The Hazard of Second Best

The international community risks settling for second best on two key issues to be discussed this month at global meetings in Washington, DC: the lingering (if currently somewhat dormant) European debt crisis, and the selection of the World Bank’s next president. It is not too late to change course, but doing so will require the United States and governments in Europe to resist harmful habits, and emerging countries to follow up effectively on recent initiatives.

In the last few days, European leaders, including French President Nicolas Sarkozy and European Central Bank President Mario Draghi, have declared that the worst of the eurozone crisis is over. Others, like French Finance Minister Francois Baroin, have gone even further, claiming that Europe “has done its part,” and that it is now up to other countries to do theirs.
These announcements should come as no surprise. Having experienced prolonged turmoil, the eurozone is currently in a period of relative tranquility. The courageous reform measures implemented by Mario Monti, Italy’s technocratic prime minister, have eased immediate concerns that Greek dislocations might tip other European countries – much bigger and harder to rescue – into insolvency. Europe’s decision last week to bolster its internal financial firewalls has reinforced the resulting positive impact on market sentiment.

But, as important as these steps are, the recent tranquility has been more borrowed than earned. Since December, the ECB has twice deployed long-term refinancing operations, which provide unlimited three-year financing to banks at 1% interest. This has given the banking system more time to increase capital and improve asset quality. It has also reduced several governments’ financing costs. What it does not do, and is not meant to do, is resolve Europe’s twin problems of too little growth and too much debt.
If it is not careful, Europe risks falling into the trap of trying to shift responsibility for its problems onto others, rather than building on recent progress. That temptation is partly reflected in efforts to press officials from around the world to agree this month to a major increase in the International Monetary Fund’s resources, with emerging economies footing a significant part of the bill.

In pivoting from internal to externally-financed firewalls, Europe is pushing a political agenda that is not yet warranted by economic and financial realities. Europeans are about to embark on another round of elections, in both core and peripheral EU countries, as well as a referendum in Ireland. Recent history suggests that these votes are unlikely to favor ruling parties unless they can signal some progress in resolving the crisis.

The rest of the world should counter the risk of European complacency, and the US should take the lead. But US officials no longer seem interested because they need to secure Europe’s support for another second best this month: the anointment of the American candidate, Jim Yong Kim, as the World Bank’s new president.

For the first time in its nearly 70-year history, the Bank’s executive board is also considering two non-Americans for the job: the Colombian Jose Antonio Ocampo and the Nigerian Ngozi Okonjo-Iweala. The nomination of these two unambiguously qualified and experienced individuals to compete with Kim is an important first step in changing the feudalistic practice whereby nationality has been the overriding criterion for selecting the World Bank’s president (as well as the choice of the IMF’s managing director, which Europe controls).
All three candidates meet US President Barack Obama’s justified insistence that “a development professional…head the world’s largest development agency.” But this does not make them equal. They are not.

A consensus has emerged that, when judged by the Bank’s own criteria for the job, the highly respected Okonjo-Iweala dominates the other two candidates. On that basis, she has already gained the endorsement of influential observers and opinion-forming media outlets. Moreover, her appointment would speak to other important initiatives with which Obama has aligned himself, including efforts to fight corruption, strengthen meritocracy, and support gender equality.

I suspect that, in their hearts, US officials know that Kim, while an inspired nominee, is not the best candidate. Yet their historical attachment to a harmful nationality-based entitlement stops them from opting for the best. Meanwhile, Europeans are happy to hold their tongue as a reward to the US for having supported their nationality-based appointment last year of Christine Lagarde to head the IMF.

The responsibility of resisting two second bests now falls to emerging countries. It is up to them to do the right thing this month. And, for the first time in my career observing the international monetary system, they are in a position to take three important steps.

First, since they are expected to contribute significant financial resources, emerging economies can postpone bolstering the IMF until the eurozone does more to improve the policy mix in member countries and further strengthens its financial firewalls and fiscal harmonization.

Second, by asking Ocampo to step aside in favor of Okonjo-Iweala, they can unite their votes behind a highly credible merit-based appointment for the World Bank.

Finally, they can put pressure on their Western counterparts by maintaining momentum on the alternative of a “development bank for the South,” an initiative that received support at last week’s BRICs meeting in India.

The considerations of Realpolitik that influence global meetings often lead to second-best compromises as a means of avoiding more costly inaction. By contrast, this month’s discussions in Washington can and should opt for the first best. But this will happen only if emerging countries play their cards well, and if Europe and the US do what is in their own best longer-term interests, as well as those of the global economy.

Mohamed A. El-Erian is CEO and co-CIO of PIMCO, and author of When Markets Collide.

Mohamed A. El-Erian -->