Wolfowitz

I've recently written an article about Wolfowitz at the World Bank for publication, so I was going to avoid the topic here. But then I found myself today reading Thursday's WSJ editorial on the subject, and it incensed me so much that I just had to fisk it. I rarely take the WSJ editorial page seriously, and I don't this time either, but this leader shares a lot of sloppy thinking with a lot of the people who both oppose the World Bank generally and who support Wolfowitz's nomination. Hence this blog.

Banking on Wolfowitz
Our World Bank sources tell us that when news was received yesterday of Deputy Defense Secretary Paul Wolfowitz's nomination to succeed outgoing Bank President James Wolfensohn, a collective shudder could be felt throughout its Washington headquarters. It's an affront to multilateralism. It will make the Bank look like an arm of American imperialism. It will spark a revival of the antiglobalization movement the Bank has tried so hard to "dialogue" with and co-opt.

This is actually true. The Bank staff reacted with dismay to Wolfowitz's nomination. This, in and of itself, should be reason enough to think twice about nominating him: the job of running the World Bank is hard enough without having to overcome the obstacle of everybody mistrusting you before you even begin.

Whatever. The World Bank is a dysfunctional bureaucracy that requires deep reform if it is to recover the trust of American taxpayers and survive as a relevant institution in the 21st century.

This might have been true at the beginning of Wolfensohn's tenure, but by this point the needed reforms are no longer deep. Most of Wolfensohn's first term in office was pretty disastrous, mainly because he was so busy stomping all over the Bank staff with his reformist agenda that he didn't actually achieve anything in the outside world. What Wolfensohn eventually learned is that development is a subtle and complex creature, and that it's better to slowly tease the Bank into what you want it to be than to try to enforce major change from on high. If Wolfowitz arrives believing that the Bank needs "deep reform", the result will be chaos for at least a couple of years, at the end of which he will have to start from scratch in building his vision. Much better that he decide where he wants to get, and then work out how to get there organically from here.

That President Bush named as talented and senior a public servant as Mr. Wolfowitz is a sign he still takes the World Bank seriously--something we sometimes find hard to do--and that he means to reshape its cash-input-driven culture, which so far has produced negligible outputs for its ostensible clients, who are the world's poor.

That President Bush unilaterally named Wolfowitz to the Bank's presidency without any kind of transparency or consultation – indeed, without even saying in advance what qualities a World Bank president needed – is a sign that the Bank's cash-input-driven culture is stronger than ever. The USA, as the Bank's single largest shareholder, calls all the shots in naming its president, and has completely ignored the rest of the world, including the Bank's ostensible clients, in trying to work out who should run it. There is, indeed, often a clash at the Bank, between what donor countries want and what aid recipients want. We can surely assume that whenever Wolfowitz has to come down on one side or the other – whenever the Third World wants one thing and the USA wants another – he will do America's bidding. The shareholders, rather than the clients, will continue to call the shots.

To gain a sense of what ails the Bank, it's useful to read the bipartisan 2000 Meltzer report on international financial institutions, which counts liberal development guru Jeffrey Sachs among its authors. The report is a bit dusty, but since the Bank fiercely resisted its conclusions, the analysis remains valid. Inter alia, the report found that 70% of the World Bank's "non-aid" funds go to 11 countries that already have easy access to capital markets, such as China, Mexico, Brazil and Thailand.

This is not the time to rehearse all the arguments of five years ago about the Meltzer Commision report; suffice to say that its main authors, Allan Meltzer and Adam Lerrick, essentially want to abolish the Bretton Woods institutions. But it's true that a lot of Bank funds go to middle-income countries like China and Brazil. Guess what? A lot of the world's poor are in middle-income countries like China and Brazil. Have a look at page 4 of this PDF file: as of 2001, the latest year for which numbers are available, there were 596 million people living on less than $2 a day in China, compared to 514 million in all of sub-Saharan Africa. If you ignore China and other middle-income countries, you ignore a huge part – probably the majority – of the problem of poverty.

