Successful official financial institutions, whether national or international, supply what social scientists call public goods: outcomes that benefit many specifically but everyone generally, despite that fact that the production of such goods often requires some to pay disproportionately to sustain them. Thus, a decision to supply public goods can be in the U.S. interest, but has an altruistic twist: Providers pay but still benefit, even though recipients benefit more.
As World War II came to an end, the United States and Great Britain agreed on the need to create public goods for international finance, lest a mess on the scale of the pre-war situation make a stable, peaceful recovery more difficult. As part of their commitment to an international system based on more open trade, an end to trading blocs and a program for economic growth based on markets and competition, they set up rules for international economic policy designed to avoid currency competition and provide more certainty about exchange rates. Thus, in 1944, three new institutions designed to supply public goods arose at Bretton Woods, New Hampshire. Most states accepted the rules for exchange rates and signed the charter of the International Monetary Fund. Most endorsed what became the General Agreement on Tariffs and Trade, the GATT. As something of an afterthought, they also agreed to establish the International Bank for Reconstruction and Development, later called the World Bank, to help finance recovery from the war. The Soviet Union participated in the meeting, but elected not to join the Bretton Woods institutions.
Looking back today, it is clear that this provision of public goods has been a resounding success. More people in more places have gained under the new rules than in any previous era. Living standards have risen, poverty has lessened, and life expectancy, health and education have all increased thanks to the supply of public goods afforded, in part, by the Bretton Woods institutions.
Much of the success resulted from the GATT’s large reduction in tariff barriers and other restrictions on trade, and much of the GATT’s success was a product of very supportive U.S. policies. Both the United States and Europe, and then much of the rest of the world, have benefited greatly overall, but some American industries and their workers, and then some European industries and their workers, have suffered from the structural adjustments enabled by a more open trading system. The failure of leaderships to handle the political implications of these structural changes means that both European and American publics have become less willing to supply additional public goods, as we have seen from pressure in the United States to modify the North American Free Trade Agreement and the failure of the Doha Round of tariff reductions. Thus, one of the three principal postwar international arrangements, the GATT (later the WTO), seems unlikely to remain as important in the early 21st century as it was in the mid-20th. That is unfortunate, but with wise and effective leadership in the United States and abroad, it is not an irreversible trend.
The IMF, too, has had a reasonably good run in the shadow of U.S. policies. But it had to reinvent itself to do so. An IMF created to be the lubricant and buffer in a system of fixed exchange rates changed its mandate to one in which it served as a quasi-lender-of-last-resort and a pedagogue of macroeconomic orthodoxy to a succession of economic truants. Its resources were limited but adequate for the problems arising before capital became highly mobile—although how good a teacher the IMF really was is open to debate. Now, however, the IMF’s funds are very modest (indeed, it is running a $200 million deficit), and capital is plentiful and very mobile. Thus the second coming of the IMF, so to speak, is now nearly as obsolete as the first.
If the IMF were abolished, the world would not suffer greatly. But it would be wiser to reform the IMF into a smaller organization with two specific responsibilities. First, as current international financial instability suggests, there is still a need in extremis for a standby quasi-lender-of-last-resort. The IMF would no longer be responsible for bailing countries out of their problems, but only for preventing a crisis in one country from spreading to others. Its loan to Uruguay following Argentina’s default in 2001 is an example of this policy.
Second, though private lending is now much larger than lending by international agencies, improvements in the quantity and quality of information can still contribute to lower risk and the more efficient functioning of international financial markets. This is an important role the IMF could play effectively. These two roles—preventing the spread of crises and improving the quantity and quality of information—require a smaller IMF. This is precisely what the Obama Administration should pursue.
While the Administration should save the WTO and reform the IMF, there is really no point of doing either with regard to the World Bank. It has been marginal at best and a bust all along at worst—and probably on balance counterproductive to its own mandate of stimulating economic development.
