Reforming IMF and World Bank governance: in search of Simplicity,

Transparency and Democratic Legitimacy in the voting rules

Dennis Leech

Warwick University and VPP, LSE

and

Robert Leech, Imperial College

LSE November 20th 2008

Outline

1. Voting rules in the IMF2. Voting power3. Latest board decisions to redistribute

votes4. The 85% rule5. Changes to Basic Votes6. Democratic legitimacy and the

Penrose square root rule

Simplicity, transparency and democratic legitimacy of voting rules

• Simplicity: How easy are they to understand?• Transparency: Do they mean what they

appear to mean? We specifically focus on voting power.

• Democratic legitimacy: can they be justified in a world of representative democracy? How can we reconcile weighted voting with democracy?

1. Voting in the IMF/World Bank

• 185 members; all have seats on the board of governors

• Weighted voting• Each country has

– 250 “basic” votes, and– In IMF: 1 vote for each 100,000 units (SDR) of

quota– In WB: 1 vote for each share (based on IMF

quotas)

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Determination of quotas

• How are quotas determined?

• The rules (Articles) contain no quota formula

• Each country’s quota set by the board (political process)

• Guided by a ‘simple’ formula

• …or rather 5 (complex) formulae:

Tab le 1 The Existing Five Quota Formulas

Bretton Woods: Q1 = (0.01Y + 0.025R + 0.05P + 0.2276VC) (1 + C/Y);

Scheme III: Q2 = (0.0065Y + 0.0205125R + 0.078P + 0.4052VC) (1 + C/Y);

Scheme IV: Q3 = (0.0045Y + 0.03896768R + 0.07P + 0.76976VC) (1 + C/Y);

Scheme M4: Q4 = 0.005Y + 0.042280464R + 0.044 (P + C) + 0.8352VC;

Scheme M7: Q5 = 0.0045Y + 0.05281008R + 0.039 (P + C) + 1.0432VC;

where:

Q1, Q2, Q3, Q4, and Q5 = Calculated quotas for each formula;

Y = GDP at current market prices for a recent year;

R = twelve-month average of gold, foreign exchange reserves, SDR holdings and reserve positions in the IMF, for a recent year;

P = annual average of current payments (goods, services, income, and private

transfers) for a recent five-year period;

C = annual average of current receipts (goods, services, income, and private

transfers) for a recent five-year period; and

VC = variability of current receipts, defined as one standard deviation from the centered five-year moving average, for a recent 13-year period.

For each of the four non-Bretton Woods formulas, quota calculations are multiplied by an adjustment factor so that the sum of the calculations across members equals that derived from the Bretton Woods formula. The calculated quota of a member is the higher of the Bretton Woods calculation and the average of the lowest two of the remaining four calculations (after adjustment).

2.Transparency: voting power analysis

• Vote shares often described as voting powers• Misleading: power connotes the ability to

influence decisions• Voting power analysis studies the relation

between vote shares and voting power by examining all possible outcomes of a vote and calculating a measure of decisiveness

• Power indices– Banzhaf index is a share in the decisiveness of all

voters (power share)

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Voting rule not transparent

• Vote shares very unequal by design (dominated by quotas)

• BUT voting power even more unequal– A ‘hidden’ redistribution of voting power to the

USA from all other countries due to weighted voting

– USA has more than 7 percent more power than weight

3. New vote distribution

• Singapore resolution Sept 2006:quota increase for 4 countries

• Board resolution April 2008: New “simpler, more transparent” quota formula

• Quotas to be adjusted in light of formula– Some rich countries to forego formula increases

• Tripling of Basic Votes: – Each country’s basic vote increases from 250 to

750

The New Quota Formula The proposed new quota formula includes four quota variables (GDP, openness, variability and reserves), expressed in shares of global totals, with the variables assigned weights totaling to 1.0. The formula also includes a compression factor that reduces dispersion in calculated quota shares. The proposed new formula is:

CQS = (0.5*Y + 0.3*O + 0.15*V + 0.05*R )k

Where CQS = calculated quota share; Y = a blend of GDP converted at market rates and PPP exchange rates averaged over a three year period. The weights of market-based and PPP GDP are 0.60 and 0.40, respectively; O = the annual average of the sum of current payments and current receipts (goods, services, income, and transfers) for a five year period; V = variability of current receipts and net capital flows (measured as a standard deviation from the centered three-year trend over a thirteen year period); R = twelve month average over a year of official reserves (foreign exchange, SDR holdings, reserve position in the Fund, and monetary gold); and k = a compression factor of 0.95. The compression factor is applied to the uncompressed calculated quota shares which are then rescaled to sum to 100.