Yes, it is true that China, with its investment-grade credit rating, has easy access to capital markets. Then again, it was only a couple of years ago that Brazil had no access to capital markets at all. These things come and go, and Murphy's Law states that if the World Bank leaves a country because it has access to private capital, that country will end up losing that access to private capital at precisely the instant that it needs it most.

More to the point, however, whether or not a country has access to private capital is rather irrelevant in the Bank's war on poverty. Right now you'd be hard pressed to find a single analyst who thinks that credit spreads aren't insanely tight, but even so Brazil is still trading at 424 basis points over Treasuries. What that means is that if Brazil wants to raise money in the capital markets, it has to pay whatever the US government is paying, plus 4.25 percentage points. The Journal seems to think that if any development is going to be funded in Brazil, it should be funded at market rates. But why should development in Brazil be more expensive than development in China, which is trading at just 47 basis points over Treasuries? The fact is that a lot of the calculations that go into those numbers – things like total amount of foreign debt outstanding, or the country's perceived willingness to repay foreign bondholders – are not and should not be relevant for the purposes of development.

The World Bank, it's worth remembering, is a bank, of sorts. It borrows money in the market at very low rates, and then lends it out at higher rates – albeit at levels high enough that it can make a bit of a profit on the transaction. It can lend at lower levels than the market as a whole because it has something called preferred creditor status: that is, even when countries like Argentina default on their bonds, they still pay the IMF and the World Bank in full. Chances are, if private investors could get preferred creditor status, then they too would lend at World Bank levels. In fact, if you look at the long-term returns received by the World Bank and by private investors, they turn out to be pretty much identical. The Bank charges lower interest rates, but has a lower default rate; net-net, it's a wash.

In other words, the market charges an extra premium to make up for the fact that countries default. With the World Bank, there's no premium and no default – a much better state of affairs for all concerned. There's no doubt that development projects in countries like Brazil would be scaled back or even cancelled altogether if they had to be funded at market rates. Since there are millions of Brazilians in poverty who can be helped by World Bank projects, a decision to cut off Brazil from all World Bank funding just because it has access to markets would measurably harm those millions of people.

What's more, the decision would harm poverty-stricken people in sub-Saharan Africa and other places without market access, as well. The reason is that, as we have seen, the Bank actually makes a profit on its loans to the likes of China and Brazil. The profits the Bank makes in those places help to subsidise its activities in Africa and other desperately poor areas of the world. No profits from China, less aid for Africa. It's as simple as that.

It found that beneficiary countries that do not have access to markets mostly "remain poor because their political system is unstable, private property rights are very limited, the judicial system is weak or subservient, or the government is corrupt," and that assistance to such countries "at best provides relief [and] at worst . . . supports corruption or programs that waste scarce local and external resources."

There is a germ of truth in these allegations. But the Bank is getting much better at delivering aid directly to where it's needed, and dealing with countries on a case-by-case basis. Looking at the bigger picture, however, it has always been true that some unknown percentage of all aid is wasted. It is right and proper for the Bank to try to identify and minimise that waste. It is entirely wrong, however, to use that wastage as an excuse to spend less money on aid overall.

The report also devastated the Bank's internal culture. It found "weak counterbalance to the incentive to lend" and "no penalties for project failure." It found that by the Bank's own evaluations, 59% of its investment programs in the 1990s failed.

So the bank has tough internal auditors: that's a good thing. The more that the Bank knows where it's going wrong, the more it can learn from its mistakes. Yes, there are some reforms needed within the bank, but there will only be serious counterbalance to the incentive to lend if and when Bank officials themselves actually sign off on those decisions. Much of the problem at the moment lies in the fact that loans are ultimately given the green light not by Bank officials but by the Bank's shareholders on the board of directors. Sometimes they want one thing, sometimes they want another. And although they're quick to take the credit when things turn out well, they're also quick to blame the Bank when their pet projects implode. If the Bank can get out of its current excessive shareholder oversight, it might be able to take more responsibility for its lending decisions. After all, how many private corporations have a board which meets every couple of weeks, with dozens of full-time board members constantly second-guessing the actions of the executive officers?

