Henry Owen. Foreign Affairs. Volume 73, Issue 5. September/October 1994.
Of great service in its first 50 years, the World Bank Group will render even greater benefits in its next 50 years if it can adjust to the vast changes that have occurred since its founding. The World Bank Group faces 2 overlapping challenges. The immediate one is to make the World Bank more responsive to the needs of the private sector in client countries, enlarge the role and resources of the International Finance Corp. (IFC), and mobilize more private capital to complement both World Bank and IFC operations—all the while taking greater account of environmental considerations, promoting greater openness in World Bank operations, and otherwise reflecting the views and interests of the non-governmental organizations. A tougher challenge, to be faced in the next century, is to decide how much to reduce the role of the World Bank and the IFC in the face of growing private financial institutions and markets in both donor and recipient countries. Support for the Bretton Woods institutions—the World Bank and the International Monetary Fund—may not last the next 50 years, nor should it, unless the World Bank Group’s ends and means are radically revised to keep pace with a changing world.
A Child of War, a Parent of Prosperity
Of great service in its first 50 years, the World Bank Group will render even greater benefits in its next 50 years if, unlike most institutions, it can adjust to the vast changes that have occurred since its founding. These changes require the World Bank Group to make substantial policy and posture shifts. To examine such shifts wisely, one must first look at the record.
In country after country, the World Bank has made a difference. To take but one example, its aid has been a major factor in making India agriculturally self-sufficient. When that vast realm became independent after World War II, it had endured a tragic wartime famine, which was renewed evidence of the fragility and inadequacy of its agricultural system. Since then, large-scale financial and technical assistance by the World Bank has greatly strengthened Indian agriculture by increasing food production, expanding reserves, and improving distribution. It has transformed the lives of hundreds of millions of people on the Indian subcontinent. And by relieving the pressure of India’s food purchases on world supply, the World Bank has improved the global food situation and, as a result, international economic prospects.
This sequence of events illustrates a broader point. The world economy went forward after World War II, rather than receding as it did after World War I, in part because the Bretton Woods institutions—the World Bank(1) and the International Monetary Fund—met the need for international banks of last resort The absence of such institutions in the 1930s prolonged and deepened the Great Depression. After World War II, most of the world lacked investment capital. Governments, except for the United States, could not provide that capital; they were too poor. Private financial markets were small and cautious. The World Bank filled some of the gap. With guarantees from its founding governments, the Bank was able to raise substantial funds, which it put to good use in restoring a devastated world. Then it took on the greater and longer-term task of spurring economic development. The Bank’s operations grew in scale and diversity, and the benefits of its work spread around the globe.
Over time, two deficiencies in this work became evident. Since the Bank’s money was largely raised in private markets at market rates of interest, its loans were necessarily extended to borrowers at those same rates. Such rates could not be paid by certain poor countries, particularly in South Asia and Africa. The International Development Association was created as a remedy in 1958. Its loans were subsidized by donor government grants to the IDA, and thus could be made at below-market rates. The IDA’s success is reflected in the fact that the number of countries requiring such “soft” loans has steadily declined, due in part to the development assistance received from the IDA.
Moreover, the World Bank was founded at a time when governments were the main economic actors in the world. The fact that the Bank was prohibited by its articles from making loans that were not either directed to or guaranteed by governments initially posed no problem. As private sectors grew in developing: countries, however, it became clear that the World Bank Group’s effectiveness would be limited if it could not find ways to help that sector. This deficiency led to the founding of the International Finance Corporation, which is prohibited from lending to anything other than private entities, and which can also invest in these entities. More important, it serves as a catalyst in mobilizing the debt and equity resources of private entities in the industrial world to join the IFC in aiding developing countries. The Multilateral Investment Guarantee Agency was created for the same reason, and it is now operating on a large scale.
There were other important changes in the World Bank Group as it grew and learned from experience. A couple are worth special mention. The World Bank has played a growing role in stimulating and coordinating research and development of new technologies that have proven to be especially relevant to developing countries, particularly in agriculture. The World Bank’s agricultural research coordinating group has contributed much to the “green revolution,” which contributed so much to economic growth in the developing world.
Increasingly, the Bank also coordinates the actions of other donor agencies and governments. It periodically convenes and chairs country committees of these donors. Such meetings have helped to convert unrelated national and multilateral aid programs for such key countries as India into reasonably integrated international efforts.
