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501 April 4, 1986 BARBER CONABLE AT THE WORLD BANK NEW HOPE FOR WORLD ECONOMlC GROWTH Bruce Bartlett J0hn.M. Olin Fellow INTRODUCTION Ronald Reagan is nominating former Congressman Barbe r Conable the New York Republican, to be the new president of the World Bank.

Conable takes over an institution which has strayed far from its original purpose of promoting private sector growth however, have enormous power within the organization to refo rm World Bank operations to make them more effective and more consistent with Reagan's philosophy of aiding the developing world primarily through the private sector He will Conable could, for example, appoint staff committed to fostering market-oriented p olicies. He should reestablish the sound banking practice that loans are made to encourage growth and development--and use the Bank's leverage to'nudge recipient countries toward free market policies. And by opposing a suggested $40 billion increase in th e Bank's general capital, Conable could force the Bank to use its resources more effectively.

During his long tenure as World Bank president, Robert McNamara showed that a strong president, virtually by himself, can fundamentally alter the Bank's direction . If it could be done once it can be done again-this time turning the Bank back toward the private sector and making it a more effective engine of development in the hard-pressed Third World I a HISTORY The World Bank was established after World War I1 pr i ncipally to aid reconstruction of war-torn Europe. During its first decade or so the bulk of its loans went to industrialized countries, such as Japan and France. As these countries advanced, the Bank turned its attention increasingly to the less develope d countries of Asia, Africa, and Latin America In 1960 the Bank established the International Development Association (IDA) as a separate facility to make llsoftll loans at below market rates to poor countries.

In its first two decades, the Bank saw itself largely as facilitating the flow of private capital to the Third World not as a substitute for private capital flows the World Bank: IIFrom the beginning and through most of the first quarter century of its existence, the Bank saw itself,dealing with onl y a minor part of total developmenF finance; the major part would have to come from private investors.I1 Explains a recent history of Hence the Bank was much concerned with llclimatell for investment in developing courkries In the 1950s, under President Eu g ene Black the World Bank took a hard line against countries which expropriated prjvate property without just compensation, which defaulted on foreign loans, and which relied too heavily on government, rather than the private sector, for growth. Indeed, th e Bank had a policy of not lending directly to governments for industrial projects unless they were intendzed to he transferred to the private sector upon completion international devdopment finance, that a lack of capital was not the major detriment to gr o wth.in the developing countries, and that loan amounts should be limited so that debt service payments remained manageable payments grew above 10 percent of export earnings opposition to government involvement in the development process and The Bank maint a ined that llsoftll loans had no role in Typically, the Bank became alarmed if3debt service In the late 1960s, however, the Bank began to soften its 1. Edward S. Mason and Robert E. Asher, The World Bank Since Bretton Wood$ (Washington D.C.: The Brookings Institution, 1973 p. 336 2. Ibitl, pp. 336-338, 371-373 3 IL pp. 458-4

70. Today the debt service ratio of all indebted countries is 22 perceilt of exports, ranging from I1 percent in Asia to 40 percent in Latin America. World Econpmic Outlook: Ami1 1985 ( Washington, D.C.: International Monetary Fund, 1985 p 268 2also took a softer line on lending terms capacity of developing nations to absorb capital as being much greater than it previously thought and Lncreased its lending accordingly the late 1960s the B ank was evexi willing to lend directly to governments for industrial projects The Bank came to view the By The Bank changed dramatically during the lengthy (1968 to 1981 Said presidency of Robert McNamara, former president of Ford Motor Company and Secret a ry of Defense under Presidents Kennedy and Johnson. He moved the Bank even further away from its founding principles an observer of McNamara's approach He has seemed almost obsessed with redistribution of He seems to have turned away from the concept of i ncome helping the poor by raising overall national economic standards. He seems to feel that dams and roads and ports and steel mills...may help the economy but they don't necessarily put extra food into the stomachs of the teeming poor.

