EVENTS

Date:	Tuesday, June 7, 2005
Time:	3:30 PM -- 5:00 PM
Location:	Wohlstetter Conference Center, Twelfth Floor, AEI 1150 Seventeenth Street, N.W., Washington, D.C. 20036

June 2005

The World Bank under Wolfowitz

Paul Wolfowitz assumes the presidency of the World Bank on June 1 amid great speculation about his vision for the institution and considerable public debate about its broader purpose and future. What priorities should Wolfowitz set during his tenure at the World Bank, and what lessons can he draw from the successes and failures of previous World Bank presidents? Will he champion the fundamental restructuring of the World Bank or pursue a more cautious approach toward its reform? These and other questions were the subject of a June 7 AEI panel discussion, the first in a series of events focusing on World Bank issues.

Desmond Lachman
AEI

When there is a change of leadership of any organization, it is a good time to reflect on whether or not that organization’s strategy and operations are consistent with its goals. This is particularly true of the World Bank, given how much the world has changed under James Wolfensohn’s stewardship of the bank.

The major change has to be the emergence of the economies of China and India that have succeeded in lifting so many millions out of poverty.  Along with other middle-income nations, what is notable about India and China is that they have easy access to international capital markets. This provides them with several times the amount that they can expect to get from multilateral lending institutions and raises important questions regarding the rationale for World Bank lending to middle-income countries--and whether the focus should not be on the poorer countries in the world.

One of the things to note with Mr. Wolfensohn’s tenure is that the poorer countries have not faired particularly well, particularly those in Africa. Many of these nations are handicapped by poor governance and weak institutions, and they are saddled with massive debt. This raises questions about what the World Bank should be doing towards these countries, whether debt should be forgiven, and whether one should not be moving towards grants rather than loans. We should particularly examine the role of the International Financial Corporation (IFC)--the section of the Bank which lends to the private sector, particularly to middle-income countries--given that these nations have access to private capital markets.

Nancy Birdsall
Center for Global Development

A basic priority for Mr. Wolfowitz must be to evaluate the World Bank development finance programs, as well as investments that developing countries themselves make. In a recent paper published by the Center for Global Development, we suggest that a club of nations be created with members that pay some dues and become part of a consortium to select and decide upon specific interventions, so that we could learn from and improve upon the way these interventions operate. It would also create some credibility for the investments that are working and producing results. For instance, in education, donors have spent billions of dollars. But how much do we really know about the efficiency of that spending? There is a lot of worry about the bank’s effectiveness, but there is no disagreement about what it needs to be doing. That is the vision of the bank as a development agency--itself, a kind of club, with government members--in which all of the members have some sense of affiliation and ownership and use the bank as a global forum for considering how to alleviate global problems.

Bearing in mind that 70 percent of the world’s poor live in middle-income countries (which, admittedly, have ready access to capital markets), borrowing from these countries has declined. In the 1990s, this group of countries was borrowing about $18 billion per year. Today this is now down to around $11 billion.

Why should the bank lend? Many of these middle-income countries have problematic access to capital markets in bad times. It can be risky, prices can be volatile, and there can be rapid withdrawal of access. It is reasonable to be concerned about these nations if commodity prices fall or if interest rates rise in the United States. These countries face risks on sovereign borrowing because they have shallow financial and borrowing sectors, and they face risks on exchange rates when they do borrowing in foreign capital markets. This is true of Asian nations, too. What the World Bank does is finance investments that have high social and economic returns, but relatively low or no financial returns. So access to that borrowing can complement access to private capital markets and can help countries make the decisions that are helpful for crowding in that private investment.

It is in the interests of the United States and the other rich, non-borrowing members to promote equitable growth. In many middle-income countries, for instance China, it is not necessarily politically attractive to commit resources to investments that are necessarily pro-poor. There are also security interests of the United States and other non-borrowers to encourage middle-income nations to address issues that can, if unaddressed, create global public costs (such as greenhouse gas emissions or turbulence in financial markets), so you want them at the table. For the World Bank, the money provides a vehicle for dialogue and policy advice. Although there may be disagreement about the nature of that advice, the bank’s intervention often helps nations promote reform agendas internally.

