586 June 15,1987 THE INTER-AMERICAN DEVELOPMENT BANE RE-THINKING AMERICA'S ROLE INTRODUCTION The Inter-American Development Bank (IDB which provideasubsidized develo ment loans to Latin America and the Caribbean, is facing a crisis of purpose and funding. he IDB has lent more than $35 billion over the last 26 years. Yet since its clients include Mexico, Brazil, and Argentina, which are among the most troubled of all Third World debtors, the lDB clearly has fhiled in its funda mental mission of promoting growth and financial stability in the region.

Current negotiations on the Seventh General Increase in Resources for IDB and funding for its highly concessional loan affiliate, the Fund for Special Operations FSO have broken down over policy reform issues. The United States and other member countries had pro osed a 25 billion capital increase, including $9.3 billion from the U.S and cut to zero its budget request for the IDB from the Congress. The U.S. Treasury ap arently is taki n g ths unprecedented but warranted action to reduce the size of the efficiently Power in the Hands of Borrowers. The IDB is owned by its 44 member countries, whose subscription to its capital determines each member's voting power. It began operations in 19 6 0 wth 20 shareholders--the U.S. and virtually every country in Latin America plus Haiti. Since the 1970s, in an effort to attract additional resources, Canada and 16 countries from outside the WesteTHemisphere. have been allowed to join the U.S. as non-bo r rowing members. At the end of 1986, total subscribed capital had reached $34 the main financi ar contributor. But the U.S. Treasury recently withdrew from negotiations ID k 's loan pool in the hope that the lDB would lend its diminished resources more I 1 . These include most West European countries, Britain, Israel, Japan, and Yugoslavia. billion 2.6 billion of this was paid-in and the remainder is callable (in the form of credit guarantees). The resources of the FSO have reached $9 billion. The IDB financ es much of its loan program with funds obtained through borrowing in private capital markets guaranteed by its callable capital.

Despite the growth in the number of non-borrowin members, the IDB today remains largely a recipient-run institution. Some 54 pe rcent o t its capital is supplied by the Latin American countries. The U.S. accounts for 34 ercent, Canada 4.5 percent, and. the non-regional members 7 percent;. Since the U.8 contributes in dollars and the1Lat.h American nations in their own currencies, t he U.S. is the overwhelming source of hard currency for the bank. Voting power, however, is not assigned on this basis but instead has been vested in the hands of borrowers. In return for a new replenishment, the U.S Treasury' has proposed that votes on l o an proposals and policy would require 65 percent su port rather than the current rule of 51 percent. This would mean the U.S. would need The U.S. has a number of convincing reasons for being reluctant to participate in the 1) Leverage to help improve the q uality of IDB lending. With less money to lend, the 2) Dissatisfaction that the IDB is run by the countries which receive the subsidized o s y one ally, possibly Canada, to block unsound loans favored by the Latin American bloc seventh replenishment. Amon g them IDB would have to be more discriminate about how its capital is used loans. It is the onl multilateral development bank (MDB), in fact, in which the loan Control by recipients has hampered the establishment and enforcement of proper economic policy c onditions attached to the loans 3) Dissatisfaction that the IDB has allowed itself to become part of an extensive system of Latin American political patronage. It funds parochial projects and employs many friends and relatives of Latin American government officials, as well as former government officials themselves recipients decide t g e "who, when, what for and how much" lending questions of the Bank 4) Severe U.S. budgetary problems The U.S. does not have the resources to supply continual capital increa s es to the multilateral development banks. It does not make much sense for the U.S. to borrow funds from international markets, provide this money to MDBs, which in turn lend it back to international borrowers--sometimes even back to foreign countries from which the resources came from in the first place 5) The highly concessional FSO loans to such relatively high income nations as Brazil which can make no objective case for receiving such subsidies 6) FSO loans have not promoted economic growth and develop m ent in Latin America's poorest countries. A 1982 Treasury Department study on U.S. ppcipation in the MDBs recommended a gradual reduction in funding levels for the FSO 7) IDB and the FSO loans to Nicaragua Its leaders can hardly claim to be pursuing econo m ic and political policies deserving the support of U.S. taxpayers 2 US. Treasury, U.S. Particination in the Multilateral DeveloDrnent Banks in the 198Os, February 1982 2 8) The delay in launching the InterAmerican Investment Corporation. It is the one new facility of the IDB which has a good chance of helping Latin economies.

