Recruiting the right MD for the IMF

The recruitment of the IMF MD has turned into quite a controversy. For an interesting set of views, see this page on the website of The Economist. In a remarkable development, the EDs of India, China, Russia, Brazil and South Africa came out with a clear joint statement on the silliness that is afoot.

There are four perspectives on this question which are worth noting:

1. There is an obvious gap between the power structure at the IMF, which reflects the structure of the world economy after the Second World War, as compared with the present reality. As an example, at present, the Netherlands has 2.08% of the votes while India has 2.35%. But Indian GDP is now $1.6 trillion while Netherlands is at half that.
   
2. The world would benefit from a competent and capable IMF. The best man (or woman) for the job will not be obtained by having any restrictions on nationality. As an example, in today's world, a name that leaps out to me is Stan Fischer. But he's not European, and hence was never even considered for the top job in the last decade. (As with Montek, he is now over age 65 and is hence not eligible for the job today). Given that a large fraction of the top economists of the world are not European, this rule yields a less capable IMF.
   
3. A quota system where the IMF MD must now be from an emerging market is as bad as a quota system where the IMF MD is only recruited from a European country. The key is to get away from all these restrictions, and to only recruit the best person for the job. The emphasis should be on technical capability. As an example, see how in the UK, they recruited an American into their Monetary Policy Committee.
   
4. In the standard narrative, one hears the idea that in this crisis in Europe, the Europeans are gaining from their control of the IMF. I disagree. In the Asian crisis, it was good for Asia that the IMF was not conflicted by considerations of domestic Asian politics. Similarly, the IMF program in India in 1981 and 1991 was uncontaminated by domestic Indian political considerations. This helped produce technically sound programs, which helped in jumpstarting India's growth. It is not accidental that we see structural breaks in India's GDP growth around these two dates.
   What Europe needs most is a tough IMF, which will be a stern taskmaster, which will force difficult political choices so as to heal the economy. Economic policy in Europe today needs to be cruel to be kind. Instead, by placing a string of career politicians from France into the IMF MD's job, the valuable role which the IMF could have played in solving the European Crisis is being negated. This damages Europe. The wise thing for Europe today is to say: Give us a tough and competent taskmaster, recruited through global search, where European politicans are not allowed to apply. The biggest loser from the present arrangement is Europe.

Exchange rate regime of systemically important countries

Many people believe that the exchange rate regime (i.e. the monetary policy regime) of each country is its own sovereign choice.

In the Great Depression, we saw the harmful effects of the exchange rate mercantalism that is feasible with fiat money. This was a key motivation for Keynes and others in their design of the post-war order. The IMF was supposed to be a multilateral body that would help bring pressure on countries to move towards good sense through `ruthless truth-telling'. This didn't work out too well. The IMF got itself into a box where it would not say anything about exchange rate regimes. To some extent, by standing ready to help countries that got into a currency crisis, it has helped perpetuate exchange rate pegging.

For the present discussion, I want to emphasise the distinction between small countries who can pretty much do as they like as opposed to systemically important countries where actions have a significant impact upon the world economy at large. In this approach, the four interesting questions are:

1.  In the selfish maximisation of one country at a time, what is the optimal choice of monetary policy regime / exchange rate regime?
2. What the mechanisms and empirical magnitudes through which the exchange rate regime choice of one country imposes externalities on others? I.e. what is the consequence of the Nash equilibrium?
3. What is an ideal solution for the world, which combines optimality for the local economy with good system outcomes?
4. What international institutional arrangements can help push the system towards the right solution?

On the first question, some people believe that exchange rate mercantalism is good for the country. You don't find much of this amongst professional economists.. As Merton Miller said: If devaluations could make a country rich, Argentina would be the richest country in the world.  For a careful rebuttal of this loose thinking, done by one of the world's top economists, see these discussant comments by Michael Woodford about a paper with this view by Dani Rodrik. As Andrew Rose said in a discussant comments at the Neemrana conference about a similar paper by Surjit Bhalla: This is either a home run or it's totally wrong.