Bank lending ballooned from $1.4 billion in 1968-1969 to $10.3 billion in 1981-19

82 . World Bank productivity seemed to be measured by how much money could be dispersed, rather than on the quality of the project or ebility to repay A. W. Clausen to succeed McNamara as World Bank chief. Upon taking office, Reagan confirmed Clausenls appoi n tment. In his five years leading the Bank, Clausen has done little to change the direction set by McNamara. Although he says iill the right things about the need to encourage growth through the private sector, he has done almost nothing to redirect Bank'p rograms so that they foster private sector growth finance, where h3 has improved the Bank's ability to raise funds in capital markets.

Seoul, Clausen announced that he would retire this June Late in 1980, Jimmy Carter chose former Bank of America president Clausenls main accomplishment has been in the area of At last Septemberls World Bank annual meeting in 4. Ann Hughey Is the World Bank Biting Off More Than It Can Chew?" Forbes, May 26 1980, p. 123 5. E. Dwight Phaup, De World Bank: How It Can Serve U.S. Interests (Washington, D.C The Heritage Foundation, 1984 p. 14 6. Hughey, OD. cit, p. 127 3- THE WORLD BANK PRESIDENT The problems of executing a market-orielited development strategy are many, but the World Bank president is uriquely situated to have a m a jor impact on such a strategy. This is because of the Bank's enormous financial leverage. The World Bank and IDA together lend about $16 billion per year the actual impact of this lending is much higher. In 1985, for example, the World Bank contribute? $1 . 5 billion'to co-financing projects worth almost 24 billion organization But because of co-financing arrangements The president of the World Bank has enormous power within the The organization's Articles of Agreement specify that The President shall be chi e f of the operating staff of the Bank and shall conduct, under direction of the Executive Directors, the ordinary business of the Bank. Subject to the general control of the Executive Directors, he shall be responsible for the organifation, appointment and dismissal of the officers and staff In short, the president has virtually J:otal authority to hire and fire staff and direct the Br,r.k's operation changes would be necessary to reorient Bank policy, major changes are neither needed nor desirable. Most of the Bank's professional staff is very competent. More important, most probably agree that economic growth comes principally from the private srictor and that Bank operations should be geared more toward the private sector will provide ample opportunity fo r Conable to put his lrstampl1 on the operating staff. In the meantime, he should not underestimate his ability to send llsignals'l to the staff through public statements and subtle actions which will tell the Bank staff that changes in policy are required . Most Bank staff are not ideologues, but professionals whose expertise is essential to efficient BE.nk operations Although some staff Attrition The one staff change which Conable may find unavoidable is the Senior Vice President of Operations, who oversee s the Bank's day-to-day functions determines what the lending policies of the Bank are, what projects will be funded, and what condLtions will be attached to Bank loans.

Naming someone to this position who is committed to market-oriented policies is essential if there is to be any change in Bank policy.

One candidate for this position currently under discussion is David The person holding this post effectively 7. World Bank Annual ReDort 1985 (Washington, D.C World Bank, 1985 p. 27 8. Article V, Section 5, paragraph vii 4 I I i I I Mulford, Assistant Secretary of the Treasury for Internatimal Affairs LENDING POLICY Historically, productivity at the World Bank has been measured in terms of loan output seen, more or less, as an end in itself, rather than a m e ans to an end. Bank staff are, in effect, rewarded for giving out as much money as possible. Neither praise nor reward accrues to those staff who resist making loans because the projects are unworthy or because the host government persists in following an t i-growth policies Making loans to developing countries has been A top Conable priority, therefore, should be reestablishing the sound banking principle that loans are made for a purpose--to encourage growth and development. Another priority is for the Ban k to use its leverage more to nudge recipient countries toward free market policies. To be sure, the Bank already attempts to do this through Ilpolicy dialogues Such efforts, however, tend to be short-lived and half-hearted. This is because there is too mu c h pressure within the Bank to make loans, too little encouragement for staff to be I1hard-nosedt1 about conditionality, to little follow-through on conditionality, and too many problems for those who would try to cut off project loans once the project has begun if the conditions attached to the loan are flagrantly ignored.