Latin American governments, multilateral institutions, and U.S. officials must recognize that the Inter-Amencan Development Bank must regain the confidence of the U.S.

Congress. This will be possible only if the IDB.demonstrates that its loans in fact do trigger economic growth. For their part, Latin American nations must rove they-can create the marketplace. These countries must attract commercial lending and equity capital 1 Get To u gh. And the IDB must prove it can assist in this. It must.get tougKe?&th those countries unwilling to initiate reasonable economic reforms. For this to happen, the U.S and other donor governments will have to put greater pressure on the IDB to develo more effective policies for Latin America's economic-development. Until IDB does this e U.S should provide no new funding for the bank. As such, the U.S. Treasuy deserves support for its refusal to participate in the IDB's Seventh Replenishment IDB LENDING WOR K S AGAINST GROWING WORLD ECONOMIC TRENDS j conditions making their economies more responsive to forces o F the internatioiid 6 After nearly three decades of well-intentioned but often ineffective lending, the IDB faces a fundamental challenge. Will it reco g nize that continuing its roject-specific aid to admittedly has helped Latin America and its commercial bank creditors muddle throu h the debt crisis, it has not encouraged recipients to lay the economic groundwork to mafe development projects more self-su staining.

Since the IDBs lending o erations and policy advice are controlled in large part by its governments is no solution to Latin America's development woes ile IDB lending borrowers, lending levels an B country allocationsxue highl politicized. There is no truly considering non-governmental J ternatives to the Bank's project lending. IDB lending spur the creation of loc af private corn anies. The Bank's methods of operation rely almost r objective procedure for analyzin the long-term viability o a par t icular project or moreover, offen works a ainst national efforts to attract private capital mvestment and to entirely on the public sector to provi e the elusive answers to social and economic development Working Against Encouraging Trends. Ironically, it seems that the IDB, by not playing a stronger role in shaping market-oriented policies and using its lendin6 more strategically works against some encouraging new trends within Latin America and mternational organizations. These are trends toward sensible monetary and fiscal olicies, more In the past seven years, there has been a transition from the rapid expansion of the public sector m the developing and industrialized world to new efforts to find more ways for market incentives to work. This includes wa ys to make the public sector and state-owned enterprises more responsive to the world economy.

Some Latin American leaders, such as Ecuador's President Leon Febres-Cordero, have on occasion begun to acknowledge publicly that excessive governmental interfer ence through trade restrictions, heavy public s ending, subsidized businesses, commodity cartels, and preferenti$ trade agreements P has failed to increase the economic well being of developing nations. The irony is that while Latin American nations, at t i mes, now call B market-oriented economic policies, and a recognition that liberalize B trade spurs growth 3. See David Asman Free Market Theories Become Public Poky in Ecuador The Wall Street Journal April 11 1986,p. q 3for freer trade and greater private investment, they are lured in the opposite direction by international lendin institutions often willing to provide 40-year 2 percent-interest loans recipient countries hang on to and expand their bloated bureaucracies and sluggish state-owned enterprises. Faced with a choice between selling off government assets and cutting budgets or acceptin outside aid to offset the inefficiencies of both, Latin American kans and accept their no-growth terms. There is little incentive for these leaders to follow No Stri n gs, No Reforms. The IDBs borrowers receive one'basic-kind of loan: loans with no strings attached. "Policy-based lending"--loans designed to encourage and reward proper economic reforms--is mssing from the IDB system. Typical of the IDB approach is the $2 4 .5 million rural electrification loan to Peru approved earlier this year. For one thing, many aspects of the loan do not even meet standard IDB guidelines. For another thing, and much more serious, IDB officials know that ELECTROPERU, the state-run electi c ity concern, has long been operating at a ne ative rate of return and is now likely previous IDB loan to charge market rates. The terms of the new IDB loan do not even s ecify a tar et for rates, only a request that ELECTROPERU submit a plan in the future hile the dS. abstained from the vote on this loan, effectively casting a no vote, the loan was approved.

