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By Nathan Smith : BIO| 17 May 2020
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In the wake of the recent "scandal," existential questions are being asked about the World Bank. Desmond Lachman, in these pages, questions "the World Bank's continued relevance in today's global economy." Lachman ultimately thinks "the world still very much needs a World Bank," but others do not. For columnist George Will, the Wolfowitz scandal is a "silly but useful" occasion for the world to notice that "the bank's rationale, never strong, has evaporated." That's always been the libertarian line. Small-government conservatives who have thought it through may agree.

Let me present a case for the other side: that the World Bank is an institution which, if it did not exist, would be worth inventing. Even more important, I will try to throw light on what the World Bank, an institution little understood by the public, is and does.

Full disclosure: I have been employed for the better part of the past four years at the World Bank on short-term contracts. The views expressed reflect that experience. But of course they are entirely my own, and do not represent those of the World Bank.

Basic Government Functions

Even conservatives like George Will want the government to play some role in the economy. In education, conservatives agree that government should at least finance primary and secondary education, even if some would prefer that financing to be channeled through vouchers. Conservatives want the government to provide roads and a stable currency, and to enforce contracts. Most support some regulation of competition and finance. Most would agree that government should play some role in public health (e.g., sewers, litter, contagious diseases).

That list of basic government functions includes most of what the World Bank helps governments to do. So why is the World Bank even controversial?

A great merit of the World Bank is that it lies athwart the matrix of sovereign states. This is one of the things that makes it hard for the public to understand its function and purpose.

So it is helpful to think of the World Bank and its mission in the context of the world economy. World trade growth has outpaced world economic growth for decades, making the economy increasingly globalized. The result is anomalous: Production and trade are increasingly conducted on a global stage, while economic governance remains, for the most part, national in scope. The anomaly is partly rectified by international institutions like the World Bank, the International Monetary Fund (IMF) and the World Trade Organization (WTO).

Nobody wants a United States of Earth, of course. And there's an economic as well as a political advantage to having lots of countries that run their economies in their own way: it creates policy competition. Countries with good business environments attract more economic activity, and other countries are forced to play catch-up. Case in point: French president-elect Nicolas Sarkozy won on a reform platform because the French could look at other economies and see that their model was not working. This is also why federalism is a good idea in the US: states can try out new policies, which can then be observed, copied or adapted... or not.

But it's good for business for some aspects of economic policy to be conducted over the entire relevant economic space, whether that be the United States, or the world.

Trade, Currency, and Miscellanious

Think how inconvenient it would be if all the American states erected customs barriers against each other and could exact any tariffs they wanted. We would all be poorer for it. The US constitution prevents this by giving Congress the power to regulate interstate commerce.

At the global level, the WTO has a similar role to play. By regulating tariffs and trade barriers, the WTO helps to prevent a contagion of beggar-thy-neighbor trade policies. Once, back in the 1930s, an outbreak of protectionism turned a US downturn into a worldwide depression. It could be even more devastating in today's more interdependent world.

Again, imagine that there was no Federal Reserve and all the states had their own currencies. Every time you crossed from Virginia to Maryland, or Nevada to California, you would have to change money. The Virginia-Maryland exchange rate would constantly fluctuate. All cross-border transactions would involve exchange rate risk. Speculators would trade trillions of Virginia, New York, and Nevada dollars in the currency markets every day. Sometimes a state's currency would crash, and its citizens would lose their savings.

Of course, this unsatisfactory situation still prevails in the world economy. The IMF was supposed to save us from it, not by providing a universal currency as the Federal Reserve does, but by supporting a system of fixed exchange rates. From 1946-71, under what was known as the Bretton Woods arrangement, you always knew how many pounds, francs, or marks you would get for your dollar next year. But Bretton Woods collapsed in 1971.

