It’s time to embrace the multilateral policy challenge and recognise and enhance the IMF’s central role therein, says Mohamed A El-Erian.

Over its 60-year history, the International Monetary Fund (IMF) has repeatedly adapted to changing global conditions. In maintaining an important role in the international economic system, it helped countries navigate the shift away from the Bretton Woods regime of fixed exchange rates in the 1970s; it sought to moderate the impact of the two oil shocks in 1973/74 and 1979/80; it helped solve the generalised 1980s debt crisis in Latin America; and it responded to the crisis that broke out in east Asia in 1997, spread to eastern Europe and risked engulfing Latin America.

The IMF will again be required to adapt if it is to help its member countries navigate important secular changes in global economic conditions. The institution is in a good position to do so but the process is far from automatic. It requires that the Fund receive stronger support from its members, especially those in the industrial world. And while there are short-term challenges, responding is in the longer-term interests of these countries.

Three main functions

For analytical purposes, the IMF is best thought of as providing three services of a public-good nature. First, it holds regular bilateral policy consultations with its 184 member countries; second, it provides a forum for the analysis and discussion of multilateral policy issues which, inevitably impact the design and effectiveness of national policies; and third, it makes funding available to countries facing balance of payments problems. The relative importance of these roles have varied over time. In recent years, most of the focus has been on the IMF’s funding role, as reflected in its “crisis management” and “crisis prevention” activities.

The institution helped restore financial stability in the aftermath of the 1997 Asian crisis, the Turkish 2001 currency crisis, and the Brazilian 2002 dislocation. In the process, it combined its policy advice with the provision of large conditional funding which helped restore financial balance and provide the leeway for domestic reforms to take hold.

The IMF was less successful in Russia in 1998 where, despite its intervention, the government was unable to avoid a disorderly mix of default and recession. The IMF is still dealing with the fallout of the 2001 Argentine debacle which saw that country plunge into economic and financial turmoil.

The Fund’s other two roles have taken somewhat of a backseat in recent years. Bilateral policy consultations have continued, but in a constrained manner. And while the Fund has maintained a sound analysis of multilateral issues, its relevance for the design and coordination of such policies has been limited. To the extent that international policy coordination has taken place – and there is considerable debate on this – this has occurred in other fora that are only open to a small group of countries.

Ideally, the balance among the IMF’s three main functions will need to adjust. For it is likely that the world is heading towards an important turn in its secular growth and inflation conditions. It is also likely, if not inevitable, that financial market volatility will increase given the degree of uncertainty pertaining to the timing and the orderliness of this secular turn.

Defining the secular turn

Given recent developments, we are most likely facing a secular turn involving two baseline changes: first, a shift from a powerful, albeit debt-financed single engine of global growth (in the form of the US) to a dual and more uncertain engine (the US and China/Asia); and second, a shift from 20-plus years of dis-inflation in industrial countries to a period of higher, albeit still-stable, inflation.

A number of factors underpin this secular turn; and two dominate: developments in China and the US.

China is experiencing an intense economic take-off phase. This renders China, as well as other Asian countries that are increasingly economically integrated with it, a major influence on international patterns of consumption, production and financial flows.

After a recognition lag, analysts have been noticing. They now regularly assess China’s large impact on international commodity markets; its role as a price-maker for a host of manufacturing products; and its importance in funding the large US twin deficits (budget and current account).

The US’s analytical outlook is dominated by the ongoing rehabilitation of the corporate sector after the excess of the 1990s – a rehabilitation that would potentially accommodate a (currently uncertain) hand-off to sustainable secular dynamics and away from the series of debt-financed cyclical stimuli that resulted in a sharp deterioration in public finances, the significant leverage of the household and non-bank financial sectors, and large dependence on foreign purchases of US financial assets.

If well-handled, this secular turn could become a welfare-enhancing change for the global economy. After all, it entails more balanced and durable growth; it provides an environment for the gradual correction of financial imbalances that have accumulated over many years; and it entails the small degree of price lubrication needed to contain the costs associated with the much-needed cross-country shifts in factors of production.

But, what is possible may not necessarily materialise in an orderly fashion. Indeed, history teaches us that there is nothing automatic about secular turns. Over the last century, some have disrupted global economic growth, trade, and financial flows.

Role of the Fund

Fortunately, our understanding of economic secular processes has improved significantly; as has the potential effectiveness of policies – particularly those that are calibrated and coordinated within and across countries. Moreover, most, if not all countries, have an interest in the orderly navigation of the secular turn that involves, over time, US fiscal correction, a change in the currency regimes for China/Asia, monetary policy loosening in Europe, and structural reforms in Europe, Japan and the emerging countries.

Clearly, no single country can deliver the required set of policy responses. There is also a first-mover problem. A simultaneous delivery across several countries is required, as well as the ability to respond quickly in the face of unanticipated externalities. And current modalities for this, which centre on a rapidly-aging G-7 architecture, are too exclusive and insufficiently reflective of global realities.

It is thus time for greater emphasis on the IMF’s multilateral policy coordination role. And it has all the necessary conditions needed for this: an experienced and qualified staff; a history of sound analysis; unmatched compilation of “best practices” from countries around the world; unrivaled potential access to policymakers in individual countries; and an encompassing membership with well established procedures for interaction through the existing delegation of national authority to the Fund’s executive board.

To be effective, these favourable “initial conditions” need to be accompanied by a change in the way the IMF interacts with countries. In the short term, the emphasis is on modalities pertaining to operational relationships with members; over the longer term, governance must be addressed.

While over-simplifying somewhat, the IMF currently has stumbled into an over-dualistic approach to its operational interactions with member countries: At one end, there is the inevitably-intrusive involvement with governments that borrow from the IMF; and at the other end, an overly-timid arrangement with those that do not.

It is time for these extremes to give way to the hitherto elusive centre. One in which the presumption that governs the Fund’s involvement with most countries is based on the principle of a “trusted adviser”; one that entails smoother cross-border transfer of economic policy knowledge and best practices; and one in which group decisions, such as those conducted by the G-7, involve countries that have become central to the global economy.

Over the longer term, the IMF will need to change elements of its governance structure to remain effective, responsive and credible. Much work has been done on this, including by the IMF itself. It suggests revisiting the inter-related specification of country quotas, voting power, and Board representation. And the likely outcome is a relative shift away from Europe and towards emerging economies.

As the world approaches a secular change, all countries have an interest in the timely and orderly navigation of the turn. The IMF can contribute by increasing the emphasis it places on its multilateral surveillance role, while maintaining its other functions (including a central role in financial crisis prevention and crisis management/resolution).

Industrial backing

Through existing practices and some modifications, the IMF has the necessary conditions to respond to the multilateral challenge. But they are insufficient. The IMF needs the sustained and public support of its member countries, especially those in the industrial world. And this does not come easily.

Countries are reluctant to delegate elements of national policymaking to a multilateral body. They are more comfortable with regional arrangements, or one that entails a high degree of exclusivity. But this approach is increasingly at odds with the evolution of the global economy.

Greater cross-country coordination is needed to enhance the well-being of citizens in economies around the world. It is thus time to embrace the multilateral policy challenge, and to recognise and enhance the IMF’s central role therein.

Mohamed A El-Erian is a managing director of PIMCO

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