Another example of IDB lending policy is the recent proposal for a $40 dion loan for Guatemala's subsidized housing program. The interest rates of loa ns to individual borrowers were to be negative 111 real terms, that is, not even keeping up with the rate of inflation. This disregards the IDB's policy that rates for such loans must be positive. Only after a threated U.S. veto was the proposal redesigne d so that positive real rates would be charged Guatemalan nationals Half-Completed Plant. The Bank's tendency to take on projects that are economically unproductive and rely too heavily on public financing also is illustrated in the IDBs efforts to expand a nd modernize a state-supported cement plant in Kingston, Jamaica. The lant, which received large subsidies from the government prior to its funding from the B, has never operated at a profit. The Bank nonetheless continues to disburse funds from a $573 mi llion loan approved in 19

81. And after five years, the plant is only half completed.

The Bank also has heavily subsidized oil and gas operations in Bolivia. Poor planning and chronic delays have plagued most of these rojects. A $97 million loan to help build a in 19

82. Contractors in Mexico have delivered less than half of the pipe required for the project. There is a continued shortage of replacement arts. Construction work has not even begun, and yet the Bank insists that the project A be completed wi thin two years with no strings attac ed. All that seems to be required implicitly for the loans is that the olitical leaders understan ably are tempted to make the easier choice. They take the a long-range strategy for growth 9 1- p T I I ..I I I insolven t . What is worse is that this firm has faile to comply with an agreement in a natural gas pipeline, for example, has been mo 8 Xed several times since its original design investment and spur the creation of B ocal private companies. The B anE relies almost IDB lending often works against owing national efforts to attract rivate capital entirely on the public sector for economic development. There is almost no evidence of IDB operations aimed at market forces and private capital investment 4. 1986 IDB Annual ReDort, p. 84 5. Ibid p. 56 4Dispensing Sound Advice. The IDB and its Fund for Special Operations are only part of the multilateral development bank system, which is in turn part of a very complex international economic system. The financial role these in s titutions play in any countrys development is often overstated. Latin American countries themselves provide between 70 percent and 90 percent of all the capital they use for development. For these countries obvious1 trade is vastly more important in rovid i ng foreign exchange and investment capital x an are official foreign aid or multi P ateral banks bank financing which require no policy reforms would o If y perpetuate the earlier flawed An extraordinarily important role that the.banks could-play is-in di s pensing policy advice. IDB managers could nudge recipients of IDB loans to pursue growth strategies. To do this, IDB itself would have to be reformed to enable it to design proper olicy changes and allow it to take the political heat in getting them imple mented. It wou P d also require a new willingness on the part of debtor countries to accept olicy reforms. New multilateral development strategies.

Some IDB officials have complained that making sure that each country receives a certain amount of dollars every year has become so important politically that the IDB has lost track of the more important goal of romotin economic growth and development.

Those who suggest that less lending and if etter PO icy controls might go further toward Latin Americas debt p roblems (and, among other things, improving the U.S. trade are viewed hostilely by IDB leaders. Bank managers rarely seek the more difficult linking lending levels with economic policy reforms IDB LOANS SUBSIDIZE U.S. COMPETITORS The IDB often subsidizes U.S. trade competitors, especially in energy, mining, and agriculture. These loans have helped displace private capital investment and turned would-be private enterprises into public works projects, often without regard to supply and demand conditions.

IDB energy loans, for example, have helped insulate Latin American nations from falling world oil prices, a luxury not afforded to Americas own energy producers. In 1985 the Bank approved two loans totalling $60.3 million to help expand Argentinas Norther n Natural Gas Pipeline. The loans have been used by Argentinas public gas corporation Gas del Estado, as part of the second stage of an expansion pro am. The first stage was this will produce from 9.5 million to 13.5 million cubic meters per day. Firms wer e given subsidies to expvd production during a period of worldwide surplus in natural gas, which continues today completed with a $48.4 million loan approved by the Bank m 1 B