Further coordination will be needed of bilateral aid programs, projects of regional multilateral development banks (MDBS), and World Bank efforts—particularly in Eastern and Central Europe, Russia, and other former Soviet states. At present, close contact between MDBS and bilateral aid programs directed to Eastern Europe appears to work. In some cases, however, avoidance of duplication is not enough; integration of specific programs is necessary. For example, assembling the huge funds needed to finance the building of new power plants in order to replace or upgrade dangerously outmoded nuclear power plants in Eastern and Central Europe and the former Soviet states requires the combined efforts of the World Bank, the IFC, the European Bank for Reconstruction and Development (EBRD), and the European Investment Bank.
For this, some new, tighter ad hoc means of integration should be sought. The question of coordination of aid also arises in regard to the regional development banks. So far the coordination between the World Bank and the Inter-American, Asian, and African development banks has been informal. The World Bank Group needs to take a larger lead role in ensuring that this coordination is effective.
One reason the World Bank has been able to play the varied, useful, and innovative roles described above is that it is well staffed. The caliber of its top management and staff is high. The attractions of international service to humanity and high salaries have helped in this regard. Its benefits are only partly offset by the internal management problems so vividly described in the publicly available report of Willi Wapenhans, a high-level World Bank official: too many committees, too much paperwork, too many clearances required in Washington, and too little inspection of ongoing projects and other follow-through in the field. Steps to remedy those defects are being taken, but will take time.
Some critics argue that too much of the Bank’s work has been focused on huge projects. The appropriate response to such a criticism is a question: How does one dam a great river, so that irrigation and power will be available to poor farmers, without constructing a large project? The Bank’s projects should be judged not by their size but by their effects. Does the project help or hurt in the war against poverty? In many regions, the Bank’s projects clearly have helped. Per capita income of both rich and poor people has substantially increased in the countries that have received the most Bank aid. The answer is less clear in some African countries, and there the Bank’s strategy is being reexamined. In other African countries, progress is being made, and the Bank’s loans seem to have helped.
Changes in Clients and Donors
Among the World Bank’s clients, a significant number of emerging market economies, particularly in Latin America and Southeast Asia, have made sufficient progress that they can increasingly rely on private markets to finance their growth. Most of this financing comes from the industrialized world; some of it comes from within these countries, where stock markets have expanded significantly. In those countries, governments are no longer the main economic actors in nonfinancial sectors; increasingly, manufacturing and service industries are being privatized.
The Czech Republic, Hungary, Poland, Slovakia, and Slovenia, among the countries of the ex-communist world, have embraced not only political democracy but also market-oriented economic systems. The World Bank and the IFC have moved vigorously to help the governments and private sectors of those nations, so that economic improvement can follow and reinforce political change. Although those countries’ economic problems have not been solved (witness the recent victories by ex-communist parties in Hungary and Poland), substantial progress has been made. Much more progress will be needed if those revolutions are to be preserved.
The changed economic situation in Eastern and Central Europe is very different from that in Russia and other former Soviet states. After some seven decades of communism, Russia and other former Soviet states have lagged behind the rest of the world much longer than has Eastern Europe. As a result, the economic outlook in Russia is more uncertain: the difficulties and the needs are greater, the per capita capacity to absorb investment is less, and the local capital markets are less developed. So it will be more difficult for the World Bank Group to hasten economic progress in Russia and the other former Soviet states than it has been in the Visegrad countries.
China is a World Bank client in which there has been truly revolutionary economic change. Chinese skills and entrepreneurial talent are now being given a looser rein within the limits set by a government that is largely bent on preserving public ownership of some key means of production. China’s political uncertainty may cast a shadow over the long-term economic outlook. In the meantime, the great economic progress being made in China is the biggest challenge confronting the World Bank Group, and it is one that the Bank’s government-centered traditions are well suited to meet.
Great change is also evident in South Africa. The World Bank is at the heart of both public and private international efforts to help this renewed country. Prospects for success are reasonably good, given the considerable talent and infrastructure available there, so long as moderate fiscal, economic, and politic policies are maintained and so long as the World Bank can stay the course. Private investment from abroad will not take its place until the political outlook is more certain.
The World Bank Group is also assembling an international group of donor countries and agencies to help the new Palestinian entity that will emerge on the West Bank. The object is to exploit the substantial skills and assets in this region to complement and reinforce the recent unexpected political progress there with necessary economic advances. The obstacles are enormous, but the promise of its access to the rich Israeli market is also considerable.
Two conclusions flow from these changes in client countries. Although private sectors and capital markets in developing countries are growing, an effective World Bank Group is still useful. The Bank is needed to help the public sector (particularly in health education, and infrastructure), even in rapidly growing countries, and the IFC is needed to help the expanding private sector. If you add the new requirements in Central and Eastern Europe, Russia, other former Soviet states, China, South Africa, and Palestine to the ongoing need to help eradicate poverty in areas such as South Asia (which is making considerable progress) and Africa (which is not), a strong case for a continuing and effective World Bank Group emerges.