Observes Stanley Please, a former World Bank senior staff member Policy dialogue in the past has rarely gone beyond gentle persuasiont1 at the political level, combined with technical di scussions among economists to review the analytical foundations of the diagnosis of problems and the general policy options open to a government The inner dynamics of the technical, financial, and administrative arrangements associated with the project cy cle, generate a momentum of project development and implementation within a project agency and within the Bank.

It is extremely difficult and often costly--but not, of course impossible--to interfere with this process in order to address broader problems t han those dlrectly relating to the project Experience...suggests that unless the policy issues are of very great importance, a presumption exists that the benefits fall short of the costs of delaying a projectls development and implementation This is refl e cted in the frequency with which covenants relating to policy issues, agreed to by a government in good faith and formally embodied in loan agreements, are subsequently not complied with and where little or no credible action is taken to have the covenant implemente2 For this reason 5emphasis is typically placed on implementing policy changes before the signing of a loan agreement although this procedure is often of limited usefulness when it is vital that governments sustain policy changes over a period o f time. Effective monitoring of these changes, therefore requires an equal ability to sustain action by the Bank with action or nonaction by a government. Bank credibility in respect of enforcing policy covenants is...not very great.

It is,certainly not as $reat as is demanded by the urgent need for policy reform STRUCTURAL AmSTMENT .LENDING One approach to the probl-m f imr>osins conditions n Prod ct loans-those made for building a particular-road, dam, or b;idge--is for the Bank to make more Ilstructural adjustment1! loans. These are made specifically to, encourage a change in policy, rather than for the building of tangible projects. They are, in short, a kind of Ilbribell to encourage constructive policy change. Though such loans have been made since 19 8 0, they are only a small part of Bank lending reason is the requirement in the Bank's Articles that Itloans made or guaranteed by the Bank shall, except in special circuzstances, be for the purpose of specific projects of reconstruction or development bee n taken extremely seriously by the Bank Thus, structural adjustment loans have been limited to no more than 10 percent of Bank lending. ghrough 1985, approximately $4.5 billion of such loans have been made The And as Please notes, this legal requirement "h a s Please argues strongly that structural adjustment lending is more appropriate to current development problems than traditional project lending policy and institutional reform," he says, "then, once again, its operations must be designed in such a manner that the progressive improvement in tax policy and other distortions of industrial and employment policy are placed on center-stage I1 If the Bank is to refocus its support towards far 9. Stanley Please, The Hobbled G iant: Essavs o n the World Bank (Boul d er, Colorado Westview Press, 1984), pp: 26-28 10. Article 111, Section 4, paragraph vii 11. Please PD. cit, p. 10 12. Annual ReDort g cit, p. 52 13. Please, OD. cit p. 44 6- On the other hand, leading congressional critics of the Bank argue that emphasis o n project lending at least focuses the Bank's efforts on things of tangible value and that Bank lending is limited by the availability of. eligible projects criteria and its replacement by ill-defined policy objectives, they fear, might open the flood-gat e s to additional lending and possibly be used for inappropriate objectives, rather than the pursuit of market-oriented policies. And, of course, there would still be the problem of sustaining reforms once the structural adjustment loan is completed the loa n , that currently exist with project loans, would still exist with structural adjustment loans A better approach to Bank lending may be to cut back Bank lending by ending loans for projects that can be financed commercially and by limiting lending to funds for noncommercial activities that strengthen the framework within which the private sector can operate.

Another option would be to privatize in effect more of the Bank's operations with governments profit-making projects and then the loans sold to obtain additional funds to make new loans like a private bank, funding projects of genuine economic value in the private sector Elimination of the project The problems of monitoring and enforcing the conditions of The Bank need not restrict itself to dealing exc lusively In short, the World Bank would operate m;'e Loans could be made for private sector The Bank's Articles make it clear that such a private sector approach was always intended to be a major focus of its activities.

