## _wp11208

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### Introduction
- Major changes in the Global economy have accelerated since the 1980s and continue into the 21st century.
- Benchmarks for assessing IMF governance and quota reform:
  - Less ambitious benchmark: compare reform in the last three and a half years with the preceding three and a half years — by this benchmark “important progress has been made.”
  - More appropriate benchmark: compare the power structure in the IMF with that in the Global economy — by this benchmark, “reforms have been insufficient” and the gap has widened.
- A third quota reform was launched even before the second reform (of 2009) was finalized, indicating that changes in the World economy are outpacing IMF governance updates.
- Core principles proposed for quota-based representation:
  - Primacy of economic variable(s) reflecting surrender of sovereignty to the IMF.
  - Incentive compatibility: IMF advice on broad policy issues must be mutually consistent with incentives inherent in the quota formula.
  - Simplicity and transparency of the formula to enhance credibility.
- Paper objectives:
  - Analyze existing IMF quota formula and other proposed variables.
  - Suggest a simplified formula and selection principles for leadership based on “merit without regard to nationality.”

### 1. Global Economic Trends and Financial Crisis
- Crisis effects and structural shifts:
  - The 2008 global crisis accelerated trends in relative size and power of countries.
  - Advanced Economies (AEs) faced dramatic fiscal deterioration; fiscal problems are no longer primarily a developing-country issue.
  - World growth and World Trade growth in the post-crisis decade (and a half) are projected to be much slower than in the pre-crisis decade (and a half).
  - Export-oriented EMDCs (e.g., China) risk losing relative position to domestic demand led/export neutral economies (e.g., India), unless growth models change.
  - Energy/oil rich economies will experience a short dip and then return to underlying pre-crisis trends (e.g., Brazil, Russia), with uncertainty from oil prices.
- Real size (GDP PPP) shares in 2010 (WEO, June 2011 update):
  - USA 19.7%; China 13.6%; Japan 5.8%; India 5.5%; Germany 4.0%.
  - Next ten: Russia(3%), UK(2.9%), Brazil(2.9%), France(2.9%), Italy(2.4%), Mexico(2.1%), Korea(2.0%), Spain(1.8%), Canada(1.8%), Indonesia(1.4%).
- Projections and demographic drivers:
  - China’s real GDP projected to equal that of the USA around 2022 (chart-based projection).
  - Indian economy projected to become much larger than major European economies and Japan during the next decade; India projected to become the third largest economy in the World by the end of the current year.
  - Demography cited as an important factor in long-term relative decline of Japan, Germany, Italy and Russia.
  - Increase expected in size of dynamic emerging economies (e.g., Indonesia) and of Low income and Middle income countries as a whole.
- Estimated projected country GDP shares for 2011 (based on latest available IMF data and projections in text):
  - USA (19.5%), China (12.1%), India (5.7%), Japan (5.6%), Germany (3.9%), Russia (3.0%), Brazil (2.9%), UK (2.9%), France (2.8%), Italy (2.3%).
- Projected next 10 economies by size:
  - Mexico(2.1%), S Korea(2.0%), Spain(1.8%), Canada(1.8%), Indonesia(1.4%), Turkey(1.3%), Australia(1.2%), Taiwan-China(1.1%), Iran(1.1%), Poland(1%).

### 2. IMF Mandate, Governance Principles and Quota Formula
- Mandate debate post-crisis:
  - Article IV, section 3(a) can be interpreted broadly or narrowly; those controlling governance favor broader interpretation, those with lower quota shares favor narrower interpretation.
  - Expanded mandate proposals include moving from Balance of Payments and exchange rates to the real economy (saving-investment imbalances) and global financial stability.
- Lessons from the crisis:
  - Real and monetary-financial elements are not fully separable; financial markets have unstable properties and negative spillovers.
  - Ensuring financial stability is crucial at both country and global levels.
  - Need to address both global financial imbalances and global real imbalances and improve regulation.
- Quota formula design principles:
  - Emphasize real variables to align with objectives (income, employment, stability) and ensure incentive compatibility.
  - Traditional linear thinking (deficits bad, surpluses good) is inadequate; both excess surplus and excess deficit can increase global instability.
  - Existing quota variables (e.g., “openness”, “reserves”, GDP MER components) may be inconsistent with IMF policy advice.
  - Without aligning formula and advice, neither IMF advice nor the formula are legitimate/credible measures of country importance.

### Quota Formula: Current Specification and Issues
- Current formula specification:
  - CQS = (0.5*Y + 0.3*O + 0.15*V + 0.05*R) k
    - CQS = Calculated Quota Share;
    - Y = GDP: A blend of GDP converted at market rates and PPP exchange rates averaged over the immediate three year period for which data are available, with weights of 0.60 and 0.40, respectively;
    - O = Openness: The annual average of the sum of current payments and current receipts (goods, services, income, and transfers) for the latest five year period;
    - V = Variability of current receipts and net capital flows (measured as a standard deviation from the centered three-year trend over the recent thirteen year period);
    - R = twelve month average over a year of official reserves (foreign exchange, SDR holdings, reserve position in the IMF and monetary gold).
    - k = a compression factor of 0.95.
- Attributes and critiques:
  - Weighted average in practice: GDP blend (50 percent), openness (30 percent), economic variability (15 percent), international reserves (5 percent).
  - Compression factor reduces dispersion in calculated quota shares.
  - Traditional rationale: reflect Vote share, Resource contribution and Access to loans.
  - Developments such as FCL and recent loans to European countries (loans more than 40 times quota) have effectively delinked access from quota.
- Argument against including resource contribution in quota formula:
  - IMF quotas constitute equity and reflect voting rights/share in governance, not Aid contributions.
  - Aggregate quota contribution level can be adjusted to resource needs but should not affect quota shares or the formula.
  - Members not subscribing up to eligible contribution can choose not to do so, reducing their vote share relative to those who contribute fully.
  - IMF’s borrowing is remunerated at market rates; past financial contributions should not be included in quota formula.