I feel that exporting is great for growth, but only when this exporting involves genuinely facing the market test of the global market. If a country exports based on subsidies of some sort - which I term `fake exports' -  then the gains in productivity and capability do not come about (link, link). My sense is that in China also, intellectuals no longer buy the `distort everything for exports' idea. Also see Lorenzo Bini Smaghi on this.

As with every other export-subsidy or protectionist scheme, this has more takers amongst non-economists than amongst economists. It's slow hard work, banging these down over and over.

On the second question, see Paul Krugman: link, link.

On the third question, I have a comment on `global imbalances'. Some people see big numbers for current account surpluses/deficits as being intrinsically flawed. I look upon them as being the success of globalisation, as a repudiation of the Feldstein/Horioka problem. It is in an autarkic world that you see Feldstein/Horioka problems, where capital flows are not large. If we are to get beyond the Lucas paradox, and get back to the massive `development' capital flows of the First Globalisation, it's going to require large sustained BOP surpluses in some countries and deficits in others.

As an example, the best deal for ageing OECD is to buy securities in young countries like India today, thus spurring their growth today. Over the next 50 years, these securities would yield a flow of widgets back and thus support consumption of their elderly.

Hence, I would say the question is: How can the world be made safe for large BOP surpluses/deficits? This is a more interesting and important problem, instead of saying to ourselves: How can the world eliminate large BOP surpluses/deficits.

Outcome of the G-20 meeting

The G-20 communique comprises three documents: the main note, one on the financial system and one on international financial institutions. Jonathan Portes places it in perspective.

For analysis and insight, see:

• Why take a swipe at tax havens?
• Avinash Persaud
• Jeffrey Sachs
• Eswar Prasad on how India should see this.
• Ila Patnaik in Indian Express
• Editorials in Indian Express and Financial Express.
• Mallika Ishwaran on voxEU.

Wanted: A genuine FSSA

See the editorials in Indian Express and Financial Express, Jayanth Varma, and the background to this.

G-20 meeting

Here's C. Fred Bergsten (Testimony at the US House of Representatives) on what deal the G-20 countries should shoot for. The early indicators are that what's likely to come about is a small step in this broad direction. Ila Patnaik (in Indian Express) has an Indian perspective on the G-20 meeting.

Diagnosing the global financial crisis, and reforming financial regulation in response: core readings

Even if you're overloaded with too many things being written about the global financial crisis, do look at these four most-useful readings (in my view):

• Road to the London summit, 26 February 2009: a competent summary of what has taken place and the questions that we face.
• Reforming financial regulation, supervision, and oversight: What to do and who should do it by Morris Goldstein, 24 February 2009.
• The Fundamental Principles of Financial Regulation, January 2009, by Markus Brunnermeier, Andrew Crocket, Charles Goodhart, Avinash D. Persaud and Hyun Shin.
• The financial crisis and the future of financial regulation by Adair Turner, 21 January 2009.

Given the G-20 summit which is now just a month away, it will be useful to place this documents into your working set.

Two interesting documents from the IMF

The IMF released two documents on 4 February: India: 2007 Article IV Consultation, and India: Selected Issues.

Selected Issues

While a quick search on the IMF website shows many `Selected Issues' documents, I had not noticed this product type earlier. It turns out to be a small edited book containing seven papers about India:

1. Competitiveness and Exchange Rate Policy by Hiroko Oura, Petia Topalova, Andrea Richter-Hume, and Charles Kramer;
2. Challenges to Monetary Policy from Financial Globalization: The Case of India by Charles F. Kramer, Helene K. Poirson and A. Prasad;
3. Monetary Policy Communication and Transparency by Helene K. Poirson;
4. Financial Development and Growth in India: A Growing Tiger in a Cage? by Hiroko Oura and Renu Kohli;
5. Developing the Foreign Exchange Derivatives Market by Andreas Jobst;
6. Inclusive Growth by Petia Topalova;
7. India's Social Protection Framework by Andrea Richter Hume.

