Reversing International Financial Disintegration: The Need for the EU to Move

The multilateral process is in retreat and with it the economic order as we know. IMF and World Bank representatives met on 26-27 September in Bretton Woods, New Hampshire to debate how multilateralism may change 20-30 years from now. The IMF is the only formal arrangement for multilateral economic policy cooperation, but representation at the IMF, expressed through so-called quota shares, is no longer aligned with economic realities. This reduces countries' incentives to engage constructively with the existing system. Any debate about change ought to see China's quota share increase significantly. A necessary condition thereof is a reduction in the shares of the European Union countries.

International trade is stagnating and there have been more than 3,000 trade restrictions in 2023 or more than five times than in 2015. It is a proxy for the decline of the multilateral system.

The IMF has long recognized the need for a realignment of quota shares to preserve the legitimacy of the institution. Since at least 1998, the IMF has embarked upon a review of the framework guiding the distribution of quota shares. There had been multiple adjustments, but overall change has been small.

The quota shares are the "capital" subscription of countries and foundation of the governance structure of the IMF. They determine the voting power-quota shares are very close to voting shares-a country has at the IMF (the most important decisions require an 85 percent majority), the financial contribution of the countries to the IMF, to some extent how much assistance a country can request and its share in a general Special Drawing Rights (SDR) allocation (an international reserve asset issued by the IMF). The quota shares are understood to broadly reflect the relative position of a country in the international economy, that is, the bigger a country the more say it has.

The quotas are also very much about political alignment. In July 1944, at the Bretton Woods conference where the IMF was established, the U.S. delegation expressed it as follows: "Russia is necessary to winning the war. She wants ten percent, or some such amount. […] it is well worthwhile to give them a much larger quota than they would otherwise be entitled to. […] it is foolish from purely trade considerations to give China more than India. On the other hand, if we are going to beat Japan we have got to keep China happy. […] From the point of view or respective influence in the post-war world, clearly Russia and China ought to be given more than India or France."

The IMF has been trying to move away from this discretionary approach in quota distribution, but this remains largely incomplete. There is a quota formula that exists in different guises to serve as guide for determining the quota shares. But the existing quota distribution remains significantly off the calculated quota shares (Chart). There is also a suspicion that the existing quota formula serves principally to deflate the U.S. share and justify the high shares of the EU countries. Nominal GDP at market prices seems to continue being the best proxy for the relative position of a country.

The E.U. has a combined quota share of 26.2 percent today compared with the U.S. of 17.4 percent and China of 6.4 percent. This compares to the nominal GDP of the EU of US$18.8 trillion, of the U.S. of US$28.8 trillion and of China of 18.5 trillion. The EU countries are in aggregate the most over-represented and China the most under-presented.

The most promising approach would be a unified EU quota share. Yet, the EU member countries have for some time resisted reducing their quota shares and merging them. Smaller countries in particular fear a loss of influence. Some argue that there could be legal impediments as the IMF is an organization of countries and has no provisions to accept political unions as members. But former state union Serbia and Montenegro was an IMF member before the constituents split.

The unified EU quota share shall primarily serve the multilateral system. As the US has for some time maintained a lower share than warranted by its economic weight, the EU should now do the same. A quota share of 16.0 percent seems adequate for the EU in particular relative to the US and would still allow the EU to block any major decisions at the IMF.

Political alignment matters but should not be determined by a small group of countries. While misalignments with US interests may prevent adjusting China's quota today, China may not be aligned because it has few incentives to be. To enhance countries' interest in supporting the existing economic order, the multilateral system will need to ensure countries feel they have a rightful stake in it. If the IMF believes quota shares should be distributed on the basis of criteria other than economic weight it should be transparent about it knowing that it would fundamentally change the character of the institution.

The EU member countries hold the key for any major shift in IMF quota redistribution and are the biggest obstacle to needed change. It is the EU that needs to move.

Ousmène Mandeng, Senior Advisor Accenture, Visiting Fellow London School of Economics and Political Science

All views expressed by members are their own and not reflective of the views of the Bretton Woods Committee.