The Bank’s first mission was the reconstruction of war-torn Western Europe and Japan. As things turned out, its role was minor. The Marshall Plan was a larger factor in Europe, and spending for the Korean War helped both Japan and Europe to recover economically more than anything the Bank did. Nor was the Bank a major part of the motivational ensemble of postwar developments; rather, it was the U.S. interest in getting its allies to oppose the spread of communism that helped revive and strengthen Western Europe.
The Bank next turned its attention to economic development in newly independent less-developed countries. At first, it mainly financed infrastructure, building roads and dams in many countries. Farm-to-market roads increased economic opportunities, but in many countries these new opportunities never developed into self-sustained growth because governments controlled agricultural prices to subsidize city dwellers. Price controls probably destroyed any major benefits of the Bank’s rural-sector lending, yet the Bank did not require an end to price controls as a condition of its loans.
After Robert McNamara became World Bank president in the late 1960s, the Bank changed its focus from infrastructure development to poverty reduction, and later to social and cultural concerns such as the role and treatment of women. Attractive as these objectives were, the Bank did not know how to achieve them. Of the several dozen countries designated as “least developed” several decades ago, only one ever graduated from the list despite all the foreign aid and World Bank programs designed to generate sustained growth. By the late 1990s, Bank President James Wolfensohn had finally recognized the obvious: Development policies only work when local politicians create social coalitions to support pro-growth policies. When they instead choose to sustain the hierarchical and corrupt non-democratic practices that keep them in power, no international provider of public goods can make much difference.
The World Bank was very slow to recognize this truth, and in the meantime the internal culture of the Bank evolved in such a way that compensation and promotion rewarded lending regardless of its consequences. The bureaucratic incentive structures within the Bank today warp the system to favor making loans even when their genuine development potential is small or non-existent. Bank staff have consistently opposed all efforts to curtail lending to the most corrupt countries, with the support of some member governments.
The Bank seems incapable of reforming its procedures to reduce corruption, or even to take it sufficiently into account in its practices. One of the reasons may have to do with the Bank’s own corrupt practices. Independent experts led by Paul Volcker have investigated the Bank’s own role in abetting corruption through corruption. They have found significant resistance by the staff and some of the leadership to the work of the Bank’s investigative group. This is not surprising, since the Bank’s own internal investigation found more than two thousand cases of alleged staff fraud, misconduct or corruption between 1999 and 2007.
Partly as a result of these revelations, last September the U.S. Senate approved a resolution introduced by Senator Evan Bayh (D–IN) calling on the World Bank to pay more attention to measuring results. The resolution called on the Comptroller General to measure the success of the projects financed by the Bank’s International Development Agency (IDA). This resolution followed on the conclusion of the International Financial Institution Advisory Commission (IFIAC), established by Congress in 1998 (which I chaired). The Commission was appointed by Congress as part of the legislation to increase IMF resources by $100 billion. The Bank’s success record is poorest in the poorest countries—precisely the countries where it should be investing the most and having the greatest successes. This very fact explains why the IDA and the Bank continue to subsidize loans in middle-income countries: These countries are more likely to complete projects, so they raise the Bank’s average record in a way that partially hides the poor results in impoverished countries.
The fact is, however, that the world’s private financial markets now consider many middle-income countries creditworthy, enabling them to borrow from private investors. Several studies have therefore concluded that the Bank and IDA should not subsidize loans to these countries. The Bank argues correctly in riposte that there are many poor people in middle-income countries. What it fails to say is that many middle-income countries can finance poverty programs and income redistribution in the capital markets or from domestic resources, if they choose to do so. As Senator Bayh noted, the vast majority of World Bank lending today is in countries that do not need the Bank any longer. The Bank’s raison d’être ought to be about getting results in the poorer countries that are not creditworthy in international markets. Here we come back to the problem of corruption and the Bank’s inability or unwillingness to do anything about it.
The Bank’s defenders often argue that its lending still benefits “the poor” even if some part of the loan is misappropriated or stolen. Such a claim would be plausible, save for the evidence.