Of these, three stood out for me.

It has been previously noted that the RBI fares very badly in international comparisons of central bank transparency. Further, while central banks worldwide have improved over the last decade, RBI has stagnated. The paper by Helene K. Poirson is an outstanding how-to manual on how RBI's transparency can be improved. It is sensible, well written and immediately actionable. It reviews the recent difficulties of monetary policy from the viewpoint of communication strategy, and draws on these episodes to propose solutions. I hope RBI is able to implement all this right away. Everyone interested in Indian monetary economics should read this article.

The paper by Hiroko Oura and Renu Kohli was also most interesting to me. There is a vast literature based on the CMIE firm-level database; this one stands out as obtaining interesting answers to interesting questions. Specifically, it sheds light on the areas where the Indian financial sector does or does not deliver the goods in terms of financing of firms.

The paper by Jobst on currency derivatives is an excellent policy paper, one that is particularly timely given that RBI is presently engaged in trying to ensure that a currency futures market does not succeed.

Article IV Consultation document

I am generally cynical about Article IV documents. Too often, they are suffused with bureaucratic triumphalism, with sentences of the form ``Under the steady guidance of the great leader, the peasants and workers reaped a glorious harvest''. The IMF is forced to praise India's deft handling of macroeconomic policy in every alternate paragraph. If your tastes run to `ruthless truth-telling', the result of the Article IV process is often not interesting.

However, this time, the document is well worth reading, particularly if you're able to ignore the platitudes. It gives the reader a good grip of the overall macroeconomic situation, and a sound perspective on the difficulties of both fiscal and monetary policy. It struck me that there isn't an Indian effort of this genre out there.

IMF and World Bank : Where do India's interests lie?

A lot of people have been thinking about the evolution of the IMF and the World Bank. I wrote an article Fund and Bank: Where do India's interests lie? in Business Standard yesterday offering an Indian perspective on the question.

An Indian perspective on the IMF

Many in India view the Fund as a potential source of assistance in the event of a future currency crisis, as was the case in 1981 and 1991. This thought process leads to concerns about a better relationship with the Fund in a future crisis scenario.

I think that India's globalisation has gone so far that it will not be easy to mount a 'rescue' in the event of a currency crisis. In four years time, we will be a $1 trillion GDP with much more than $1 trillion moving in and out of the country every year. The IMF lacks the resources to cope with a currency crisis for a country of this size.

More importantly, the tools are at hand for largely eliminating the risk of a currency crisis. If we embrace a policy framework comprising a floating exchange rate, convertibility, and a narrow inflation-targeting central bank, then the contest between currency speculators and central banks (for which the IMF was designed) does not arise. It is better for India to walk down this path, where there will be no need for an IMF program in the future. Once we start thinking like a mature market economy, we lose interest in issues of who controls the IMF.

An Indian perspective on the World Bank

As far as the World Bank is concerned, there is a consensus on two issues. Gross capital formation in India is slightly below $200 billion a year. In this, $1 to $3 billion from the World Bank is just not a big deal, even after the problem of India's current account surplus is firmly out of the way. More generally, the market-oriented economics that has transformed India's growth opportunities and thus poverty reduction is now sustained by a domestic process of policy reform, where the World Bank is not an actor. The core business of Indian GDP growth, leading to poverty alleviation, seems to be driven entirely by private capital and the domestic political economy that sustains liberal economic policies.

That leaves the argument about knowledge riding alongside a World Bank loan. (See notes from Singapore by Ila Patnaik).

I am a skeptic on the knowledge inputs that the World Bank is able to bring when it comes to day to day reality. When we look at a program like Sarva Shiksha Abhiyan (SSA), where the World Bank was involved, it seems to look more like a traditional Indian government program - riddled with design problems - rather than a program that has been embellished with state of the art microeconomics of information and incentives. (Bibek Debroy's recent article Scrap the SSA is of interest in this regard).