Since then, the IMF has tried at least to be a "fire-fighter," intervening to prevent disastrous currency crashes. It may be losing even that role. Developing countries seem to have been so unimpressed with the IMF's performance during the Asian crisis of 1997-1998 that many now prefer to self-insure their currencies by accumulating huge reserves of US dollars. In most developing countries, even those that still have their own currencies (El Salvador and Ecuador have adopted the US dollar as their currency), a large proportion and sometimes even a majority of bank deposits are denominated in dollars. This is one of the reasons the US trade deficit has grown so big: we're selling money!

So in the world economy, the real analogue of the Federal Reserve may now be, not the IMF but... the Federal Reserve.

If trade is the WTO's beat, and the IMF's is currency, the World Bank's seems to be "miscellaneous." It does infrastructure: builds roads and railroads, bridges and ports; upgrades power grids and gas distribution networks; promotes accessible drinking water. It does education: builds schools; helps draft curricula; provides textbooks; trains teachers; provides scholarships; expands and reforms universities. It does business climate: promotes property rights; eases licenses, red tape, and other barriers to entry; and ranks countries for "ease of doing business" in its annual Doing Business reports, to keep the pressure on. It does health care: builds hospitals and polyclinics, fights AIDS and malaria. It does governance reform: promotes transparency of public finance, helps to design and implement competition and procurement laws, assists with judicial reform. All this is done in collaboration with national governments.

There is no analogy to the World Bank in the US federal model. Instead, another pair of analogies can help to illuminate it.

Arbitrageur of Good Policy Practice

First: in the 1990s the New York Police Department under police chief William J. Bratton developed more effective crime-fighting tactics which drove down the crime rate. Later, some New York cops got high positions in other city police forces that hoped to emulate the NYPD's success. Now hold that thought.

Second: think of a multinational corporation. Coke invents a soft drink that people like. It would be stupid for Coke only to sell it in the United States. Coke would make less money, and foreigners would miss the chance to enjoy it. So Coke sells its beverage everywhere. Or when Honda develops a great car, they don't sell it only in Japan. They go global, giving customers worldwide a chance to drive it.

Now, the NYPD, Coke and Honda, are all examples of diffusion of good ideas: an idea is developed in one place, its merit is recognized, it spreads elsewhere. Diffusion of ideas is helpful in both the private and public sectors, but the process is more straightforward in the case of Coke and Honda. The NYPD cannot set up shop in Providence or Miami and sell its crime-fighting services. Policy is run by governments, and governments have jurisdictional boundaries.

Governments everywhere share many of the same objectives, and face many of the same problems in realizing them. Spreading good ideas about how to reform a school system is as useful as spreading good ideas about how to make a soft drink. But if a superintendent in, say, Poland comes up with a great new way of supervising teachers, his school system cannot do an IPO and then open subsidiaries in Cambodia and Pakistan and Rwanda to spread its good idea. Nor is it feasible for the Cambodians or Pakistanis to hire Polish superintendents to bring them the new-and-improved techniques, the way Providence and Miami might hire NYPD cops. For one thing, Poles don't speak Urdu.

This is where the World Bank comes in. World Bank staffers, a multinational lot to begin with, are constantly being shuffled from region to region, and exchanging views with colleagues working on other countries. So when they go into meetings in ministries, they are listened to because they bring the voice of international experience. In short, the World Bank is an arbitrageur of good policy practice.

But aren't we talking about a "bank" here? What does all this have to do with lending?

Two Kinds of Lending

It is instructive to ask: If the World Bank were being created from the ground up today, would it be a lending institution at all?

As an alternative, the "knowledge services" of the World Bank might be run more like a consulting firm, solving specific problems in return for fees, or like a university or think tank, doing original research to develop policy ideas which developing-country public officials could then be trained to implement. Aid might take the form of grants.

But when the World Bank was founded, people thought that what poor countries needed was not better policies, but simply capital. Supply them with the capital they need, and their economies would grow, so that it would be easy to pay the money back later. That worked in Europe, the Pacific Rim of Asia, and some other places. But where growth failed to occur, and countries ended up still poor, and now, to add to their problems, intractably indebted.