### Averaging of Variables and Specific Critiques
- Critique of averaging GDP PPP over three years:
  - GDP PPP measures real size which fluctuates marginally compared to variables like inflation and exchange rates; averaging “serves merely to dilute and minimize the effect of changing reality on the quota.”
  - For GDP MER, market exchange rate fluctuates randomly and often arbitrarily due to capital movements; recommended approach:
    - Use the latest estimate of GDP in domestic currency, and
    - Convert it to USD by using the average nominal market exchange rate (MER) for the last few years to calculate the GDP MER.

### 3. Gross Domestic Product (GDP)
- GDP: PPP vs. MER
  - Economically appropriate measure of real size is purchasing power parity (PPP); comparisons across countries should first determine PPP.
  - Difference between GDP PPP and GDP MER arises from PPP exchange rate vs. market exchange rate (MER) applied to GDP in LCUs.
  - Illustration: "100 rupees will get you a little over US$2 at MER, but it can purchase in India real goods and services equivalent to what US$6 would purchase in the USA."
  - Implication: GDP MER under-estimates the real size of Low and Lower-middle Income countries and thus benefits High Income Countries (HICs) at the cost of poorer countries (LICs).
  - Quota formula implication: the formula must give a predominant role to relative economic size or a country’s share in aggregate world GDP.
- Past or Future (data vintage and predictiveness)
  - Problem: Data used in quota reform are a year old and implementation can be about three years after approval.
  - Partial solution: Project variables forward to anticipated time of implementation, but projections lack broad acceptance.
  - Advantage of GDP PPP: The ratio of GDP PPP to GDP MER is a good predictor of future growth (consistent with catch-up growth and convergence hypotheses).
  - Empirical regression reported (chart): y = 1.1419x + 1.2625; R² = 0.1974.
  - Conclusion: GDP PPP captures future growth potential and is more forward-looking; less likely to become outdated between agreement and implementation.
- The ‘Monetary’ in IMF: GDP MER ?
  - Bryant’s argument: IMF is a Monetary and Financial institution; quota formula should weight financial variables; GDP at MER is the best proxy for assets/wealth.
  - Counter-arguments:
    - A country’s autonomy relates to real GDP and real wealth; domestic capital is captured by real GDP (GDP PPP).
    - Cross-border holdings are a small fraction of total capital even in richest capital-exporting countries.
    - Monetary conversion using MER is theoretically and empirically flawed compared to PPP.
    - Data for cross-border holdings are limited and less reliable than GDP; if GDP MER is included, its upper limit in the GDP blend should be the ratio of World cross border capital (real) holdings to total world capital stock.
  - Ranking implication (based on latest available data and IMF projections): Estimated GDP blend value ranking in 2011: USA, China, Japan, Germany, India, France, UK, Brazil, Italy and Russia.
    - Footnote: If a 40-60 (MER-PPP) blend is used instead of the current 60-40 blend, India will be ranked fourth, ahead of Germany.
- Contribution to World Growth
  - Observation: IMF quota formula does not explicitly contain 'economic growth' though growth has influenced recent quota revisions indirectly and non-transparently.
  - Claim: Since 2006, China and India have been the top two contributors to global growth; since 2007 India has been the second largest contributor to World growth if the Euro is treated as a single entity.
  - 2010 note: India’s contribution in 2010 was more than a third of that of China.
  - IMF projections: India drops to third place behind the US in 2010 and 2012 to 2014, and returns to second place from 2015.
  - Author view: These IMF projections are likely over(under) optimistic about the USA (India); consequently India will remain the second largest contributor to global growth.