80. The IDB estimates Subsidizing a Grain Glut. In 1985 and 1986 alone, the IDB approved nearly $2.7 billion in energy, mining, and industrial develo ment projects in 14 countries. This included a 108 mllion loan to Venezuela to help uild a government-owned bauxite mine, a $130 million loan to Chile to he1 increase mining and ojher i ndustrial product exports, and a own domestic energy producers are going out of business because o the combined effects of lunging world oil prices, high taxes, and dried-up investment capital. Yet U.S tax do P lars via the IDB are protectmg other nations from these circumstances P 130 million to the state oi P company of Colombia. As much as 25 ercent of Americas 6. 1985 IDB Annual ReDort pp. 48-48 7. 1985 IDB Annual Report, passim 5The situation in agriculture is similar. Last year the IDB approved $636 m illion in loans to help boost Latin America's agricultural and fisheries production. Much of this money goes explicitly to increase agricultural export revenue, such as a $60 million loan to the government of Argentina to increase production of grains, oi lseeds, and livestock.

Approved in 1984, this subsidization of Argentine grain also coincides with a world grain glut. Since 1980, the U.S. share of world agricultural trade (mostly wheat) has fallen from 44 percent to 30 percent, while Argentina's share h as doubled. With the current wheat glut on world markets and with the U.S. overnment advocating and paying farmers not to produce, it makes little sense fora thebB to be encouraging-Argentmaad otheraations to production of commodities already in oversuppl y . mcre-&e production. In making these loans, the IDB displays little sense of global supply ana demand conditions. Long-term economic growth is not spurred by subsidizing THE FSO'S FLAWED LENDING PRACTICES A March 1985 fact book produced by the IDB descri b es the Fund for Special Operations as an agen designed to make "long-term, low-interest loans to the less developed countries of& tin America, and for the special purposes which require concessional lending In practice, however, FSO loans have ope to nati o ns with comparatively high per ca ita Gross Domestic Products (GDP 3 and have supported projects which easily coul B be financed by either the IDB's hard-loan windows or Latin American nations' 9~ domestic budgets. The loans are huge subsidies for these r e latively affluent countries. is difficult to justify providing such favorable terms to far wealthier Latin American nations Concessional lendin may be appropriate for the world's oorest counties with limited infrastructures and f ittle capaaty to generate foreign exc E ange. But it contributions to the FSO over the last decade. In 1976, the B ourth Replenishment of the Declining U.S. Contributions. For this reason, the U.S. adually has reduced its FSO provided $1.4 billion for three years with $600 million or $200 nullion er year coming from Washington. The Fifth Replenishment in 1979 rovided $1.5 E illion for four years-with $700 million, or $175 million annually from the U The Sixth Replenishment in 1983 aimed at $700 million over 4 years, with $290 milli o n, or $72.5 million annually coming from the U.S This downward trend, if anythinE, must accelerate. In a June 11, 1985, letter notifying members of the House Appropriabons Subcommittee on Foreign Operations of the status of various multilateral developmen t bank replenishment negotiations (including the FSO the Treasury Department stated plainly I We believe that the question of whether any further replenishment is required should be fully examined. By comparison with other regions of the world, this Hemisp h ere has relatively few of the poorest countries. It may be possible to 8. Inter-American Development Bank Fact Book, October 1986, p. 12 9. .The GDP/per capita (1985) of recipients of FSO loans in 1986 includes: Bolivia, W, Brazil 1,852; Colombia 1,243 Ec uador 1,231; El Salvador 771; Guatemala, $1,216; Haiti 315; Honduras 719; Jamaica, $1,698 Mexico 2,22Q Panama 2,218; and Trinidad and Tobago 2,3

75. By comparison, 1984 per capita GNP for Sub-Saharan Africa was Urn, and the eligWity.cap for the 50-year, ze ro-interest loans of the World Bank's IDA is a per capita GNP of $790 10. Although FSO terms vary from country to country, average loan maturity is 25 to40 years, average grace periods are 5 to 10 years, and interest rates are 2 to 4 percent.meet 'the nee ds of these countries for continued concessional assistance by using repayments and income from past FSO loans Subsidizing the Wealthy. The record of past FSO lendin su ports these conclusions.