Why has borrowing by these nations declined? This can be attributed to the “hassle” associated with borrowing from the bank and the fact that the bank makes available only a limited range of products. Since 1948, the bank has offered mostly only loans that must be guaranteed by the sovereign. There are very few products to minimize risk and address insurance concerns. Although these are areas where the private sector has some appetite, for various reasons, it is not meeting the needs of all these countries. And countries also have to assume the currency risk associated with borrowing from the Bank. The Inter-American Development Bank (IDB) has been more innovative in assisting nations trying to catalyze private sector investment.

We should look at whether the bank can do more borrowing in local capital markets so that it can provide nations with loans in their own currency. The bank should develop a new loan product which would be available to countries like Turkey that have demonstrated reasonable economic management and met reasonable criteria for their approach on environmental safeguards. There should also be differential pricing, as a function of nations’ per-capita income. Richer countries would borrow at a higher cost than poorer countries. On the face of it, this might appear to reduce demand for these products, but the reason for this reduced demand is often not the price but the hassle factor. The reason for instituting differential pricing would be so that there would be no specific level at which countries are abruptly cut off from lending for reaching a certain level of income. This decision should be that of the member.

We should also move to facilitate grant-only transfers to nations below a certain level of income, who have not figured out how to grow and will not be able to be creditworthy for loans.

David de Ferranti
Brookings Institution

This is a good time for Paul Wolfowitz to come together with the shareholders around an explicit agreement that might guide the future course for the bank.

With monitoring and evaluation, we should be very careful to avoid a monopoly. This is a good time for Paul Wolfowitz to send a clear signal by embracing the independent monitoring unit that could determine which programs have been successful.

The bank must first identify the strategy--with consultation and evaluation--and then, having determined the strategy, it should then move to implement it. A lot more mileage could be gained in implementation by embracing the wheels that others have invented, rather than inventing a new wheel within the institution every time a new project is brought forward. It should work with other development institutions and NGOs--and there is even a new effort called the development marketplace that brings in grass roots efforts so that we can build on other people’s good ideas.

As to conditioning assistance on a nation’s performance, I think we have consensus on this point. I would only ask why this is so hard. Why is there not more of this? I would look to the shareholders to recognize that the pressure that comes on the bank’s staff to make exceptions to every rule is not helpful.

For low-income countries, the World Bank is moving towards grants. In regard to Africa, it is terrific that the world is getting more involved, but this is not going to be fixed overnight. Expectations are often unrealistic--economic growth in Africa will likely take decades.

For lending to middle-income countries, I agree with Nancy Birdsall that the World Bank does have a role. The bank’s lending to Latin America has not declined, as it has with other middle-income countries. The hassle factor and the limited range of products are not the only factors inhibiting this decline. It is not the case that bureaucrats are wasting time. The fiduciary and environmental standards are important. Attempts to reduce these obstacles have been watered down.

Modernizing financial instruments is very important. The leadership of the financial part of the bank needs to embrace the bank’s opportunity, potential, and role to innovate and learn from other institutions, such as those on Wall Street, who are far ahead--rather than resisting change. In fact, we should be thinking of creative ways of getting the resources to those who need them.

It is vital for Mr. Wolfowitz and the shareholders to seize this window of opportunity to aggressively address some fundamental issues, like independent monitoring, focusing the bank’s work, and cutting costs. Shareholders should also refrain from exerting lending pressure.

Allan H. Meltzer
AEI

Does the bank need to be reformed? Absolutely. We are making slow but encouraging progress. I can remember some of the scars that I bore five years ago when I suggested that we should have the bank make more grants. Now we see support for this. It is very encouraging to see that many of the African countries are now on the grants program, so we will not be talking about debt forgiveness forever. There also seems to be agreement that there needs to be better and more monitoring, and the bank needs more focus. I was very encouraged when one of the groups in the bank wrote a letter to Mr. Wolfensohn, saying that “this bank lacks focus, and the main problem is you.” That we all seem to be agreeing that things should be conditional on performance is also encouraging.