### Openness, Financial Openness, and Net Contribution to World Demand
- Openness critique:
  - Openness (trade to GDP) is less relevant in a globalised world where 80% of countries are WTO members.
  - Trade-to-GDP ratios vary by resource endowment, geography, and comparative advantage; large economies tend to have smaller trade/GDP ratios.
  - No logical reason to give higher quotas to countries with higher trade ratios; this could incentivize export subsidies, import taxes, or currency undervaluation.
  - Anomalies: break-up of a country increases external trade shares and quota share (example: Yugoslavia); combination of countries reduces aggregate quota share.
  - Recommendation: Drop the trade openness variable; if retained, only penalize deviations from a neutral benchmark due to policy intervention (implementation complex).
- Financial openness and post-crisis caution:
  - Current openness definition includes factor payments along with trade.
  - Unregulated/laxly regulated financial flows can cause bubbles, busts, surges, sudden stops and systemic risks.
  - Externalities from financial openness should be addressed via Pigouvian taxes and counter-measures; quota formula should not reward countries for negative spill-overs.
  - Conclusion: The argument for the openness variable in the quota formula is dated in the 21st century globalized economy.
- Net contribution to world demand as alternative:
  - In a period of low global aggregate demand, a country’s contribution to global net demand is more relevant than openness.
  - Measurement: ratio of a country’s current account deficit to the aggregate of all current account deficits.
  - Empirical highlights (Table 3 text):
    - Total positive: Deficit countries contribution in 2009 equals 100.0%.
    - United States contribution figures: -760.4 (2006), -701.4 (2007), -695.9 (2008), -373.9 (2009) — 41.2% share in 2009.
    - India contribution figures: -33.3 (2006), -45.2 (2007), -65.7 (2008), -58.9 (2009) — 6.5% share in 2009.
    - United Kingdom contribution figures: -76.5 (2006), -90.0 (2007), -70.9 (2008), -50.8 (2009) — 5.6% share in 2009.
    - Total negative: Surplus countries contributions in 2009 equal 100.0%.
    - China, P.R.: Mainland contributions: 208.9 (2006), 1307.4 (2007), 8348.8 (2008), 7220.6 (2009) — -17.2% share in 2009.
    - Germany contributions: 166.4 (2006), 238.9 (2007), 2252.0 (2008), 176.1 (2009) — -13.8% share in 2009.
    - Russian Federation contributions: 125.5 (2006), 111.2 (2007), 154.6 (2008), 99.0 (2009) — -7.1% share in 2009.
    - Netherlands contributions: 56.9 (2006), 56.9 (2007), 67.0 (2008), 66.4 (2009) — -5.2% share in 2009.
    - Note: "Total deficits do not equal total surpluses because of errors & omissions."
  - Observation: The United States has been the largest contributor to global net demand throughout the crisis; by 2009 India became the second highest contributor, pushing UK to third.
  - Policy relevance: For rebalancing global growth, net contribution to demand is a more relevant variable for inclusion in the quota formula than openness; weights may need inversion if world shifts to a global savings shortage.

### Voice and Representation
- Variability index critique:
  - G24 secretariat’s work (2008, 2010) shows the existing index of variability fails to capture potential demand for BOP financing by developing countries.
  - Scaling by mean is an improvement, but the proposed index is not easily aggregable to a global total, creating interpretive issues for country shares as global shares.
- Voice and diversity principles:
  - Voice and staff diversity are about people, not economic size.
  - Sub-Saharan Africa in 2010: 11.7% of World population but only 2.4% of aggregate world GDP.
  - Bangladesh: 0.3% of World GDP but 2.4% of World population.
  - Both voice and diversity should be benchmarked against shares in World population.
- Statistical correlations and implications:
  - GDP PPP is more closely correlated with population than GDP MER (correlation coefficient 0.66 vs. 0.46); replacing GDP MER with GDP PPP shares would raise quota shares of poorer regions/countries.
  - Alternative voice weightings:
    - Weight volatility by (a) share of the World’s poor, or (b) population shares, or (c) a blend of the two, to give the World’s poor adequate voice.
    - Simpler alternative: dispense with the volatility variable and use one of the above as the voice variable.
  - Poverty statistic: Share of Sub-Saharan Africa in the World’s poor is about 27% at the $1.25 a day (per person) poverty line.
  - Practical note: If the current GDP blend is not changed significantly, a population weight becomes more important.

### Board Representation and Leadership Selection
- EU representation anomaly:
  - EU: about 7.3% of World population and about 20.4% of aggregate World GDP, but has about 1/3 of IMF quota and 40% of the 20 permanent seats (1/3 of the current 24 seats).
  - The EU has had the Managing Director position monopoly for the last half century; the USA correspondingly holds the position of First Deputy Managing Director (FDMD).
  - Institutional concern: The overwhelming position of one highly integrated region raises questions about whether it is truly an International Monetary Fund.
- Managing Director / Deputy structure and merit selection:
  - Problem: nationality currently matters in selection; recommendation is to remove nationality from the equation to the maximum extent possible.
  - Proposal: create a procedure to judge “international orientation” or “internationalism” of potential candidates for MD and DMD.
    - Example mechanism: an independent international panel of non-government professionals set up by the IMF to rank candidates by degree of ‘internationalism’ (converse of Nationalism/Parochialism).
    - Apply a cut-off above which candidates are considered suitable to head an “international” organization such as the IMF.
    - A merit-based selection would then use the internationalism ranking as one merit criterion.
  - Creation of a fourth DMD position for China raises questions about objective criteria for number and selection of DMDs, such as the size of the World economy or selection on the basis of country size.