As of December 31,1986, the FSO had approved a total of P7 9.3 billion in concessional loans; 51 ercent of these have been obtained by 12 countries with a per capita GDP above 14

00. Ofthe remaining nine recipients, only two--Bolivia and Haiti--register per capita GDPs close to those of the concessional recipients of the World Bank.

In terms of allocatin loan funds by borrowing member countries, the "Group A or wealthy) countries as dexico, Venezuela, Brazil, and Colombia consistently have demanded that they remain eligible for FSO loans. During negotiations dealing with the Sixth Re lenishment of the IDB in June 1985, these nations voted to retain thelr eligibility I 1 Bier I L I I for FSO P ending Over the past five years, the FSO has approved $351 million in loans to Brazil Colombia, and Mexico, or almost 20 perc ent of total lending between 1982 and 1986.

Though FSO loans are made in local currency and hard currency (usually dollars, Swiss francs, or pounds sterling) or hard currency only, each of these three countries has made their contributions to the FSO in lo cal currencies. The result: these nations use the advantageous terms of 430 loans to borrow the very local currencies they then contribute to the Fund. FSO resources could be channeled more effectively if they were used to help only the most qualified rec i pients FSO LOANS TO NICARAGUA Not only have FSO loans one to countries that do not merit them, they also have worked a ainst U.S. politicafand strategic interests and those of the emerging democracies Nicaragua. The FSO has been involved in a range of pro j ects which subsidize Nicaragua's economy and strangle Nicaraguan entrepreneurs and private business. In 1985, for example, the IDB approved a $55,000 technical coo eration grant from the FSO to assist control over all sectors of the economy in Centra f an d South America. Illustrative is FSO help to the Sandinista regime in Nicara a in u dating and fulfillin its Soviet-style B five-year economic plan. This plan was in YaF act dr ted with the help o B the IDB and is intended to "improve" government A Road to Suppress the Indians. Other FSO loans have been equally puzzling. The FSO continues to disburse funds of a $65 million loan to help Nicaragua's national bank execute a wides read livestock and agricultural production control program. The loan was original l y inten B ed to benefit small-to medium scale private farmers by helping them compete with larger commercial operators. The effect of this project, however, has been to strenqhen government farm enterprises, in part by delivering cattle, equipment and mac hinery to the Nicaraguan government, and in part by forcing individual private holdings to incorporate into larger cooperative enterprises.

Finally, the FSO is actively involved in construction of a 75-mile highway between the cities of Rio Blanco and Siun a in Nicaragua. The new roadway, financed in part by a $32 million FSO loan, with the rest of the project's costs coming from Cuba and the Soviet Union, will serve as the only overland route in Nicaragua between the Pacific and Atlantic coasts. The Sandin i stas long have sought access to the more remote Atlantic region, where the re 'me has beenliuppressing brutally the low-income farmers and the Miskito and other P ndian groups 11. For hther detail, see IDB Annual Reports: 1985, p. 91; and 1986, p 88. I 7 T HE INTER-AMERICAN INVESTMENT CORPORATION A POSSIBLE SOLUTION If the IDB is serious about improving the quality of its lending, then two important 1) The FSO should either be restructured significantly so that only the poorest nations changes are needed as a start in Lath America receive concessional loans, and that the aid they receive is conditional upon implementing economic reform or. it should be eliminated altogether facility has the potential to make si 'ficant contributions to sustainable economic g r owth if correctly managed by IDB offici zr s The IIC's central goal is to encourage the establishment, expansion, and modernization of small- and medium-scale private ente rises. Its March 24, 1986, charter rovides for an initial capital stock of $200 mil l ion, with 'g t e U.S. subscribing 25 percent of i!i e total anding the role of the IIC could shift the economic policy orientation of the IDB, but until now the IIC has lacked enough su port from donor and recipient nations to get off the ground. So far, t he IDB political and p !i iloso hical bias still favors government-to-8overent programs. The &B, moreover, apparently remains uncomfortable in addressing the needs of small, evolving businesses in Latin America Encourage Reforms. Vigilence will be necessa r y to ensure that the IIC does not become another conduit of funds for Latin American state-owned enterprises, as is allowed in the IIC charter. Should this occur, the IIC would become just another organization, based on a sound concept of promoting the pr ivate sector, whose actual operation becomes permeated by funding government interventions.