Finally, the report noted that while Bank lending had doubled in 30 years, to $32.5 billion in 1999, its share of overall private sector capital flows to developing countries was only about 2%, basically an irrelevance.

Private sector capital flows to developing countries do not, generally, have anything to do with the development goals of the World Bank. Let's say that Ford builds a factory in Mexico: that could be a billion dollars of capital flows right there, but it's unlikely to help the poor of Chiapas get access to cleaner water or better education. China is the classic example: essentially all of the enormous capital flows into the country are aimed entirely at the free-trade areas up and down the coast, while the vast majority of the country remains untouched by investment. Most capital flows to developing countries go precisely to the richest areas of the richest countries. There certainly aren't many private-sector capital flows to sub-Saharan Africa. In terms of development, the World Bank is anything but an irrelevance.

Upon such terrain Mr. Wolfowitz's parachute now lands. He should be prepared for some stiff resistance to his reforms, including high-level departures to whatever is the World Bank equivalent of Canada. But so be it: The Bank can hardly demand good governance of its client states if it is incapable of imposing some internal standards and controls.
Outsourcing its auditing functions--a move resisted by Mr. Wolfensohn--is just the place to start.

As we've just seen, the Bank's internal auditors are extremely tough already. There's no reason to believe that external auditors would be better, although they would almost certainly be more expensive.

Another is to steer the Bank further away from making loans toward grants, tie grants to performance, and measure performance using well-defined metrics: miles of road built, number of students graduated and so on.

If the bank moved from loans to grants, then it would make no profits, and have to go begging to its shareholders for all of its disbursements. Far from doing more what its clients want, it would be completely at the mercy of its shareholders. As for measuring performance, it sounds good in theory, but in practice it's pretty much impossible, since no one knows what the base case is. If the World Bank gets involved in Liberia and the number of people dying goes up, it still might be a lot less bad than if the Bank had not gotten involved at all. Asking for easily-measured performance goals would simply mean that the Bank would never be able to get involved in some of the most intractable problems, like those of Haiti.

Some of Mr. Wolfowitz's critics were already asking yesterday what expertise a "neo-con" security intellectual could possibly bring to international finance. But the former diplomat has plenty of knowledge of the Third World, and has seen the Bank on the ground, in stints as Ambassador to Jakarta and Assistant Secretary of State for East Asia. He served in both posts in the 1980s, when the benefits of free-market reforms were blossoming in that part of the world.
More important, Mr. Wolfowitz is willing to speak truth to power. In Indonesia, and before that in the Philippines, he saw earlier than most, and spoke publicly about, the need for dictators to plan democratic transitions.

Or, alternatively, he cravenly supported the Suharto regime. Believe whom you like.

Too bad they didn't take his advice. His predecessor at the Bank has devoted a lot of time to berating democratic donor states for being too "stingy" with their largesse, as if another $100 billion is all that stands in the way between the poor and their redemption.

Well, there's no doubt that it would help a great deal. If the US had given that $100 billion to Jeffrey Sachs rather than Paul Wolfowitz, and used it in Africa rather than Iraq, the world would today be a much better place than it is.

In fact, it is the world's dictators who are the chief causes of world poverty. And it seems to us that if anyone can stand up to the Robert Mugabes of the world, it must be the man who stood up to Saddam Hussein.

Robert Mugabe does not get any aid from the World Bank. On the other hand, most of the world's poor do not live in stable democracies. If the Bank were to give money only to democratic regimes, it would be leaving most of its clients with no hope at all. As one Donald Rumsfeld famously said, you go to war with the army you have, not the army you might want or wish to have. It's the same with the war on poverty. It's all well and good wishing that we could fight the war on a liberal-democratic playing field, but that's not the way the world is. Let's not turn global development into a mandate for regime change in developing nations.

Note: I am indebted, for many of the points I make here, to Sebastian Mallaby and his excellent book on James Wolfensohn and the World Bank. If you're at all interested in either subject, I highly recommend you read it.

Posted by Felix at 23:58 EST

Comments

Interesting. May I ask you when and where the article you mention in the beginning will be published?