The second conclusion is that although the nature of the World Bank Group services needed will vary from country to country, the changes transforming many of these countries have this in common: they will greatly enhance the roles of private sectors and reduce the roles of governments. The relative size of the operations of the World Bank, which can only deal with governments, and the IFC, which can only deal with private entities, may thus eventually be reversed in the most rapidly growing countries. These include, as noted, certain Latin American and Southeast Asian countries and South Korea. India is also on its way.
The dramatic growth of the private sectors in donor countries was the force that radically transformed the international economic order over the last 50 years, In the industrial countries, private capital markets can now mobilize vast sums of money and move them back and forth over great distances in a matter of seconds. More and more of the needs of the most advanced developing countries will be met by private investment banks, commercial banks, investment trusts, pension funds, insurance companies, and other large sources of private capital in the industrial world. The amount of private capital now moving from industrial to developing nations, although less than that which circulates within and among developed countries, dwarfs that moving from the World Bank Group and other multilateral development banks.
In effect, the financial power that was once wielded by governments has both grown and been dispersed. Part of that power has gone to such supranational institutions as the European Union; part has gone to subnational regional institutions; and a large part has gone to private businesses and, to a lesser extent, nonprofit organizations. The World Bank Group must therefore shape its future in a world where the nations that are its shareholders are no longer all-powerful. It must respond to the claims and views not only of the national governments that created the Bretton Woods institutions, but also of other governmental and nongovernmental organizations (NGOS) in both donor and recipient nations.
Adjusting to Change
The World Bank Group faces two overlapping challenges. The immediate one is to make the World Bank more responsive to the needs of the private sector in client countries, enlarge the role and resources of the IFC, and mobilize more private capital to complement both World Bank and IFC operations—all the while taking greater account of environmental considerations, promoting greater openness in World Bank operations, and otherwise reflecting the views and interests of the nongovernmental organizations that now do much to shape the international economic scene A tougher challenge, to be faced in the next century, is to decide how much to reduce the role of the World Bank and the IFC in the face of growing private financial institutions and markets in both donor and recipient countries.
One way of meeting the Bank’s first challenge would be through amendment of its articles which prohibit loans to the private sector unless they are guaranteed by governments. However, such a move might trigger pressure to amend other articles and thereby endanger the Bank’s effectiveness. Alternative ways exist for the Bank to help the private sector. As a precondition for lending to governments, the Bank could require governmental actions—for example, tax reform and privatization—that assist the private sector. The Bank is already moving forcefully in this promising direction. And the Bank can single out for special attention projects that will more directly assist specific private ventures. It can, for example, help finance government-owned transportation and utilities in regions where they are needed for new business and manufacturing ventures. This would be in addition to the Bank’s support for nationwide health and education programs that help create an environment conducive to progress in both the private and public sectors.
Another approach would be for the Bank to secure performance guarantees, instead of repayment guarantees, from governments in recipient countries, and thus help the IFC to lend to private ventures whose prospects are improved by those guarantees. Finally, the Bank can give substantial aid to intermediaries, like government-owned development banks, which help the private sector. This has been done and has been useful. In some cases, however, it has drawn criticism on the grounds that such intermediaries compete with private banks and thus retard growth.
These examples illustrate a general point. The Bank can help the private sector, even without amendment of its articles, if there is change in its traditional culture, which has tended to focus on government projects. This, of course, requires a conviction on the part of the Bank’s management and staff that helping the private sector is their highest priority in emerging market countries. Also, it requires the Bank to rely increasingly on securing cofinancing from private sources. In Russia and other former Soviet states, the Bank’s efforts to change the recipients’ policies toward the private sector will be at least as important as its efforts to deliver more resources to governments.
The IFC, unlike the World Bank, can make both equity investments and loans within the private sector and can put together deals involving private banks and other financial institutions to leverage its limited capital. Its record in doing both is so impressive that private capital markets have allowed it to raise money on terms at least as favorable as those secured by the seemingly more conservative World Bank. The IFC’s resources are now adequate, but its tasks are multiplying rapidly, particularly in the financing of power, telecommunications, and transportation projects. Those needs are great and growing in developing and ex-communist countries. Experience suggests that they can be met most efficiently under private ownership and management. If these growing infrastructure needs are not met, economic growth will be retarded in these countries.