Can the World Bank help by improving monitoring and evaluation? I didn't see that happening with SSA. It was Pratham - and not the World Bank - which discovered (at a tiny cost) that the kids getting enrolled through SSA aren't learning much. The bureacratic incentives of the World Bank are probably as unfriendly to discovering bad news as are those within the GOI.

Another perspective is that of incentives. Compare private sector financing versus World Bank financing in an infrastructure setting. Suppose a expressway project is packaged by Goldman Sachs and has private sources of equity and debt. Compare this against a traditional World Bank financed expressway project. I think the private sector version is superior for two reasons. First, there is generally less leverage with greater private sector involvement, which leads to more healthy project structure. Second, the private owners have an incentive to fight on all aspects of project success, from effective execution to O&M to revenues. In contrast, a World Bank bureaucrat is more likely to lose interest in a project once it is signed. It is better for India to have private financing rather than World Bank financing.

Finally, I instinctively dislike bundling. It is hard to think rationally about either knowledge services or cost of capital when the two are bundled together. I think unbundling of finance and knowledge leads to better procurement of both. The Indian project would be better off separately procuring the best knowledge services, and then procuring the lowest cost equity and debt capital. Mixing them up hinders clear thinking.

Hence, I'm unable to see an important role for the World Bank in a country like India or China, where high growth rates have already been ignited. High GDP growth, and thus poverty reduction, now rides on the domestic political problems of economic policy in these countries.

On the other hand, there are much more daunting problems with "failed states" which could merit a focused effort on institution building through an agency like the World Bank. These are big threats to global prosperity, in this post 9/11 age. If we think of WMD scenarios like a nuclear bomb on Manhattan island or an antiobiotic resistant smallpox virus that is let loose into the world, then the failed states count as major threats to global prosperity. I know, the World Bank's mandate prohibits involvement in political issues. But there is plenty of low-intensity work to be done in building a State, that I call "nation-building", which is not inconsistent with the World Bank's charter.

All around us, India has countries in dire need of nation building: Pakistan, Afghanistan, Central Asia, Nepal, Bangladesh, Burma, Sri Lanka. It is in India's best interest if these countries are able to achieve sound institutions and ignite high GDP growth. From a selfish Indian perspective, that's a great role for the World Bank - to give us a safer neighbourhood and enormous trade growth in our immediate neighbourhood.

That leaves the problem of a funding model. At present, the World Bank needs customers like India and China to make ends meet. If the Bank reorients itself to focus on nation building, it needs new sources of financing. In resolving this problem, I think it helps to see that nation-building in Afghanistan or Sudan is about producing global public goods. Everyone benefits when these countries are set on track. Placing the brunt of financing of these global public goods upon India and China does not sound like a fair arrangement. A reasonable solution could be to pass the hat around to the 25 biggest countries of the world, and ask for contributions in proportion to GDP.

Rethinking the IMF (Mervyn King's lecture)

I attended a talk by Mervyn King, who is Governer of Bank of England, in Delhi. The talk, which was organised by ICRIER, was titled Reform of the IMF. The pdf file of appeared on the Bank of England website. It was fun. It was delightful hearing sharp and modern economics from an employee of a government! I admire the human capital that the UK is able to bring into economic policy. The Bank of England reform is amazing, and so are the humans of that story, such as Mervyn King, Charlie Bean, and Charles Goodhart.

As the old job of the IMF (to periodically bail out countries with a pegged exchange rate which get into trouble) has become redundant in a world with floating exchange rates and open capital accounts, many people have started pondering how to do an IMF differently.

One famous set of ideas on IMF reform has come from Charles Calomiris and Allan Meltzer. Mervyn King's ideas are more radical. He envisages an IMF that shifts into tasks of data, research and meetings. As he describes it, the only instruments that the reformed IMF should have should be the powers of analysis, persuasion and ``ruthless truth-telling''. I think it makes a lot of sense. Yesterday's Business Standard had an excellent editorial on this.