### 7. Summary and Conclusions
- Selection of MD and DMDs:
  - Remove nationality from selection to the maximum extent possible.
  - Implement an independent international panel to rank candidates by ‘internationalism’ and use that ranking as a merit criterion.
- Gap between Quotas and Economic Reality:
  - Table 4 contrast: the gap between economic reality and quota proposals is widest for India.
  - India’s Quota share after latest proposals are implemented will be the eighth highest.
  - India in 2009 was the fourth largest economy and is projected to be the third largest in 2011.
  - India was in 2009, and in three previous years, the second highest contributor to global growth and was the second highest contributor to global net demand in 2009.
  - Conclusion: by many measures India will be, by the end of 2011, among the top five economies; a governance system that does not acknowledge this reality will struggle to be legitimate or credible.
- Selected numeric fragments (as presented in source):
  - The USA with 4.5% of the World population and 19.4% of World GDP has 17.5% of the quota and 5% of the permanent seats. However its shareholding gives it a veto over major changes (which require 85% majority).
  - Table fragments:
    - United States: Share(%) 20.41; 2009 Share 17.41; other entries include -0.543, 41.21
    - China: Share(%) 12.62; 2009 Share 6.43; other entries include 1.141, -17.2
    - Japan: Share(%) 6.03; 2009 Share 6.52; other entries include -0.316, 2.5
    - India: Share(%) 5.14; 2009 Share 2.88; other entries include 0.292, 26.52
    - Germany: Share(%) 4.05; 2009 Share 5.64; other entries include -0.197, -13.8
    - United Kingdom: Share(%) 3.16; 2009 Share 4.25; other entries include -0.151, -5.63
    - France: Share(%) 3.07; 2009 Share 4.26; other entries include -0.081, 4.74
    - Russia: Share(%) 3.08; 2009 Share 2.79; other entries include -0.244, -7.1
    - Brazil: Share(%) 2.99; 2009 Share 2.31; other entries include -0.015, 6.1
    - Italy: Share(%) 2.51; 2009 Share 3.27; other entries include -0.132, 0.9
- Structure, sector development, and variables in the quota formula:
  - Country structure and sector development depend on comparative advantage, stage of development (real per capita GDP), and history.
  - No reason to reward a country for having a higher-than-normal value of indicators such as trade, non-trade current account, capital flows, or financial sector size.
  - Policy interventions that raise these ratios should be penalized to align IMF policy advice with quota incentives.
  - Excessively large capital flows or a larger-than-normal financial sector can pose risks and contribute to global instability.
  - Complexity of devising a non-linear formula for such variables and low likelihood of acceptance argue for leaving such variables out of the formula.
- Recommendations for quota formula design:
  - If simplicity and transparency are desired, use only two variables:
    - The relative size/power of economies measured by GDP PPP shares in world aggregate GDP.
    - The proportion of the World’s poor living in the country (to reflect ‘voice’).
  - If some complexity is acceptable:
    - Blend GDP PPP with GDP MER and country population share.
    - The GDP blend could include GDP MER up to a proportion equal to the ratio of cross-border holdings of (real) capital stock to total World capital stock.
    - The voice variable could be a blend of share of World poor and share of World population with or without an improved variability index.
  - Alternative replacements:
    - Replace openness and reserves variables by contribution to global growth and contribution to net demand.
    - For simplicity and transparency, replace three variables (‘GDP hybrid’, ‘Openness’ and ‘Reserves’) by a single variable: ‘country GDP PPP share in world aggregate GDP’.
  - Transition path:
    - Once principles are accepted, phase transition by progressively reducing the share of the “Openness” variable to zero over five years (say).
- Conclusion and policy implication:
  - There is a large gap between economic reality and IMF quotas.
  - Dissatisfaction among global public opinion can only be reduced or eliminated if Quota shares are changed to reflect current and fast changing economic reality.
  - This requires a much greater role for the relative size/power of economies, an element not adequately captured by the existing formula.
  - Unless fully taken into account, dissatisfaction will persist after 2013 (the year in which the next quota reform is to be completed).
  - The gap is likely to widen every year unless the formula is modified appropriately.
  - Recommended: a simple, transparent quota formula centered on GDP PPP share and voice (share of World’s poor) or an appropriately blended variant to align quota shares with evolving economic realities and IMF objectives of preserving global economic growth and rebalancing the global economy.

*Content derived from _wp11208 - References 21 (source PDF content supplied).*

### References                    21

### _wp11208 - References                    21

### Introduction
- Major changes in the Global economy have accelerated since the 1980s and continue into the 21st century.
- Two benchmarks to measure IMF governance and quota reform progress:
  - Less ambitious: compare reform in the last three and a half years with the preceding three and a half years — by this benchmark “important progress has been made.”
  - More appropriate: the gap between the power structure in the IMF and that in the Global economy — by this benchmark, “reforms have been insufficient” and the gap has widened.
- A third quota reform was launched even before the second reform (of 2009) was finalized, indicating that changes in the World economy are outpacing IMF governance updates.
- Core principles proposed for determining relative power and voice in a quota-based global institution:
  - Primacy of economic variable(s) reflecting surrender of sovereignty to the IMF.
  - Incentive compatibility: IMF advice on broad policy issues must be mutually consistent with incentives inherent in the quota formula.
  - Simplicity and transparency of the formula to enhance credibility.
- The paper analyzes the existing IMF quota formula, other proposed variables, and suggests a simplified formula and selection principles for leadership based on “merit without regard to nationality.”