The IIC could help ease Latin America's debt problems. First, the IIC could encourage reforms in economic policies and local business laws. Local businesses operati ng in a more conducive environment are likely to keep their employees and their profits at home, thus reducing the capital'flight which drains Latin American nations of hard currency. The ICC also could press for an easing of the burdensome regulations on foreign capital investment such as limts on re atriation of rofits, price and supplier controls, and technolog transfer can clear the way for the development of private enterprise.

Second, the IIC can encourage Latin American entrepreneurs by supporting b asic business training rograms. Entrepreneurial develo ment is the key to success of the solutions outside the scope of government as one way to overcome the chronic difficulties of dealing with inefficient and corrupt bureaucrats. r 2) The Inter-American Investment Corporation (TIC) should be strengthened. This new requirements. IIC P oans should 1 e tied to investment, trade, and tax reform policies that private sector in Ei tin America, as it is elsewhere I e IIC could stimulate new ideas and ownership, such as employee stock ownership plans an B other schemes involving workers in and Western E! urope indicates that wor K er productivity often rises when employee income Expand Ownership. Finally, the IIC could explore o tions for expanded capital their o w nershi of Latin American com anies. Experience with these plans in the U.S is linked to the roductivity of the firm. There are clearly many alternatives to state ownership whic E have not been explored by the IDB and which the IIC could help fashion to fi t specific situations in Latin American countries 8For more than a year, IDB members have been bickering over the form of the IICs investment regulations and the choice of a General Mana er. As such, the IIC still is not functioning. In part because of thi s , Congress did not fun the IIC in the fiscal 1987 foreign aid appropriations bill. Some IDB officials do not expect the IIC to be operating until early next year--if then. At this rate, the IIC can anticipate little or no funding from the Congress in fisc a l year 1988 and even beyond O I SEARCHING FOR A LONG-TERM SOLUTION Lh F. i I A In its 1986 annual report, the IDB came to an unsurprising conclusion: Latin America re uires major new investments if it e ects to achieve economic growth and service its is u n likely to create the attractive conditions which would prompt local investors to reinvest their own funds and to keep their capital at home, let alone attract new foreign investment de 1 t. But in the search for capital, the ?I3 anks reliance on debt and g overnment programs The Rea an Administration is correct in emphasizin fundamental reform of IDB current replenishment discussions have he d firm on their demand to change the DBs voting structure. Such a chan e would allow 35 percent of the Banks voting r i ts to block dile the U.S. Treasury should be a plauded for this, it would be a mistake for Treasurys A commitment for the 7th Replenishment could have been 25 billion, which would have nearly doubled the amount of the last Replenishment IDB As Cause of t h e Debt Problem. The investment capital needed by Latin America cannot come solely or even mainly from higher contributions to the Inter-American Develo ment Bank. The sums are too huge. Nor are Latin Americas economic problems economics, the IDB has demon strated that it can e as much a cause of the debt problem as a ossible solution to it. Meanwhile, the enormous U.S. federal deficit means that Was ington no longer can foot the bill for increased IDB and FSO lending.

The meaning of these developments is cl ear. In the near-term, the U.S. must continue to refuse to participate in the Seventh General Increase in Resources for the IDB. In the longer term, U.S. participation in the IDB and FSO must be conditioned on these organizations adopting policies and pro g rams which trigger growth in Latin America by unfettering Latin Amends potentially creative and dynamic private sector B f before new a nding is committed to the or anization. reasury negotiators durin the a roposed loan, thus giving t e U.S. along with o n eother donor nation an e ff? ective veto negotiators to trade the voting issue P or a major expansion of the Banks capital resources simply E nancial. Over the past decade, by lendin more on the basis of politics than Pre ared for The Heritage Foundation b y Je 2 rey D. Pierson Jeffrey D. Pierson is a legislative assistant for Congressman Mickey Edwards (R-OK who serves as vice-chairman of the House Appropriations Subcommittee on Foreign Operations. The Views in this study are those of the author and should not be construed as representing the opinion of any other individual or agency of the U.S. government 9-