Probably, in these countries, loans were not the best form for aid to take.

If lending to the poorest countries is more problematic than it sounds, lending to middle-income countries is less so, because these loans are not made on concessional terms. Desmond Lachman criticizes the World Bank because "in 2006 over 50 percent of the Bank's lending went to as few as five middle income countries— Brazil, China, India, Mexico, and Turkey." But Lachman fails to mention the all-important distinction between (non-subsidized) IBRD loans and (subsidized) IDA loans. Four of Lachman's five—all but India, which, with a GDP per capita of $730 in 2005, is not a middle-income country but a poor country—are IBRD borrowers. IBRD borrowers do not drain the World Bank's money but, on the contrary, replenish it by paying higher interest rates than the World Bank pays on its own bonds. Annual transfers from IBRD cross-subsidize IDA loans. Eligibility for subsidized IDA aid depends on GDP per capita being below a low threshold (US$1,025 in 2007).

One reason that middle-income countries keep borrowing from the Bank is to "leverage" technical assistance. In effect, they pay for the Bank's knowledge services by borrowing and thus creating a revenue stream for the Bank.

For Better or Worse?

Which leaves the big question: Does it work? Does the World Bank's money and policy advice actually help the poor?

There have been many attempts to measure the effects of aid through regression analysis. Frankly, this approach is beset with intractable econometric problems such as endogeneity and omitted variable bias. It does seem, though, that World Bank advice is no substitute for a government with its own development vision. The best-performing countries, like China, have their own agendas and take World Bank advice selectively. When the government is at a loss to deal with the country's problems, as in Russia in the 1990s, it may be superficially more cooperative, accepting proposals from the World Bank for lack of better ideas, then lacking the will or the capacity to implement them. Also, in the first decades the World Bank abetted the wrong turn towards big government that was taken by most post-colonial nations. When Jawaharlal Nehru was nationalizing the "commanding heights" of the economy and emulating Soviet-style planning, the World Bank was eager to help.

Since then, however, the World Bank has undergone two revolutions, one intellectual, one operational. The intellectual revolution was the turn away from Keynesianism, from seeing big government as the solution to seeing it as, in many cases, the problem. Just as important was the recognition, based on the success of East Asia, that globalization is the high road to economic growth. The operational revolution was the work of President James Wolfensohn, a high-powered business consultant who came to the World Bank from Wall Street bringing many aspects of the New-Economy American corporate model, with its flattened hierarchy and its emphasis on information technology and institutional learning. Wolfensohn made the Bank more versatile and less insular.

Since the 1990s, the World Bank's raison d'etre is not to allocate capital but to influence policy. What may be evidence that the approach is working is that developing countries are booming. Since 2003, overall growth in what the IMF calls "other emerging markets and developing countries" (i.e., not including the "newly industrialized countries" of East Asia) has been over 6.5% per annum. Sub-Saharan Africa grew 5.6% in 2005, 5.5% in 2006; central and eastern Europe at 6.0% (2005) and 5.7% (2006); the post-Soviet countries at 6.6% (2005) and 7.7% (2006); the Middle East at 5.4% (2005) and 5.7% (2006); Latin America at 4.6% (2005) and 5.5% (2006); and developing Asia at 9.2% (2005) and 9.4% (2006). For the first time in decades, all regions of the developing world are moving forward and closing the gap with the rich countries. High commodity prices are one reason for this, but improvement in the quality of policy seems to be playing a role, too.

How much credit for this, if any, should go to the World Bank, is hard to know. But the World Bank is part of the world's economic machinery, part of the thin web of global economic governance in a roaring world economy. At a time when the world economy manifestly ain't broke, why try to fix it?

Nathan Smith is a writer living in Washington, D.C. He blogs at The Free Thinker.

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