Let developing nations rule: further issues

Posted by on 27 January 2009

I entirely agree with Dani Rodrik. One of the major outcomes of the current crisis will be the weakened leadership of industrial countries, and the need for developing countries to play a more prominent role in global governance.

The need to govern globalization has never been clearer, but at the same time the institutional arrangements that we have had never been so impotent. So, a radical restructuring of the governance of economic globalization is called forth, and major developing countries must play a leading role in their design and functioning.

Let me add, however, some issues to the agenda proposed by Rodrik, with which I also agree. The first two refer to institutional design, the final two to substantive issues.

Institutional design: a UN Global Economic and Social Council

The first one, and by the far the most important, is that the institutional design must be inclusive. It is important for major countries, including now major developing countries, to show leadership, but a desirable institutional structure must give adequate voice to industrial and developing countries alike, and to both large and small countries. So, the major reform is not to replace the G7/G8 by another G. The G20 is certainly better in this regard, but it is still an ad hoc arrangement, where major developing countries (say Indonesia or Nigeria) and major developed countries (say Spain) are unrepresented.

The developing countries have been victims of inequitable representation in the past. They must not push for institutional reforms that have a similar problem. So, any global governance must be based on representative institutions, not on ad-hoc grouping of countries, which will always face problems of legitimacy. And it is necessary, for the same reason, to involve the United Nations, the most representative global institution, perhaps by taking the step, recommended in the past by many, of creating a Global Economic and Social [Security] Council in the United Nations with effective powers of coordination over the system of global economic and social governance.

Networks of global, regional and national institutions

This leads to a second institutional issue: in a heterogeneous international community, the creation of networks of global, regional and national institutions will provide a better system of governance than arrangements based on single global organizations.

This is based on old federalist principles. Regional and sub-regional institutions give stronger voice and sense of ownership to smaller countries, and are therefore more likely to respond to their demands. In some areas this is recognized today, such as in the system of multilateral development banks, where the World Bank is complemented by regional development banks and, in some parts of the world (Latin America and the Caribbean, in particular), sub-regional banks. But in others this principle is ignored.

An IMF modelled on the European System of Central Banks

This is why the IMF of the future should be a network of regional reserve funds – that is, a structure closer to that of the European Central Bank or even the US Federal Reserve system than the unique global institutions that it now is. Arrangements such as the Chiang Mai Initiative in East Asia and the Latin American Reserve Fund should be seen, therefore, as part of the network of monetary funds. And such arrangements should probably evolve over time into a true world central bank.

This comment serves well as a bridge to the two substantive issues that I want to underscore, and that relate to major responsibilities that should be assumed by the IMF or, better, by the global network of reserve funds that should replace it.

Two substantive issues: macro coordination, and the global reserve system

The first relates to macroeconomic policy coordination.

The need for more coordination of macroeconomic policies has been clearer, as well as the inadequacy of current arrangements. In any well designed system, the IMF should be at the centre of such policy coordination. This is the only way to give developing countries a strong voice in this regard. The multilateral surveillance on global imbalances launched by the Fund in 2006 was an interesting step in that direction. However, it failed because it lacked binding commitment by the parties and an accountability mechanism.

The second issue relates to the global reserve system.

The IMF was created on the basis of the dual dollar-gold system. This system collapsed in the early 1970s and was replaced by a system based on fiduciary dollars or, perhaps, on competing fiduciary reserve currencies – i.e., on the use of a national currency (or national and regional currencies) as a global currency.

Both systems are inequitable and unstable. The current system is inequitable because it forces a transfer of resources from developing countries to the developed nations that provide the global reserve currencies. It is unstable because it does not provide macroeconomic discipline to countries issuing reserve currencies. Another way of looking at this issue is that in the world of floating exchange rates that we have today, it allows the US to impose its monetary policy on the rest of the world. A system based on competing reserve currencies would not solve these problems and would add another: the instability of the exchange rates among major reserve currencies.

This is why any system that is development friendly should be based on a truly global reserve currency – a global fiduciary currency backed by the central banks of the world. This is what was hoped for when the Special Drawing Rights were created in the 1960s. This process must be completed, by either transforming the SDRs into such global currency or creating a global reserve asset that could be more actively used. Among other advantages, this system would provide a mechanism for the IMF to play a more active counter-cyclical role during crises, by issuing SDRs in a counter-cyclical way. This would indeed be the global equivalent to what the Fed has been doing on a massive scale since September.

José Antonio Ocampo

Professor, Columbia University