“… the reforms will realign quota and voting shares to member countries' weight and position in the global economy and enhance significantly the voice and participation of emerging markets in low income countries.” (IMF senior official)

Hype

New vote shares do not justify the hype

• Changes to the formula and tripling of basic votes make almost no difference in voting power

• Serious lack of transparency

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4. The 85% voting rule

• This analysis for Ordinary Decisions requiring a 50% majority

• But major decisions require an 85% majority

• (Ensuring the USA a unilateral veto)

• But this is even more seriously distorting…

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5. Increasing basic votes

• Increasing share of basic votes makes the distribution of vote shares, hence voting power, more equal.

• How important is this?• We consider increases to

• 11% (restoring the 1946 level)• 25%• 50%

• The effect is surprisingly weak - restoring the 1946 level makes very little difference

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6. Square root rules

• Consider vote shares proportional to square roots of

(1) Populations(2) Quotas

• (1) can be justified by democratic legitimacy - OPOV (Penrose square root rule)

• (2) needs a justification in terms of one-dollar-one-vote

• These rules are almost transparent in practice

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Democratic legitimacyThe square root rule• Simple• Almost transparent• Population rule has democratic legitimacy

through Penrose square root rule: – Democratic vote at country level, OPOV, then

weighted voting in the international body, with vote shares square roots.

– Gives equal indirect voting power to all citizens

• Can an analogous justification be given to the square root of quotas? One dollar one vote?

References

• Buira Ariel (2005) Reforming the governance of the IMF and World Bank, London: Anthem Press.

• Felsenthal, Dan and Moshé Machover (1998), The Measurement of Voting Power, Cheltenham: Edward Elgar.

• IMF (2008)). “Reform of Quota and Voice in the International Monetary Fund—Report of the Executive Board to the Board of Governors”. March 28, 2008. Washington:IMF.

• Kirsch, Werner (2005), “What is a Fair Distribution of Power in the Council of Ministers of the EU?”, Brussels: Centre for European Policy Studies.

References

• ---------------------, Moshé Machover, Wojciech Słomczynski and Karol Zyczkowski (2004), “Voting in the EU Council – A Scientific Approach”, http://www.ruhr-uni-bochum.de/mathphys/publikationen/voting.pdf

• Leech, D. (2002) “Voting Power in the Governance of the International Monetary Fund”. Annals of Operations Research 109, pp. 373-95, 2002.

• --------------and Robert Leech (2006a) “Voting Power in the Bretton Woods Institutions”, ch. 1 in Alberto Paloni and Maurizio Zanardi (eds.), The IMF, World Bank and Policy Reform, Routledge.

• ------------------------------------------website: Algorithms for Voting Power Indices, www.warwick.ac.uk/~ecaae

References• ________ and Haris Aziz (2007), “The Double Majority Voting

Rule of the EU Reform Treaty as a Democratic Ideal for an Enlarging Union: An Appraisal using Voting Power Analysis” (with Haris Aziz) Warwick Economic Research Papers no. 824; forthcoming in Słomczynski, Wojciech and Karol Zyczkowski, eds., The Distribution of Voting Power in the EU, Warsaw.

• Penrose, L.S. (1946), The elementary statistics of majority voting, Journal of the Royal Statistical Society 109: 53-57.

• Słomczynski, Wojciech and Karol Zyczkowski (2007), “The Jagellonian Compromise: An Alternative Voting System for the Council of the European Union”, Institute of Mathematics, Jagiellonian University, Krakow, http://chaos.if.uj.edu.pl/~karol/pdf/JagCom07.pdf