Even if due precautions are taken to avoid IFC competition with private financial institutions, vast sums will be needed by the IFC. The IFC can finance part of this increase by its recent move toward a gearing ratio that requires less reserves for its operations, by reshuffling its priorities, and by securitizing (selling off) some of its high-quality loans and investments. But the IFC would probably also need new money from the World Bank or donor governments if it were to expand its activities beyond the planned 10 percent rate to, say, 15 percent The expansion of infrastructure financing will be a major factor in deciding whether this happens.
There are several ways this program can be accomplished. Existing IFC programs could be enlarged, or the IFC could launch a global infrastructure fund in which other multilateral development banks and private financial institutions could invest. Alternatively, the IFC and the EBRD could jointly create and manage an infrastructure fund for Eastern and Central Europe and the former Soviet states. Such a fund could help to finance new power plants to replace dangerous and outmoded nuclear power plants in these regions. If a European infrastructure fund were created, it could be followed by the IFC’s creation of infrastructure funds in cooperation with the Inter-American and Asian development banks for projects in their respective regions.
In all such infrastructure. funds, private participation and investment should be sought. The objections of private investors to the long-term loans required for infrastructure financing might be alleviated by greater use of the World Bank’s guarantee authority, not so much in providing guarantees of repayment as in providing guarantees of performance.
Eventually, external financing of infrastructure and almost all other profit-making enterprises, in all but the poorest countries, can be provided by private financial markets. Even in the long term, however, there will be a continuing need for some World Bank Group programs. There will be governments that prefer dealing with the World Bank and some countries that only the World Bank will be willing to take on. When people suggest that the Bank should eventually limit itself to advising client countries, we should remember that the Bank’s advice will be taken more seriously if it is accompanied by loans. It will be a long time before the private markets can finance the health and education programs that the World Bank now supports in poor and rapidly growing developing countries. The IFC will remain the preferred means of aiding the private sector in countries where political risks deter many private lenders and investors.
The IDA will remain a special case. It offers loans below market rates and must therefore be subsidized by governments. Their desire to make these transfers is waning in the face of budget stringencies. The need of sub-Saharan Africa and certain other regions for aid on concessional terms will continue. It may be necessary to raise the level of transfer payments to IDA, if poverty in such regions is to be overcome by new investment.
Toward Effective Cooperation
With increasing reliance on private institutions to move financial resources to the developing world, the question arises as to how they use their resources. Do they help to meet the recipient countries’ needs, or do they merely multiply their own wealth? In fact, it is hard to do one without doing the other. If an investment yields a large return, the goods and services that it produces must meet a large and effective demand. The market generally rewards ventures according to their economic usefulness. So a private financial institution that responds to the market is usually doing not only well but good.
The increasing shift to private sources of development financing will thus not cause as great a change in the priorities of either donor or receiving countries as might be supposed. This is all the more true because of the growing role of nonprofit and nongovernmental organizations in the private sector. Increasingly, they shape the environment in which both multilateral development banks and for-profit financial institutions must work. NGOS are not new. What is new is the growth in many countries of a large, reasonably well-off, educated middle class that leads and supports their work, championing such causes as family planning, the environment, and the role of women in economic development, and doing so more because of its ideals than because of economic self-interest.
World Bank policies are not likely to change as rapidly as some NGOS want. The optimum balance between environmental and antipoverty goals is not always clear. This, along with the slow pace at which a large organization like the World Bank Group can change its policies, even when the merit of change is clear, has led some American NGOS to oppose continued appropriations for the World Bank Group. This attitude poses a threat not only to the Bank but to the IDA, since there are already serious objections to its continued funding because of tight budgets in the donor countries. NGO opposition, added to these objections, could push the IDA over the edge, which would help doom at least 100 million people in Africa to continued economic stagnation.
NGO criticism of the World Bank is but one example of a more general phenomenon. The World Bank Group does not have much of a constituency, at least in the United States, where its work is little known or understood. The result is that there are often pressures for starting less efficient ad hoc aid programs to do what the World Bank Group is already well-equipped to do.
One way for the World Bank Group to secure the public support it needs would be for it to be more open and disclose information about its views and deeds. This is now being done. The Bank must also seek to create new and closer relations with NGOS in both donor and receiving countries. Not only do NGO views deserve attention, NGOS can sometimes work with the Bank in shaping and executing needed programs, as they are now doing in some developing countries.
Over the years, the World Bank Group has been criticized from the right for preferring public-sector projects over private-sector development. Of late, more pronounced criticism from the left has contended that the Bank pays too little heed to the “little man.” The record shows otherwise on both counts, but a good record is not enough. Support for the Bretton Woods institutions may not last the next 50 years, nor should it, unless the World Bank Group’s ends and means are radically revised to keep pace with a changing world. The time to start changing is now.