The governance of the IMF and the distribution of IMF quotas have come under much scrutiny in recent years. At issue is the question of the allocation of quotas and the attendant voting rights of member countries consistent with their relative size in, or contribution to, the world economy. Quota increases resulting from general quota reviews have fallen far short of the amounts needed to maintain their relationship to world GDP when the IMF came into being in 1945, and at the same time the distribution of quotas between the industrial and developing countries has been broadly maintained despite the enormous growth of the world economy over this period. However, on the basis of the formula that guides the IMF in deciding members’ quotas in these reviews, giving prominence to GDP as the primary variable, the share of developing countries would be appreciably greater if GDP were to be converted by purchasing power parities (PPPs), rather than by market exchange rates .For most inter country comparisons, GDP converted by PPP is seen as the appropriate measure, and this view has been enhanced by the recent strengthening of the quality of PPP data within the International Comparison Program. Market exchange rates, which continue to serve as the conversion factor in IMF quota calculations of members’ GDP, are regarded by statisticians and analysts alike as unsuitable because of their short term volatility. While a significant change in quota distribution involving a shift to the developing countries would require much more than a change in formula, the adoption of PPPs for the conversion of GDP would set that process in motion.

This paper discusses a proposal to include capital flows volatility as an additional variable in the quota formula. The motivation is to capture macroeconomic volatility associated with capital accounts shocks as well as countries’ vulnerabilities to balance of payment crisis. A proposal to this effect was requested by the G-24 Ministers in the Communiqué of October 2004 and also introduced in recent quota reviews at the IMF.

However, the methodology put forward by IMF staff papers measures capital flows volatility in dollar terms. This measure does not fully captures vulnerabilities to balance of payment crises because it does not take into account the differential macroeconomic impact of volatility among developing and industrial countries. In particular, fluctuation in capital flows implies a bigger real adjustment for developing countries since capital flows to these countries represent a larger share of their economies and tend to be more volatile.

We propose an alternative measurement of capital flows volatility based on the volatility of net capital flows as a proportion of GDP and argue that it is a more appropriate measure to capture the economic effects of capital flows volatility. We also measure volatility in exports and capital flows altogether as a share of GDP to capture countries’ total vulnerabilities to balance of payment crisis arising not only from capital account shocks but also from current account shocks, i.e. commodity shocks.

The following outlines a mode to enhanced financial crisis prevention and management through better surveillance and transparency. In the absence of a Westphalian voting system in the International Monetary Fund, power tilts excessively towards creditor countries resulting in skewed crisis analysis and resource distribution. Consequently, exploring the democratic deficit within the governance structure of the Fund reveals needed changes in the quota regime and voting system of significant import. Expressly, the democratic deficit results from three factors (1) the decline of basic votes in the Fund’s quota regime has reduced the voice of smaller countries in the governance of the Fund; (2) biases in the calculation of economic strength have caused the IMF to neglect the strength of emerging market economies; and (3) the needless complexity and opacity involved in the calculation of quotas. As the governance structure of the Fund is a product of the political and economic agreements embodied in the quota regime, addressing the quota bias, the variable measurement and specification problems, will provide the means for a Fund that is in tune with the growing contiguous democratic consensus. Quota adjustments alone prove insufficient towards this democratic end and therefore we will explore: reassessing the Fund size given the pressing need for a larger Fund as the present size is too small when compared to the global GNP; readjusting access to the resources of the Fund in accordance with the gross financing need of the concerned country; reexamining the voting system and the veto market; restructuring the Executive Board so that every member of the Board is an elected member; and the establishment of an Economic Security Council.

The IMF is governed by a 24-member Executive Board which represents 184 countries. Although often prized as a small and efficient decision-making body, the Board represents some countries more effectively than others. This is due to the institutional structure and incentives within which the Board operates. Prime among them is a system of constituencies which have formed and evolved as countries have sought to improve their position in the organization. These groups vary in size, shared interests, and distribution of power. Their effectiveness is not only affected by these attributes. It is also determined by decision-making rules across the institution, by the lack of formal accountability of Board members, and by the strength of other coalitions of countries acting informally within the institution. The analysis implies that representation on the IMF Board could be improved without altering the size of the Board.

The current realities of the global economy are far from being reflected in the Fund’s quota structure, with emerging market economies accounting for the bulk of the underrepresentation. This paper explores the characteristics of the representation distortions using cross-section regression analysis and the results indicate that economic growth, population, credit rating and dummies for the US and China, explain most of them. To the extent that the faster growing countries are not recognized as such in their IMF quotas, the distortions will continue to increase. Eliminating such distortions requires adjusting the quota structure in line with the relative participation in global economic activity, but to the extent that individual quotas cannot be reduced, a large increase in total IMF quotas would be required. Simulations performed under the assumption that all advanced economies over represented would accept to reduce their quotas indicate that only about one half of the rate of increase in total quotas would be required. As an initial step towards the elimination of distortions in representation rules for a professional IMF board are proposed, including that all Executive Directors should be elected and be independent from the influence of a permanent employer, that all countries with a common currency be represented by the same ED, and that each chair should represent at least three member countries and at most fifteen. In a scenario using these rules and attempting to preserve the existing regional representation, Advanced Economies would lose three chairs, Emerging Markets would gain two, and Developing Countries gain the remaining one.