### 1. Global Economic Trends and Financial Crisis
- The 2008 global crisis accelerated previously identified trends in relative size and power of countries.
- Key effects of the crisis:
  - Advanced Economies (AEs) faced dramatic fiscal deterioration; fiscal problems are no longer primarily a developing-country issue.
  - World growth and World Trade growth in the post-crisis decade (and a half) are projected to be much slower than in the pre-crisis decade (and a half).
  - Export-oriented EMDCs (e.g., China) will lose relative position to domestic demand led/export neutral economies (e.g., India), unless they change growth models.
  - Energy rich/oil rich economies will experience a short dip and then return to underlying pre-crisis trends (e.g., Brazil, Russia), though uncertainty remains due to oil prices.
- Real size measured by GDP PPP:
  - In 2010: USA 19.7% of aggregate world GDP; China 13.6%; Japan 5.8%; India 5.5%; Germany 4.0% (WEO, June 2011 update).
  - Next ten: Russia(3%), UK(2.9%), Brazil(2.9%), France(2.9%), Italy(2.4%), Mexico(2.1%), Korea(2.0%), Spain(1.8%), Canada(1.8%), Indonesia(1.4%).
- Projections and trends:
  - China’s real GDP projected to equal that of the USA around 2022 (chart-based projection).
  - Indian economy projected to become much larger than major European economies and Japan during the next decade; India projected to become the third largest economy in the World by the end of the current year.
  - Demography cited as an important factor in long-term relative decline of Japan, Germany, Italy and Russia.
  - Increase expected in size of dynamic emerging economies (e.g., Indonesia) and of Low income and Middle income countries as a whole.
- Estimated projected country GDP shares for 2011 (based on latest available IMF data and projections in text):
  - USA (19.5%), China (12.1%), India (5.7%), Japan (5.6%), Germany (3.9%), Russia (3.0%), Brazil (2.9%), UK (2.9%), France (2.8%), Italy (2.3%).
- Projected next 10 economies by size (as given):
  - Mexico(2.1%), S Korea(2.0%), Spain(1.8%), Canada(1.8%), Indonesia(1.4%), Turkey(1.3%), Australia(1.2%), Taiwan-China(1.1%), Iran(1.1%), Poland(1%).

### 2. IMF Mandate, Governance Principles and Quota Formula
- Debate over IMF mandate expansion post-crisis:
  - Article IV, section 3(a) can be interpreted broadly or narrowly; those controlling governance favor broader interpretation, those with lower quota shares favor narrower interpretation.
  - Expanded mandate proposals include moving from Balance of Payments and exchange rates to the real economy (saving-investment imbalances) and global financial stability.
- Lessons from the crisis:
  - Real and monetary-financial elements are not fully separable; financial markets have unstable properties and negative spillovers.
  - Ensuring financial stability is recognized as crucial at both country and global levels.
  - Need to address both global financial imbalances and global real imbalances and improve regulation.
- Quota formula must emphasize real variables to align with real objectives (income, employment, stability) and be incentive compatible with IMF policy advice.
  - Traditional linear thinking (deficits bad, surpluses good) is inadequate; both excess surplus and excess deficit can increase global instability.
  - Existing quota variables (e.g., “openness”, “reserves”, GDP MER components) may be inconsistent with IMF policy advice (e.g., “Neither subsidize exports nor tax imports”; “Limit reserves to ‘optimal’ levels and not maintain ‘excess’ reserves”).
  - Without aligning formula and advice, neither IMF advice nor the formula are legitimate/credible measures of country importance.

### Quota Formula: Current Specification and Issues
- Current formula as described:
  - CQS = (0.5*Y + 0.3*O + 0.15*V + 0.05*R) k
  - CQS = Calculated Quota Share;
  - Y = GDP: A blend of GDP converted at market rates and PPP exchange rates averaged over the immediate three year period for which data are available, with weights of 0.60 and 0.40, respectively;
  - O = Openness: The annual average of the sum of current payments and current receipts (goods, services, income, and transfers) for the latest five year period;
  - V = Variability of current receipts and net capital flows (measured as a standard deviation from the centered three-year trend over the recent thirteen year period);
  - R = twelve month average over a year of official reserves (foreign exchange, SDR holdings, reserve position in the IMF and monetary gold).
  - k = a compression factor of 0.95.
- Summary of formula attributes in text:
  - Weighted average: GDP blend (50 percent), openness (30 percent), economic variability (15 percent), international reserves (5 percent).
  - Compression factor reduces dispersion in calculated quota shares across members.
  - Traditional rationale: reflect Vote share, Resource contribution and Access to loans.
  - Developments such as FCL and recent loans to European countries (loans more than 40 times quota) have effectively delinked access from quota.
- Argument against including resource contribution in the quota formula:
  - IMF is a quota-based organization where quotas constitute equity and reflect voting rights/share in governance, not an Aid organization.
  - Aggregate quota contribution level can be adjusted to resource needs but should not affect quota shares or the formula.
  - Members not subscribing up to eligible contribution can choose not to do so, reducing their vote share relative to those who contribute fully.
  - IMF’s borrowing is remunerated at market rates; past financial contributions should not be included in quota formula.

### Averaging of Variables and Specific Critiques
- Critique of averaging GDP PPP over three years:
  - Logic flawed because GDP PPP measures real size which fluctuates marginally compared to variables like inflation and exchange rates.
  - Averaging GDP PPP “serves merely to dilute and minimize the effect of changing reality on the quota.”
  - For GDP MER, market exchange rate fluctuates randomly and often arbitrarily due to capital movements; therefore it would be better to:
    - Use the latest estimate of GDP in domestic currency, and
    - Convert it to USD by using the average nominal market exchange rate (MER) for the last few years to calculate the GDP MER.

