It is no secret that Europe punches below its weight in the international monetary and financial arena. Whether the issue is IMF governance, World Bank reform, the renminbi exchange rate, or global imbalances, the dominant voices remain the United States, accompanied by a chorus of increasingly assertive Asian countries (not always singing in harmony). Europe has no shortage of opinions, but these suffer from a shortage of impact.
This sad state of affairs has several explanations. The physical proximity of the Bretton Woods institutions to the US Treasury amplifies America’s opinions, as John Maynard Keynes feared when he opposed locating them in the US capital. Then there is the complexity and fragmentation of Europe’s representation. Switzerland is a member of the G10 but not of the European Union. Norway is a large reserve-holder and sometime chair of an IMF constituency but, again, not an EU member. The UK is a member of the European Union but not the euro area. And these groupings are not static: the composition of the EU and the euro area has and will continue to evolve.
One could imagine organising these affairs in a number of different ways. Europe’s representation in the multilaterals could remain as it is -- as a national competency. It is said that there is no more appetite in Europe for a single foreign financial policy than for a single foreign policy in general. This option would also be consistent with the principle of subsidiarity.
Alternatively, member states could coordinate their international monetary and financial policies more closely in the effort to more effectively counterbalance the United States and advance their common position (assuming, of course, that they in fact have a common position). The idea, in other words, would be closer de facto cooperation but not institutional reform.
Finally, a concerted effort could be made to advance a single European position. This would entail assigning responsibility for its formulation to the European Commission and reorganising Europe’s representation, ultimately by appointing a single EU representative to engage with the Union’s interlocutors in the various global venues.
Economics can help in choosing between these alternatives. The theory of fiscal federalism provides the standard tools for deciding how responsibilities should be delegated across levels of government. It suggests assigning to the most encompassing level, in this case the EU, issues where tastes are uniform and there are economies of scale in centralised provision. Here, economies of scale means that Europe’s positions can be represented and advanced more effectively when centralised. Homogeneity of tastes means that European countries have broadly similar views of those objectives.
The problem is that there are costs to change. Creating exclusively EU constituencies in the Bretton Woods institutions means negotiating with non-EU countries. (Presently, a number of EU countries chair so-called “mixed constituencies” made up of a combination of European and non-European members.) Reform means asking EU members that presently chair constituencies to give up their privilege in favour of a single EU chair. These negotiations will require governments to spend valuable political capital. Against the backdrop of these costs, uncertainty about whether change will really deliver a welfare improvement lends inertia to existing arrangements. It creates a status quo bias.
To overcome this, we suggest building on theoretical work inspired by the transition from plan to market in formerly centrally-planned economies.1 There it has been argued that experience with limited reform helped to convince otherwise skeptical stakeholders of the positive effects of further reform. This suggests investing first in the development of unified representation and common policies in the venue where the case for doing so is strongest. If the results are positive, it may then be possible to emulate this example subsequently in other venues.
Concretely, we recommend starting by consolidating Europe’s representation at the IMF. One can imagine a single EU chair or a pair of chairs, one for the members of the euro area and one for other member states. The reluctance of the smaller EU member states to give up their seats on the IMF Board is the major obstacle to be overcome here. But, increasingly, their intransigence is seen as an impediment to meaningful governance reform and thus as undermining the legitimacy of the institution. If they value the IMF, these countries will have to move.
The IMF is also the right place to start because EU member states have relatively similar preferences on IMF-relevant issues. To the extent that the IMF is concerned with issues revolving around exchange rates, the fact that half of EU members have the same currency, and therefore the same exchange rate, points strongly in this direction. The infrastructure to establish a single European position at the Fund is already well-advanced. The EU has a subcommittee on IMF-related issues in the Economic and Financial Committee (SCIMF) and an informal committee of EU countries’ representatives in the IMF (EURIMF).
Finally, the IMF is the right place to start because economies of scale in representation are strong. Analytical work has shown that a single seat, or even a pair of EU seats, will make the EU, with its block of votes, a key swing voter.2 The EU will be better able to achieve its goals by consolidating its representation in a single seat or a pair of chairs.
Smaller member states that have inherited privileged positions will resist the call for sacrifice. But this dilemma is artificial. The IMF risks losing relevancy and legitimacy if reforms to its governance to enhance the voice and participation of underrepresented emerging countries are not introduced. If EU members do not give up their excessive numerical representation at the IMF’s Executive Board table, that table will ultimately become one where no one wishes to dine.
1 For details, see our recently published chapter “External monetary and financial policy: a review and a proposal,” in the book edited by Andre Sapir, Fragmented Power: Europe and the global economy, Bruegel, Brussels, July 2007.
2 See the swing-voter analysis of Lorenzo Bini Smaghi (“Powerless Europe: Why is the Euro Area Still a Political Dwarf?“ International Finance 9, pp.1-19, 2006), and Dennis and Robert Leech (“Voting Power Implications of a Unified European Representation at the IMF,“ unpublished manuscript, January, 2005).