Why the IMF needs change at the top

16 May 2011 | By Nick Rice

Now Dominique Strauss-Kahn, the managing director of the IMF, faces charges of sexual assault in America, the fund must use the opportunity to reassert its independence.

It should break the cosy relationships of international politicking, whereby a European is typically appointed to lead the IMF, and an American to head up the World Bank.

In particular, it should break the not unjustified assumption (see chart in our article here) that the IMF is becoming a second European bailout facility.

Strauss-Kahn was one of the architects of the euro. The IMF money pouring into the eurozone, rather than into poorer countries, raises inevitable conflicts of interest. Even if the IMF loans are the best possible decision, it looks better coming from a leader outside Europe.

Questions of where the candidates should eventually come from are moot at this point. What the fund needs now is experience and stability. John Lipsky, the first managing director and now acting head, was due to retire in August. But in a time of crisis, there is a case for retaining him for longer and giving the fund more time to hunt for a successor.

Some might say selecting an American is as great a problem, if not greater, than choosing a European. The IMF is already located in Washington. An American remains in charge of the World Bank. America itself was the epicentre of the financial crisis and has not yet agreed a plan to tackle its government debt. If America needed extra assistance, the argument runs, the same conflicts of interest will pertain.

While this might be true of the medium term, however, a short-term dose of Lipsky would probably prove a good remedy.

Since the election of Barack Obama as its president, America has done a more thorough job than Europe of stress testing wobbly financial institutions and forcing them to recapitalise.

It also did a good job on selling off and restructuring American automakers, which could yet be a good model for the eurozone periphery.

Faced with social chaos in manufacturing states if the automakers went bust, America sold Chrysler off and put General Motors into a structured bankruptcy within months.

The next year, it re-listed the company in America’s largest ever stockmarket float.

For an old-school eurozone politician like Strauss-Kahn, a flexible approach like this would be unthinkable.

Under Strauss-Kahn’s leadership, the IMF has reiterated the eurozone’s personal mantra. Member states must not exit the eurozone, restructure their debt or default.

Strauss-Kahn’s solution is complete financial integration of the eurozone, despite the fact that this would violate national sovereignty and produce possibly even more social unrest than the alternative.

Overall, this dogma has masked the fact that a debt restructuring is in fact possible, and easily achievable for an experienced technocrat like Lipsky.

It is an incredible anomaly that in its latest report on Europe, the IMF only mentions the word “restructuring” in the context of banks, not of the public sector.

As some financial institutions are obliged to hold large swathes of government debt, the EU and the IMF should simply convert it into super-senior perpetual bonds, which never mature and have lower interest payments. They should persuade as many lenders as possible to move to this structure or receive severe haircuts.

In opposition to Strauss-Kahn, national institutions should also be required to support their national governments. The euro has enabled Greek institutions, for instance, to hold foreign debt denominated in euros with impunity.

In America, this type of cross-border free-for-all between states has a safety net. The federal government can step in to fund states that are starved of capital.

Europe does not have such a system of fiscal transfers and cannot do so unless it becomes a financial United States of Europe overnight. Contrary to Strauss-Kahn’s hints, this situation is politically unacceptable without a widespread public debate and referendum. The EU and the IMF have to move much faster.

Once Lipsky or an equivalent has cleared these initial hurdles, the IMF has to rebalance its government away from the crisis-hit eurozone and the rest of the developed world and towards emerging markets.

The developing world is not only a major and growing contributor to the fund. It has also historically been underrepresented in the fund’s previous dealings and best implemented the fund’s own orthodoxies.

Here, however, there are equal pitfalls. The IMF should be wary of giving too much weight to China and India. China is already extremely powerful could easily use the fund as an instrument of its own foreign policy, which the developed world has been known to do in the past.

Although India has been less successful than China, it aspires to the same aims, particularly in Africa.

As an independent economy in a financial sweet spot, Brazil would probably be the best candidate. The question is whether the developed world would offer its candidate the job.

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