Yesterday, I received an email from a member of the bank’s staff saying that the bank faces many challenges, but is a “dysfunctional organization.” The bank has within its ranks some of the most knowledgeable people in the development area, but what it lacks is effective leadership. I agree with that completely. The letter goes on to say that although the former President Wolfensohn deserves credit for cutting the “cancer of corruption” at the center of the development agenda, too often the bank’s actions belied his words. Too often the bank fails to distinguish between client governments and the true clients: the people who are governed.

What is wrong with the bank? In one word, it is incentives--both internal and external. The bank needs a performance audit. It needs to find out what it does well and what it does not do well. It needs to either improve the things it does not do well or get rid of them and concentrate on the things that it does well. I made that suggestion to President Wolfensohn, who rejected the idea completely in his usual charming way.

Second, we need performance-based outcomes. We need to know, for example in education, not that bricks are put into schools, but that people can read and write. Developed countries have that problem too, but we are making progress there. We need to find out why these villages still lack water and sanitary facilities if the bank is spending billions of dollars.

For grants, monitored grants matter. We should only pay for performance. When we award a bid for inoculating children, we should go back and look at the children’s arms and see how many children were in fact inoculated. Why is it that the bank has fought that for so long? We can do a lot–even in countries where the government is corrupt and does not give a damn about what happens to the people in the country. We can go around them (or try to go around them) by going in with private vendors. We may need the government’s acquiescence, but we do not need to give the money to the governments and have it stolen or misappropriated.

We need an effective program for graduation. China can borrow $60 to $70 billion per year on the capital markets. It can finance any project that it wants. Money is fungible. When they present a project for a “social purpose,” they present whatever they think we will finance, and they use the money for some marginal project. The bank does not know–it is not easy to know. It is just not true that China needs the money. We need to take that money, and instead of having a grandiose scheme called “The Marshall Plan For Africa,” we need to reallocate the money into projects that are more worthwhile and make sure (according to the performance criteria) that they actually turn out to be more worthwhile.

We need independent evaluation of the Bank. The independent office of the bank is better, but it is not like the independent office of the IMF, where they go in and say how the spending could be improved. We need to have the beginnings of something that says “this works, and that doesn’t work”; make it work or get rid of it. Something might be very important to talk about, but if it does not work, then we should not be doing it.

In the last twenty years, the Chinese have lifted about 400 million people out of poverty from earning only a dollar a day. They did not do that on World Bank grants, although there were World Bank grants. It was the opening of the market, the encouragement of private investment from corporations, the fact that they have something approaching the rule of law, the fact that they have private property rights, the fact that they have opened their economy to trade fairly well, to investment--those are the things that work. Let us see if we can get that kind of institutional change. It is the hardest part of development work, but we are at the earliest stage in many of the poorest countries in getting it. If the country does not want to do it, then it does not want to develop, so we should not give them any money. We should only give money to those countries that really want to develop. That means that they must be willing to seriously do the institutional changes that are the heart of the development program.

While the 400 million people in China were being lifted out of poverty, what was happening in the rest of the world? Not a damned thing. When you looked at the number of people in the rest of the world living on a dollar a day, the number did not go down. That tells us a lot of what we need to know.

Those are the external incentives: property rights, rule of law, monitoring–these are the things that will produce reform. This is serious business--we ought not to treat it as if we were giving it the back of our hand and not paying any attention to it. It is harder to get Congress interested in the bank than it is for the IMF, where it is possible to get interest from the senator for Nebraska because it helps export wheat.

In terms of the internal incentives, the bank has a lending culture. It needs to have a performance culture. We need to not reward people on the basis of how many loans they make. That puts the emphasis on the inputs and not on the outputs. That is where the independent evaluation office can be important in asking why it is that certain programs did not work. We need to get these well-meaning, dedicated, and mostly well-intentioned people, who are seriously devoted to the idea of economic development, to be more effective.

AEI research assistant Chris Pope prepared this summary.