For starters, even the Bank’s own unreliable statistics on its achievements show little evidence of success in helping the poor. Independent analyses show even less. A recent study by senior IMF economists concluded that foreign aid does not increase economic growth at all. Aid can encourage development in some countries, but in others it can deter it by helping ruling cliques sustain anti-growth policies. A 2007 report by a Canadian Senate committee concluded that more than $12 billion in bilateral aid had not changed living standards in sub-Saharan Africa. The reason: bad government and corrupt leadership. The U.S. Government Accountability Office evaluated a $14 billion child-survival program financed by USAID and found absolutely zero evidence of positive results. The British development economist Paul Collier has found that less than one percent of the funds granted to Chad for rural health clinics was actually used for their intended purpose.
These and other studies have also offered broader appraisals of why the Bank’s programs fail. The Bank, they all say, has too many programs and too little accountability. It fails to develop regional programs. It rewards lending, not poverty reduction, which would require it to measure results—something it seems not to know how to do. It does little to prevent corruption, and it drives out presidents like Paul Wolfowitz who want to focus on doing more.
Senator Bayh has urged the Bank to adopt some of the principal internal reforms proposed by the IFIAC. The first proposed reform called for reduced lending to middle-income countries. The second requested a performance audit by an external examiner to learn which programs are effective and which are not. The Bank refused both recommendations. Instead, it changed the name of its Operations Evaluation Department to the Independent Evaluation Group, but it has continued the practice of using Bank employees to staff the unit. There is nothing independent about it, and it is folly to expect an in-house evaluation group to criticize the performance, ultimately, of those who have hired them.
The Bank’s major failing, however, is common to aid programs in general. The Bank has not accepted two principal lessons about development and poverty reduction. The first is that development is not something that can be decided in Washington. The developing country’s leaders must be willing to make the changes that promote or encourage development. The second is that development is much more likely to occur when a country protects property rights, adopts and maintains the rule of law, encourages freedom, and opens the economy to trade and foreign investment. In other words, economic growth and poverty alleviation are not about economics as a technical exercise; they are about political economy—the critical intersection of power and wealth in a society. It is impossible to change a social system to generate economic growth without affecting the dynamics of that intersection.
Look at the experience of China and India before and after they undertook market-opening reforms. Before reforms, poverty was widespread; afterward, poverty indicators in both countries plummeted (more in China than in India because China’s economy is the more market-driven of the two). World Bank lending played a minor role in both countries compared to private capital inflows. Institutional change driven from the political echelons in these countries, above all, made the principal difference.
Until about twenty years ago it was possible to argue that the Bank provided a public good: loans to countries that could not secure them in any other way. But that is no longer the case. There is plenty of capital available for countries that adopt promising development programs. Even China, Singapore and other formerly poorer countries now supply capital to the developed countries, and this at a time when some observers still try to justify World Bank lending to China!
Indeed, the Chinese government has become a major supplier of capital to Africa on terms that the borrowers find more attractive than the World Bank’s offerings. At first glance this is surprising, since the Bank’s IDA facility has lent at a low (0.75 percent) rate for as much as forty years with an initial grace period. As the loans became due, moreover, the Bank’s directors forgave many of them. But from the perspective of the borrowing countries, the principal cost of the Bank’s loans has not been financial. It has been instead the hectoring and advising from the Bank’s management and staff. Some governments would now rather pay China a higher interest rate just to escape condescending chatter from World Bank economists who do fancy sums and can draw up colorful PowerPoint charts, but who simply ignore political realities in the countries they say they are trying to help.
It is hard to escape the conclusion that the World Bank no longer provides public goods, if it ever did. It follows that those who bear the brunt of the costs are no longer getting their money’s worth. Perhaps the Bank could again become a provider of public goods, if it were prepared to reform itself sufficiently to do so. But every attempt to nudge the Bank to adapt to new circumstances has failed. Not only does the Bank no longer have a special role, it has resisted acquiring one. Instead of showing others how to be dynamic and grow, poor and corrupt countries seem to have taught the Bank how to lock itself in stasis and resist all change. It should therefore be closed. Maybe then its remaining clients will finally be induced to undertake the reforms that would permit them to borrow from private capital markets.
Counterpoint: Katherine Marshall—The World Bank is the fittest, most experienced institution we have to address the problems of development.