Old Challenges for New IMF Chief

by Berly

One of the old challenges Mr Strauss-Kahn should immediately addresses, ironically, is the mechanism how he received his post. An unwritten rule establishes that the IMF's managing director must be European and that the president of the World Bank must be from the United States. The practice is increasingly questioned since IMF policy affect developing countries significantly more. A developed country in financial crisis can afford not to take IMF advice and loan since their access to financial market are not drying up. IMF usually become the main, sometime the only, source of fund for developing country in crisis and exerted enormous influence.

The voting weight of each IMF members are determined by the amount of money a country provides to the fund relative to the size of its role in the international trading system, but the relative size reflected each economic prowess more for the time IMF was founded than today. Europe is over represented and US practically held a veto with its 17 % vote since major decision require 85 % support. In 2001, China was prevented from increasing its quota to reflect rising share of its economy ensuring it remained at the level of the smallest G7 economy. Under leadership of Rodrigo de Rato, China contribution has been allowed to be increased slightly further.

The second old challenge is the role of IMF. The Great Depression were characterized by bank run caused by panic investors and IMF was supposed to act as lender of the last resort to prevent systemic meltdown at international level. Recent studies (Banerjee, 1992; Lux, 1995) in behavioral finance has shown that herd behavior to sell investment at the first hint of trouble is a self fulfilling prophecy that precipice the crisis it fear.

Each member country entitled to withdraw a percentage of its quota immediately in case of payment problems meaning developing country has quick access to less fund just where the need is greatest. When a member country in need of financial infusion, IMF should act like a central bank in similar situation. Lend freely with penalty, slightly higher interest rate than usual, for a temporary period.

IMF tends to overestimate the ability of high interest rate to attract investment after crisis despite the empirical evidence otherwise (Sach, 2005). The structural adjustment program and fiscal austerity to repay the loan, normally in full value despite principle of share responsibility, typically disproportionably affect the poor population and caused political instability which heighten and prolonged the crisis IMF supposed to ease in the first place.

Evading the policy strait jacket of IMF lead developing countries to accumulate huge amount of reserve, mainly in form of US Treasury bill, to defend their currency in the face of speculative attract. Southeast Asian nations have been developing a regional cooperative to share foreign exchange reserves in the event of a crisis. But developing countries received low return from T-Bill and the opportunity costs are calculated to be 300 billion dollar per year (Stiglitz, 2006). The amount is more than four times the total foreign assistance in the world and could have been used to reduce poverty and increase education/ health expenditure if IMF properly conducts the job it’s designed to do.

As finance minister in Socialist government from 1997 to 1999, Mr Strauss-Kahn challenged his party orthodoxy and cut the public deficit to qualify France for the euro. Let’s hope that he still got the backbone to challenge Washington Consensus orthodoxy as IMF Managing Director. The world certainly need, and deserve, a better IMF.