CHAPTER 3

Structural Reform: The Multilateral Development Banks

The World Bank was set up as a sister institution of the IMF. Its original mission was to provide long-term capital to countries whose infrastructure had been devastated by World War II at a time when little or no private capital was available. Gradually, it switched its focus to less-developed countries (LDCs). Regional development banks were set up on the model of the World Bank.

 

The World Bank’s capital was contributed mainly in the form of guarantees from industrialized countries, against which the World Bank could borrow in capital markets with a AAA rating. This was an ingenious financial gimmick that conferred a benefit on poor countries at practically no cost to the rich ones. The guarantees have never been invoked.

 

The arrangement suffers from a significant drawback: It has locked the World Bank’s lending into an intergovernmental straitjacket. The charter of the World Bank requires that its loans be guaranteed by the governments of the borrowing countries. The guarantees become instruments of control in the hands of the recipient governments. The loans often serve to reinforce corrupt or repressive regimes. The governments of the developed countries that dominate the board can also exercise a nefarious influence over the lending activities of the World Bank: They can push loans that benefit their export industries or veto loans that would create competition or otherwise hurt their interests.

 

In 1960, the International Development Association (IDA) was added to the World Bank to provide very lowinterest, long-maturity loans to the poorest Bank member countries.⁵⁶ Subsequently, the World Bank set up another subsidiary, the International Finance Corporation (IFC), which can invest in and lend to the private sector. Further, it has established a Multilateral Investment Guarantee Agency (MIGA), which is similarly directed at the private sector.

 

Originally the World Bank engaged mainly in large infrastructure projects, but as its focus shifted to developing countries, it has gradually reoriented itself toward creating human and social capital and alleviating poverty. Under the leadership of James Wolfensohn the changeover became more explicit and more pronounced. He introduced the idea of Comprehensive Development Frameworks (CDFs). Subsequently, debt forgiveness for HIPC has led to the PRSP, which is a joint Fund/Bank process. A new paradigm for international assistance is emerging that gives the recipients a greater sense of ownership, tries to reinforce those who make progress, and penalizes those who fail to meet targets. The IFIs are clearly trying to learn from their mistakes. Unfortunately, antiglobalizaiton activists and other critics are unwilling to give them the benefit of the doubt. These are early days. There is much confusion about the way the process is supposed to work; the roles of the IMF and the World Bank are far from clarified. The IFIs must be given time to elaborate the new paradigm.

 

Since James Wolfensohn took charge, the World Bank has undertaken much-needed social initiatives, from microlending to distance learning and fighting AIDS and other infectious diseases. It has begun to experiment with lending to subnational units and some NGOs, but its charter limits the scope of such efforts because loans must flow through the central governments. These activities could be carried out more effectively by giving grants and dealing directly with other elements of society besides the central government: the private sector, local government, and community groups. But the World Bank has only limited funds available for outright grants and technical assistance. These funds are derived mainly from the profits of the lending operations. IDA’s Development Grant Facility is only $100 million. In my view the discretionary spending activities of the World Bank are much more beneficial, with fewer adverse side effects, than are its lending activities.

 

The Bush administration has recently proposed that the World Bank reduce its lending and increase its grantmaking activities. It calls for half of IDA’s disbursements to be in the form of grants.

 

On the face of it, replacing loans by grants would be a step in the right direction. But as the president’s proposal did not provide for additional funding, the actual effect could be to reduce the activities of the World Bank overall. That meshes with the recommendations of the Meltzer Commission, which was established by the U.S. Congress in November 1998 to recommend future U.S. policy toward the IFTIs.

 

In its final report, issued in March 2000, the Meltzer Commission criticizes the World Bank for being a bureaucratic organization with too large a staff and for engaging in lending activities that could be taken care of by the capital markets.⁵⁷ It recommends that the World Bank get out of its bread-and-butter lending business, return its guarantee capital to the industrialized countries, and reconstitute itself as a World Development Agency providing assistance to the worlds’ poorest countries. The Meltzer Commission has a highly restrictive definition of eligibility: Countries with a per capita income in excess of $4,000 would be excluded, and starting at $2,500 official assistance would be limited. Callable capital would be reduced in line with the declining loan portfolio; the IFC would be merged into the World Development Agency and its $5.3 billion capital returned to shareholders; MIGA would be dissolved. It all amounts to a massive resource transfer from the World Bank to the rich countries. As mentioned before, the Meltzer Commission called for an increase in grants to the poorest countries “if grants are used effectively.” There is a danger, however, that the downsizing of existing activities would be implemented while the increase in grants would get bogged down in working out the details.