One purpose of the Bank, the Articl es state, is Itto promote private foreign investment by means of marantees or participation in loans and other investments made by private investors Il1 however, chose not to emphasize the private sector approach. Instead it established an affiliate, the I nternational Finance Corporation, to fill this purpose. The IFC, which invests about 1 billion per year deals exclusively with private firms, even taking equity positions in private companies. If the World Bank chose to reorient its lending more toward co m mercially viable projects, then consideration might be given to spinning off the IFC altogether and making it a true private bank The Bank BANK FINANCES Conable could redirect Bank lending by opposing the suggested 40 billion increase in the Bank's genera l capital. The U.S. taxpayer's 14. Article I, paragraph ii 7-shartr of this would be approximately $8 to $10 billion. Politically it would be nearly impossible for the U.S. or most other Western governments to grant additional funds to the Bank against the wishes of the Bank's own president. By denying the Bank additional capital prerisure will mount inside the Bank to use existing resources more efficiently.

Most of the Bank's 60 billion capital is in the form of 18callable11 capital. Paid-in capital--mone y actually transferred to the Bank--amounts to only about 10 percent of total capital callable capital is like a loan guarantee which the Bank presumably would call upon only in the event that the Bank was about to suffer a major default on a loan actuall y would kick in extra funds in the event of a default, despite having obligated themselves to do so. Nevertheless, callable capital represents a significant potential obligation on the part of U.S taxpayers. At present, the U.S.'s share of the World Bank's callable capital is $11.2 billion The It is questionable whether Bank shareholders Only about half of the Bank's callable capital is in lwhardll currencies. In the event of a default and a call on the Bank's callable capital, the Bank might find many coun tries fulfilling their obligations with currencies which cannot be used to satisfy bondholders' claims.

The Bank maintains a very conservative capital-lending ratio.

According to its Articles, outstanfiing loans and loan guarantees may not exceed 100 perc ent of capital capital-lending ratio from exceeding one-to-one. Private banks, in contrast, often have capital-lending ratios of 1 to 10 or even 1 to 20. This suggests that the World Bank could alter its capital-lending ratio above &to 1 in order to incre a se its lending without increasing its capital. Although the Bank's Articles would have to be amended, this might prove easier to accomplish than getting the wor."ld's governments to increase the Bank's capital This prevents the To be sure, a price would b e paid for such action. The Bank's credit rating--currently AAA, the best available-undoubtedly would suffer without a general capital increase and without creating significant problems for the bond holders, if the aLternative is a general capital increase which would impose additional risk on the U.S. taxpayer. A 1 to 2 ratio of capital to lending would still be extremely conservative, yet allow for a doubling of Bank lending. Moreover, the Yet a modest expansion of Bank lending might be desirable 15. Arti c le 111, Section 3 16. For a general discussion of these issues, see Eugene H. Rotberg, The World Bank: A Financial ADDraiSal (Washington, D.C World Bank, 1981 pp. 21-26 8-r Bank's credit raf:ing is ultimately backed by the willingness of its member govern men'x to contribute additional capital if necessary.

This would not change.

BUILDING POLITICAL SUPPORT FOR REFORM It would be useful for Conable to cultivate better relations with the Bank's bondholders-largely big financial inst itutions in New York and other money centers. They have a very strong vested interest in making sure that the Bank's lending practices are sound bondholders also can appreciate the virtues of reorienting Bank lending away from governments, which have prov e d risky in recent years, and toward the private sector. Bondholders know too how important it is for recipient countries to open their economies to competition and foreign direct investment. Thus the bondholders, a group previously neglected in terms of B a nk operations, could provide support for new Bank policies The Conable could also find support for policy changes among the countries which are the Bank's major shareholders minister of each country is a member of the Bank's board of governors serves at B a nk headquarters in Washington. Conable could find that he could win support for changes at the Bank from the finance ministers of such key countries as West Germany and Japan. Such support for policy changes could blunt predicted opposition from Bank staf f executive directors, and the recipient countries The finance He also appoints his country's llexecutive director who The World Bank presidency is an important ''bully pulpit which can affect the economic policies of the world's ''less developed nations.