*Italicized source attribution: Content derived from _wp11208 - References 21 (source PDF content supplied).*

### 3. Gross Domestic Product (GDP)

### 3. Gross Domestic Product (GDP)

### GDP: PPP vs. MER
- Conceptual point: The economically appropriate way to measure the real size of an economy is in purchasing power parity (PPP); comparisons across countries (absolute values or ratios) should first determine purchasing power parity.
- Practical explanation: Difference between GDP PPP and GDP MER is the difference between the PPP exchange rate and the market exchange rate (MER) applied to GDP measured in local currency units (LCUs).
- Illustration: "100 rupees will get you a little over US$2 at MER, but it can purchase in India real goods and services equivalent to what US$6 would purchase in the USA."
- Implication: GDP MER under-estimates the real size of Low and Lower-middle Income countries and thus benefits High Income Countries (HICs) at the cost of poorer countries (LICs).
- Quota formula implication: The quota formula must give a predominant role to relative economic size or a country’s share in aggregate world GDP in determining quota shares.

### Past or Future (data vintage and predictiveness)
- Problem: Data used in quota reform are a year old and implementation can be about three years after approval.
- Proposed partial solution: Project variables forward to anticipated time of implementation, but projections lack broad acceptance.
- Advantage of GDP PPP: The ratio of GDP PPP to GDP MER is a good predictor of future growth (consistent with catch-up growth and convergence hypotheses).
- Empirical statement: Plotting the initial ratio of GDP PPP to GDP MER (in 2000) against average growth rate during the 2000s for IMF member countries (152) shows a strong positive relationship (Chart 3).
- Regression reported on chart: y = 1.1419x + 1.2625; R² = 0.1974.
- Conclusion: GDP PPP captures future growth potential and is more forward-looking; less likely to become outdated between agreement and implementation of quota reform.

### The ‘Monetary’ in IMF: GDP MER ?
- Argument by Bryant: IMF is a Monetary and Financial institution; quota formula should weight financial variables (size of financial assets and cross-border holdings); GDP at MER is the best available proxy for assets/wealth.
- Counter-argument in text:
  - A country’s autonomy relates to real GDP and real wealth; domestic capital is captured by real GDP (GDP PPP).
  - Cross-border holdings are a small fraction of total capital even in richest capital-exporting countries.
  - Money and financial assets are stores of value whose relative value should be compared using PPP exchange rates; MER is a theoretically and empirically flawed conversion factor compared to PPP.
  - Data for cross-border holdings are limited and less reliable than GDP; a proxy is needed.
  - If GDP MER correlates with real cross-border wealth holdings, it could be included in a GDP blend; evidence is limited.
  - If included, "the upper limit of the GDP MER proportion in the GDP blend would be the ratio of World cross border capital (real) holdings to total world capital stock."
- Ranking implication (based on latest available data and IMF projections): Estimated GDP blend value ranking in 2011: USA, China, Japan, Germany, India, France, UK, Brazil, Italy and Russia.
  - Note: "Thus even in terms of the questionable GDP blend used in the current quota formula, India will be ranked number five above France and UK and Brazil will be ranked higher than Italy."
- Footnote: If a 40-60 (MER-PPP) blend is used instead of the current 60-40 blend, India will be ranked fourth, ahead of Germany.

### Contribution to World Growth
- Observation: IMF quota formula does not explicitly contain 'economic growth' though growth has influenced recent quota revisions indirectly and non-transparently.
- Proposal: Consideration of a country's contribution to world economic growth as a relevant indicator for quota formula.
- Structural transformation claim: Since 2006, China and India have been the top two contributors to global growth; since 2007 India has been the second largest contributor to World growth if the Euro is treated as a single entity.
- 2010 note: India’s contribution in 2010 was more than a third of that of China.
- IMF projections summary: According to IMF projections cited in the text, India drops to third place behind the US in 2010 and 2012 to 2014, and returns to second place from 2015.
- Author view: These IMF projections are likely over(under) optimistic about the USA (India); consequently India will remain the second largest contributor to global growth.

### Openness in a Globalised World
- Critique of openness variable:
  - Openness (trade to GDP) played a role in a post-war world with trade barriers, but has little traction in a globalised world where 80% of countries are WTO members.
  - Trade-to-GDP ratios vary by resource endowment, geography, and comparative advantage; large economies tend to have smaller trade/GDP ratios.
  - No logical reason to give higher quotas to countries with higher trade ratios; doing so incentivizes export subsidies, import taxes, or currency undervaluation.
- Anomalies produced by openness variable:
  - Break-up of a country increases external trade shares and quota share (example: Yugoslavia).
  - Combination of countries reduces aggregate quota share.
- Recommended approach: Drop the trade openness variable from the formula; if retained, only penalize deviations from a neutral benchmark due to policy intervention (but implementation is complex).