Posted by: Dennis at 5:42 EST, March 20, 2005

I'm afraid it will be in the April issue of Euromoney -- not exactly easily obtainable at your nearest newsstand.

Posted by: Felix at 10:38 EST, March 20, 2005

Hmmm, suspect the good folks at the Journal were looking to replicate their editorials in support of Bolton at the UN, and assumed that they could make similar criticisms of the WB - that it's an overstaffed, bureaucratic and inefficient monster. That by the end they come out in favor of using the Bank as a source of soft money is largely, as you suggest, because it would bring the Bank further under US control.

And when you talk about board approval of bank projects, there's an interesting parallel to be made with conservative coverage of the oil-for-food program. Although many of the lapses in oil-for-food were explicitly sanctioned by the security council, the conduct of the program has been presented by the Journal, Safire, and others as an inevitable result of a liberal, do-gooding, incompetent bureaucracy.

A final point about the debates at the World Bank - the school, led by many at the International Finance Corporation, that thinks that if anything, the Bank is not commercial enough. Wolfowitz, the Journal, and the neocons, by presenting the Bank as a developmental blunt object, ignore the smaller ways, say in the development of capital markets and equipment leasing ventures, in which the Bank makes a difference.

Posted by: Gringcorp at 15:38 EST, March 20, 2005

"I'm afraid it will be in the April issue of Euromoney -- not exactly easily obtainable at your nearest newsstand."

My university subscribes to Euromoney, even though it's a one month moving wall, so I will be able to read it.

Posted by: Dennis at 16:12 EST, March 20, 2005

I agree that it would be bad policy for the World Bank to require a "democracy test" before lending.

There are plenty of "democracies" right now but there is a big difference between liberal democracies and illiberal democracies. National elections, even relatively fair ones, are only part of the process, as many emerging markets have learned the hard way. So exactly how do you define "democracy"? Merely holding an election, even if it is roughly fair, is not enough, although it is an important step.

The bigger problem with the idea of denying World Bank money to non-democracies, however, is that it would probably slow the pace of democratization. Illiberal democracies, for example, particularly those bordering failed-state status, are often those founded in really poor countries. You need a certain critical mass of per capita GDP for proper democracy to take hold. This has nothing to do with culture, it's about having a sufficiently large population that has the luxury of time and education to keep society moving in the right direction. If the World Bank can contribute to basic needs in an autocratic country, it ultimately bolsters the protean middle class. Stifling this opportunity only increases a regime's isolation - making it doubly hard for poor people to get the information, educational skills and free time required to foment political reform.

China is not a democracy, and I don't think it will become one soon, but much of that has to do with the fact that the per capita GDP remains very, very low. Visitors who swan through Shanghai and Beijing see dynamic metropolises, but miss the 800 million peasants toiling upcountry. Continue to target those peasants and improve their livelihoods, their access to healthcare and education, as well as to markets, and eventually even China will have the necessary middle-class mass to tip the scales.

Posted by: Jame at 7:25 EST, March 21, 2005

I would have liked the author to have stuck more to policy perscriptions of a proposed Wolfowitz regime and less to his personal perceptions or that of the World Bank staff. Bureaucrats in international institutions and American populist politicans have different philosophies and don't get along. In that contest, for better of worse, the American politicans have the money, and will win. Does that narative mean anything in this particular narrative? Probably not.

The author says the prior administration was disastorous, and yet we no longer need reforms in the World Bank because of it. I'm not in the World Bank to know if it needs reforms, but the argument sure needs help.

But the meat of the argument is that certain investment grade countries should qualify for development aid support. Well, its a zero-sum game, what goes to Yunnan doesn't go the Chad. Just as important, what goes to Yunnan may well free up funds to be used to extend the reach of the Chineese armed forces which, suprise, competes with the US. Help me, why exactly should the US support that displacement?

Posted by: peter at 22:07 EST, March 21, 2005

Yeah, I'll second peter's comments. Maybe development aid should be turned into a mandate for regime change.

Posted by: mike at 10:21 EST, March 24, 2005