massive distortion of the global adjustment process. Policymakers in many emerging market countries are right to be concerned that the IMF may not be there to help in the future. Therefore, a key component of the IMF reform agenda must be an updating of the Fund's lending instruments to provide high-access financing, contingent on automatic prequalification of countries with strong macroeconomic and financial policies.

Meaningful IMF reform requires a balanced, comprehensive package. It will necessarily contain elements that some would prefer to omit, including the United States. Mr. Secretary, discussions have advanced beyond the technical and analytical stage to the political stage. Politics demands results. Politics is the art of compromise.