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.