### Financial Openness: Post-crisis
- Current quota formula includes factor payments along with trade in openness definition.
- Caution against rewarding financial openness:
  - Deviations from neutral benchmarks for capital flows can be positive or negative for stability depending on conditions.
  - Recent global crisis shows unregulated/laxly regulated financial flows can cause bubbles, busts, surges, sudden stops and systemic risks.
  - Externalities from financial openness should be addressed via Pigouvian taxes and counter-measures; quota formula should not reward countries for negative spill-overs.
- Conclusion: The argument for the openness variable in the quota formula is dated in the 21st century globalized economy.

### Net Contribution to World Demand
- Relevance: In a period of low global aggregate demand, a country’s contribution to global net demand is more relevant than openness.
- Measurement: Ratio of a country’s current account deficit to the aggregate of all current account deficits (world deficits should equal world surpluses for the world as a whole).
- Empirical point: Countries with current account surpluses subtract from global net demand (negative contribution).
- Table 3 highlights (text):
  - Total positive: Deficit countries contribution in 2009 equals 100.0%.
  - United States contribution figures: -760.4 (2006), -701.4 (2007), -695.9 (2008), -373.9 (2009) — 41.2% share in 2009.
  - India contribution figures: -33.3 (2006), -45.2 (2007), -65.7 (2008), -58.9 (2009) — 6.5% share in 2009.
  - United Kingdom contribution figures: -76.5 (2006), -90.0 (2007), -70.9 (2008), -50.8 (2009) — 5.6% share in 2009.
  - Total negative: Surplus countries contributions in 2009 equal 100.0%.
  - China, P.R.: Mainland contributions: 208.9 (2006), 1307.4 (2007), 8348.8 (2008), 7220.6 (2009) — -17.2% share in 2009.
  - Germany contributions: 166.4 (2006), 238.9 (2007), 2252.0 (2008), 176.1 (2009) — -13.8% share in 2009.
  - Russian Federation contributions: 125.5 (2006), 111.2 (2007), 154.6 (2008), 99.0 (2009) — -7.1% share in 2009.
  - Netherlands contributions: 56.9 (2006), 56.9 (2007), 67.0 (2008), 66.4 (2009) — -5.2% share in 2009.
  - Note: "Total deficits do not equal total surpluses because of errors & omissions."
- Observation: The United States has been the largest contributor to global net demand throughout the crisis; by 2009 India became the second highest contributor, pushing UK to third.
- Policy relevance: For rebalancing global growth, net contribution to demand is a more relevant variable for inclusion in the IMF quota formula than openness; weights may need inversion if world shifts to a global savings shortage.

### Voice and Representation
- Critique of variability index:
  - G24 secretariat’s work (2008, 2010) shows the existing index of variability fails to capture potential demand for BOP financing by developing countries.
  - Scaling by mean is an improvement, but the proposed index is not easily aggregable to a global total, creating interpretive issues for country shares as global shares.
- Voice and diversity principle:
  - Voice and staff diversity are fundamentally about people, not economic size.
  - Sub-Saharan Africa in 2010: 11.7% of World population but only 2.4% of aggregate world GDP.
  - Bangladesh: 0.3% of World GDP but 2.4% of World population.
  - Both voice and diversity should be benchmarked against shares in World population.
- Statistical correlation: GDP PPP is more closely correlated with population than GDP MER (correlation coefficient 0.66 vs. 0.46); replacing GDP MER with GDP PPP shares would raise quota shares of poorer regions/countries.
- Alternative voice-weighting suggestions:
  - Weight volatility by (a) share of the World’s poor, or (b) population shares, or (c) a blend of the two, to give the World’s poor adequate voice.
  - Simpler alternative: dispense with the volatility variable and use one of the above as the voice variable.
- Poverty statistic: Share of Sub-Saharan Africa in the World’s poor is about 27% at the $1.25 a day (per person) poverty line.
- Practical note: If the current GDP blend is not changed significantly, a population weight becomes more important.

### Board Representation
- EU representation anomaly:
  - EU: about 7.3% of World population and about 20.4% of aggregate World GDP, but has about 1/3 of IMF quota and 40% of the 20 permanent seats (1/3 of the current 24 seats).
  - The EU has had the Managing Director position monopoly for the last half century; the USA correspondingly holds the position of First Deputy Managing Director (FDMD).
- Institutional concern: The overwhelming position of one highly integrated region in an international organization raises questions about whether it is truly an International Monetary Fund.
- Managing Director / Deputy structure debate:
  - Creation of a fourth DMD position for China raises questions about objective criteria for number and selection of DMDs, such as the size of the World economy or selection on the basis of country size.

*Source: _wp11208 - 3. Gross Domestic Product (GDP)*

### 7. Summary and Conclusions

### 7. Summary and Conclusions

### Selection of Managing Director (MD) and Deputy Managing Directors (DMDs)
- Problem articulated: nationality currently matters in selection; recommendation is to remove nationality from the equation to the maximum extent possible.
- Proposal: create a procedure to judge “international orientation” or “internationalism” of potential candidates for MD and DMD.
  - Example mechanism: an independent international panel of non-government professionals set up by the IMF to rank candidates by degree of ‘internationalism’ (converse of Nationalism/Parochialism).
  - Apply a cut-off above which candidates are considered suitable to head an “international” organization such as the IMF.
  - A merit-based selection would then use the internationalism ranking as one merit criterion.