 

I agree with the Meltzer Report that the World Bank’s mission and operating methods ought to be reconsidered. Its lending business is inefficient, no longer appropriate, and in some ways counterproductive because it reinforces the role of the central government in the recipient countries. But I cannot agree that the role of the proposed World Development Agency should be as restricted as the Meltzer Commission would have it. There is too much poverty remaining in countries like Brazil, which would be excluded under the Meltzer formula. These countries also suffer from the high cost of capital. Local enterprises, particularly the small and medium-sized ones, are penalized vis-à-vis multinationals. Therefore there is no justification for returning capital to the rich countries or canceling the callable capital of the World Bank. Rather, the callable capital of the World Bank ought to be put to more active use.

 

Contrary to the Meltzer Commission’s recommendation, it would be premature to terminate the existing lending operations of the World Bank. So-called middle income countries like Brazil, and even Chile, have very uneven income distributions and great social needs. Capital markets are rather intolerant of government expenditures and unforgiving toward accumulated debt in periphery countries. The World Bank has an important niche to fill.

 

The methods of the World Bank’s lending operations do need to be reformed to eliminate unintended adverse consequences. The World Bank has to be more attentive to internal political conditions in the borrowing countries. This is already happening. CDFs envisage consultations with civil society. Transparency and the fight against corruption now rank high among the Bank’s priorities. But more must be done. Even though the Bank cannot lend without the recipient governments’ guarantees, the Bank should be more aggressive in monitoring whether its loans are disbursed on the basis of merit and not political influence. The Bank should refuse to make loans to repressive and corrupt regimes. The standards embedded in U.S. law are excellent and ought to be followed by other members.⁵⁸

One of the benefits of the lending operation is that it does provide the World Bank with some discretionary income. Converting it into a World Development Agency would make it much more dependent on the donor governments, and that would expose it to all the disadvantages from which bilateral aid agencies suffer. The management of the Bank ought to be made less rather than more dependent on the donor governments. The bane of international aid is that the interests of the donors too often take precedence over the needs of the recipients.

 

To make the Bank less dependent on the shareholder governments, directors ought to be appointed based on their personal and professional qualifications for fixed terms and be given more independence from the governments that appointed them—as in the case of the United States with the governors of the Federal Reserve. Among other things, directors should not be expected to try to steer bank project procurement to their own nationals. The Bank’s public bidding system offers some protection now. Nevertheless, U.S. legislation requires that an officer of the Foreign Commercial Service be assigned to the office of the U.S. Executive Director of the World Bank and all the regional development banks to look out for U.S. business interests. Some Bank trust funds financed by individual member governments are tied to procurement from nationals of that donor country. Other member governments may be more subtle, but the development business is also big business. Untying procurement is not enough; international assistance needs to be protected against the interests of the donors.⁵⁹

 

At the same time, steps must be taken to prevent the interests of the staff from dominating the agency. This could be accomplished by putting a time limit on employment—say, five years, renewable once, based on performance. Those are the same term limits that apply to the president of the World Bank. Performance should not be measured by the amount of loans disbursed. The World Bank has a large and competent staff—too large, according to the Meltzer Report—drawn from all over the world, including the developing world. The staff is familiar with local conditions and concerned with social issues. But it is human nature that they are reluctant to go home. Term limits could provide talent-short home countries with a welcome infusion of desperately needed expertise.

The Meltzer Commission’s calculation that the World Bank guarantee capital constitutes a subsidy on the part of the United States and the other industrialized countries is highly contrived. The guarantees have never been invoked because Bank management knows that the shareholder countries would not stand for it. In my view, the argument ought to be turned on its head. There is an urgent need for the provision of public goods, and the rich countries ought to pay for them. Wealth redistribution used to take place on a national scale until globalization rendered progressive taxation counterproductive; now it ought to be practiced on a global scale.

 

One way to implement this principle would be to use the guarantee capital of the World Bank more actively by the Bank engaging in riskier activities. For example, the World Bank could guarantee commercial paper issued by a “Microcredit Finance Corporation.” This would be a great boon to the world because microcredit and SME financing have proven themselves effective in reducing poverty. Microcredit, however, cannot grow without being continuously fed from the outside because it operates around break-even level. If the World Bank provided successful operations with additional capital, microcredit and SME financing could become a significant force in economic and political development.

 

Attractive as the idea is, it is impractical in today’s world. The finance ministries of the developed countries would raise an outcry if they were required to make good on their guarantees. They would not authorize the World Bank to use its guarantee capital in such a way, and even if the Bank did, they would resist replenishing the guarantees. Given their attitude, the AAA rating of the World Bank could come into question.

 

In my judgment, this is not the right time to embark on a major reform of the World Bank, because any restructuring is liable to result in a reduction of its resources. It would be better to implement the SDR scheme than to try to put the guarantee capital of the World Bank to more active use. The time to reform the World Bank would come after the SDR scheme has proven successful. By then the IFIs will have had time to make the new paradigm work, and the atmosphere will have become more propitious for constructive reforms.