Published: July 18, 2008
Mohammad El-Erian is co-CEO of Pimco, the largest bond investor in the world. A former deputy director of the IMF, and world expert on emerging markets, El-Erian here writes exclusively for emeafinance on why a reformed IMF has a critical role to play in saving the global economy from its present crisis.
There is a clear need for a global solution to the present economic crisis. The global solution calls essentially for countries to implement specific measures in a coordinated and simultaneous fashion in the context of a “shared responsibility”.
The specific steps are as follows: The US is to reduce consumption to allow for a halt and a reversal in the mounting external and internal imbalances; Europe and Japan are to implement structural reforms that would allow their economies to increase growth capacity and productivity; and Asia and the oil exporters are to stimulate domestic components of aggregate demand. The result of this policy cocktail is the maintenance of high global growth concurrent with a reduction in global imbalances and a lowered risk of financial system instability.
Sounds easy, right? Well, here is the rub: In the absence of strong coordination mechanisms that ensure simultaneous policy implementation, no rational, free-choosing country would necessarily proceed on its national policy agenda. This is called a ‘prisoner’s dilemma’. In order to act, each individual country needs strong assurances that others will also implement their policy agendas. Why? Because any country that goes it alone ends up in a worse state. In other words, a national policy action may not be desirable unless it is implemented simultaneously with the other national policy measures.
The situation is reminiscent of the predicament of an orchestra that has been given a new score to perform but lacks a conductor. There are no good alternatives – the attempt of individual musicians to proceed and start playing on their own will most likely end up in a rather raucous and ineffective composition that will have the audience asking for their money back; while the alternative of not playing and waiting for a conductor that is slow to appear also results in audience impatience and dissatisfaction.
Institutions like the IMF start with the best set of structural attributes to play the role of conductor. But to have any chance of convincing a sceptical world, the IMF needs to start by enhancing its own expertise and operating modalities. It then has to position and market its services as part of the response to the new secular global realities. Finally, it needs to do so in the context of strong leadership.
There is little disagreement on the needed enhancement at the IMF. Indeed, a common set of issues has emerged from the work done by the institution itself, the reports of committees, and the views of observers and practitioners. These include the need to:
- Retool internal staff expertise to ensure that the traditional focus on economic issues is adequately complemented by a good understanding of the manner in which increasingly complex financial markets behave and influence the global economy
- Alter internal modalities so that the IMF country missions respond to the actual challenges facing member countries as opposed to imposing a discussion agenda that is driven by a more narrow and inevitably dogmatic headquarters-based view.
- Strengthen the analytical standing of the institution so that it is able to engage credibly in sensitive national policy issues that require reconciliation at the global level, such as the surveillance of exchange rate policies.
- Develop a more robust internal income model that diversifies the sources of revenues and links them to the range of activities of the institution.
- Adequately budget and price where appropriate the services that are being provided, including through a more transparent system of cross-taxation and subsidization.
- Remove feudal practices that reserve key management and staff positions to certain industrial country nationalities; and
- Allocate voting power and Board representation on the basis of today’s realities rather than have them reflect an out-moded past.
This is quite an agenda, in terms of both the number of items and the manner in which they speak to altering historic entitlements. Understandably, the temptation is to pursue the agenda in a sequential manner. Indeed, that is the approach that was being adopted in 2007. Unfortunately, at the end of the day, such an approach is unlikely to result in meaningful reform progress.
Each item is inevitably subject to negotiations and compromises among member countries. Unless the negotiators believe in a ‘grand bargain’ or what I called elsewhere a ‘critical mass’, they will pursue individual positions that have little chance of striking the correct macro tradeoffs. Indeed, this is already apparent in the manner in which the discussions have evolved over modifications to the quotas that determine, among other things, voting power.
The result is an outcome that leaves everyone with a sense of under-accomplishment, unsatisfactory compromise, and a recognition that some further changes will be needed. Indeed, this episode reminded me of an observation by the late physicist Richard Feynman in his insightful assessment of what had gone wrong with the space shuttle: “reality must take precedence over public relations, for Nature cannot be fooled”.
[Nobel prize-winning economist] Michael Spence and I have suggested a way in which this grand bargain can be pursued with a higher probability of success: Do so in the context of a unifying theme that speaks directly to the common challenge facing the global economy. We proposed that this theme be defined in terms of “facilitating the ongoing breakout phase in the economic development of emerging economies”.
We argued that such a theme did more that just reflect global realities; it offered strategic advantages for realizing a shift in focus from entitlement-driven, bilateral discussions towards more multilateral deliberations, including in providing greater assurances to individual countries that their policy actions will be accompanied by reinforcing measures on the part of others. By contrast, the more hesitant and disjointed strategy being pursued at this point risks undermining the health of the international economy.
Taken from Mohammad El-Erian’s new book, ‘When Markets Collide’, published by McGraw Hill