### Gap between Quotas and Economic Reality (Table 4 and related findings)
- Text summary:
  - Table 4 contrasts variables that reflect economic reality with the Quota proposals approved by executive directors and the Board of Governors (pending formal approval/financial contribution by member governments).
  - The gap between economic and quota rank is widest for India.
  - India’s Quota share after the latest proposals are implemented will be the eighth highest.
  - India in 2009 was the fourth largest economy and is projected to be the third largest in 2011.
  - India was in 2009, and in three previous years, the second highest contributor to global growth and was the second highest contributor to global net demand in 2009.
  - Conclusion: by many measures India will be, by the end of 2011, among the top five economies in the World; a governance system that does not acknowledge this reality will struggle to be legitimate or credible.

- Selected numeric and tabular extracts (as presented in the source):
  - The USA with 4.5% of the World population and 19.4% of World GDP has 17.5% of the quota and 5% of the permanent seats. However its shareholding gives it a veto over major changes (which require 85% majority).
  - Table fragments (as in source formatting):
    - United States: Share(%) 20.41; 2009 Share 17.41; other entries include -0.543, 41.21
    - China: Share(%) 12.62; 2009 Share 6.43; other entries include 1.141, -17.2
    - Japan: Share(%) 6.03; 2009 Share 6.52; other entries include -0.316, 2.5
    - India: Share(%) 5.14; 2009 Share 2.88; other entries include 0.292, 26.52
    - Germany: Share(%) 4.05; 2009 Share 5.64; other entries include -0.197, -13.8
    - United Kingdom: Share(%) 3.16; 2009 Share 4.25; other entries include -0.151, -5.63
    - France: Share(%) 3.07; 2009 Share 4.26; other entries include -0.081, 4.74
    - Russia: Share(%) 3.08; 2009 Share 2.79; other entries include -0.244, -7.1
    - Brazil: Share(%) 2.99; 2009 Share 2.31; other entries include -0.015, 6.1
    - Italy: Share(%) 2.51; 2009 Share 3.27; other entries include -0.132, 0.9
  - Notes included in source:
    - 1/ Data are from table 4 of the Statistical appendix to the World Economic Outlook, October 2010
    - 2/ Based on data underlying the charts/figure 1.2 (global indicators), World Economic Outlook, 2009 and earlier issues.
    - Net contribution to global demand is based on the balance of trade (in G&S). A deficit (surplus) represents positive(negative) contribution.
    - 3/ Based on data for goods and services export and import, given in the database of World Economic Outlook.

### Structure, sector development, and variables in the quota formula
- Argument:
  - Country structure and sector development depend on comparative advantage, stage of development (real per capita GDP), and history (including earlier policy choices).
  - No reason to reward a country (through the quota formula) for having a higher-than-normal value or ratio of indicators such as trade, non-trade current account, capital flows, or financial sector size.
  - Policy interventions that raise any of these ratios should be penalized so as to align IMF policy advice with quota incentives.
  - Excessively large capital flows or a larger-than-normal financial sector can pose risks (bubbles and busts, surges and sudden stops) and contribute to global instability.
  - Complexity and difficulty of devising a non-linear formula for such variables, and low likelihood of acceptance of a variable that reduces calculated quota, argues for leaving such variables out of the formula altogether.

- Recommendations for quota formula design:
  - If simplicity and transparency are desired, use only two variables:
    - The relative size/power of economies as measured by GDP PPP shares in world aggregate GDP (to reflect economic weight and surrendered autonomy).
    - The proportion of the World’s poor living in the country (to reflect ‘voice’).
  - If some complexity is acceptable, blends can be used:
    - Blend GDP PPP with GDP MER and country population share, respectively.
    - The GDP blend could include GDP MER up to a proportion equal to the ratio of cross-border holdings of (real) capital stock to total World capital stock.
    - The voice variable could be a blend of share of World poor and share of World population with or without an improved variability index.
  - Option to replace variables:
    - Replace the openness and reserves variables by contribution to global growth and contribution to net demand (incentive compatible and more relevant to IMF objectives).
    - If preferring simplicity and transparency, replace three variables (‘GDP hybrid’, ‘Openness’ and ‘Reserves’) by a single variable: ‘country GDP PPP share in world aggregate GDP’.
  - Transition path:
    - Once principles are accepted, a phased transition could be implemented by progressively reducing the share of the “Openness” variable to zero over five years (say).

### Conclusion: Implications for IMF Quota Reform
- Main conclusions:
  - There is a large gap between economic reality and IMF quotas.
  - Dissatisfaction among global public opinion can only be reduced or eliminated if Quota shares are changed to reflect current and fast changing economic reality.
  - This requires a much greater role for the relative size/power of economies, an element not adequately captured by the existing formula.
  - Unless fully taken into account, dissatisfaction will persist after 2013 (the year in which the next quota reform is to be completed).
  - The gap is likely to widen every year unless the formula is modified appropriately.

- Policy implication:
  - A simple, transparent quota formula centered on GDP PPP share and voice (share of World’s poor) or an appropriately blended variant is recommended to align quota shares with evolving economic realities and IMF objectives of preserving global economic growth and rebalancing the global economy.

*Source: _wp11208 - 7. Summary and Conclusions*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2011/_wp11208.pdf_