Sevelopment, ironically, are the industrial nations which control the Bank. Whether prompted by guilt over their own affluence or simply by ignorance, they have perpetuated Bank policies for many years which not only have not aided development, but in man y cases retarded i$+ by stressing the role of government, rather than the private sector during the McNamara years Yet many of those most in need of lessons on economic The focus on government-directed development reached its peak More than anyone else, he turned the Bank 17. Milton Friedman, "Foreign Economic Aid: Means and Objectives The Yale Review Su.mmer 1958, pp. 500-516; P. T. Bauer, Dissent on DeveloDment (Cambridge Massachusetts: Harvard University Press, 1972). See also Doug Bandow, ed U.S. Aid to the Develooinn World: A Free Market Anenda (Washington, D.C.: The Heritage Foundation 1985); Alan Rufus Waters, "In Africa's Anguish, Foreign Aid is a Culprit," Heritage Foundation Backprounder No. 447, 1985; and James Bovard, The Continuinn Failure of Fo r einn Aid (Washington, D.C.: The Cat0 Institute, Policy Analysis No. 65, 1986 9-away from the private sector t,award government, transforming the Bank into a kind of international welfare agency, concerned about "basic human needs" and population ccntrol, r ather than banking. Though it will take enormous effort to turn this around, the lessons of the McNamara years are instructivs. McNamara proved that the World Bank president can, virtually by himself, fundamentally alter the Bank's direction. If it could b e done once, turning the Bank away from the private sector, it can be done again, turning the Bank toward the private sector A PROGRAM OF ACTION Ronald Reagan clearly spelled out the principles of international economic development and the role of the Wor l d Bank in an'address to the annual meeting of the World Bank and the International Monetary Fund on September 29, 1981. "Trust the people,Il he said This is the one irrefutable lesson of the entire post-war period, contradicting the notion that rigid gove rnment controls are essential to economic development.

The societies which have achieved the most spectacular broad-bdsad economic progress in the shortest period of time are not the most tightly controlled, not necessarily the biggest in size, or the wealthiest in natural resources.

No, what unites them all is their willingness to believe in the magic of the marketplace.

Since 1981 Reagan has renewed the traditional policy emphasis on the private sestor, unleashing one of the strongest sustained periods of economic growth in 2herice.n history. The same emphasis could be applied to World Bank policies. In his speech at last yearls World Bank annual meeting in Seoul, Treasury Secretary James A. Baker I11 listed the institutional and structural policies whi ch developing countries need to pursue to achieve growth and deal with their debts.

They include o increased reliance on the private sector, and less reliance on government to help increase employment, production, and efficiency supply-side actions to mobi lize domestic savings and facilitate efficient investment, domestic and foreign, by means of tax reform, labor market reform, and development of financial markets; and o 18. Public PaDers of the Presidents of the United States Ronald Reagan. 1981 Washingt on, D.C US. Government Printing Office, 1982 p. 855 10 -o market-opening measures to encourage foreign direct investment and capital inflows, as well a& 1iberz.lize trade, including the reduction of export subsidies.

Barber Conable would do well to make th is his agenda for the World Bank So doing, he can make the Bank a key catalyst of growth in the developing world economic program and the Baker Plan, a confident and assertive Conable could make his tenure as World Bank president the most successful in it s history. And the chief beneficiaries would be those who need help the most--the world's poor In tandem with the principles of Reagan's I I I 19. 1985 Annual Meetinas of the Boards of Governors: Summarv Proceedings (Washington D.C World Bank, 1986 p. 2

09 . See also Bruce Bartlett The Promises and Pitfalls of Baker's Third World Debt Plan," Heritz:ge Foundation Backerounder No. 474, 1985 11 - No. The Heritage Foundation 214 Massachusetts Avenue N.E. Washington, D.C; 20002 (202) 546-4400 I t Note: Nothlng w ritten here is to be construed as necessarily reflecting the views of The Heritage Foundation or as an attempt to aid or hinder the passage of any bill before Congress.