GEI Newsletter Issue No. 3

The World Bank at Fifty - by Christopher L Gilbert

Also in this issue:

GEI Regionalism Meeting, London, 14 November 1995
by David Evans

The World Bank at Fifty

by Christopher L Gilbert


Queen Mary & Westfield College, University of London, and CEPR. Email address: C.L.Gilbert@QMW.AC.UK. This essay is based on a forthcoming GEI discussion paper, “The World Bank: its Functions and its Future”, jointly authored with Raul Hopkins, Andrew Powell and Amlan Roy.

Professor Christopher Gilbert is Professor of Economics at Queen Mary and Westfield College, London. Together with Dr Amlan Roy (Queen Mary and Westfield College, London) and Professor Ron Duncan (Australian National University, Canberra) he is directing a project in the GEI programme entitled ‘Global Economic Institutions and Risk Management in Developing Countries’.


There are various possible dates on which the fiftieth anniversary of the World Bank might be celebrated. Although the Bank is a product of the 1944 Bretton Woods conference, the inaugural meeting of the Board of Governors did not take place until 8 March 1946 (at Wilmington Island, near Savannah, Georgia), and formal operations commenced on 25 June 1946 when the initial call for funds was issued. Spring 1996 therefore seems the appropriate time for the birthday party.

As its fiftieth birthday approaches, the World Bank, under a new president, is, for the perhaps the third time in fifteen years, embarking on a major reform process. Pressure of funds, both from member countries and from new claims (relating to the ex-Soviet Union and eastern Europe) competing with established activities, is forcing some ‘resizing’. The fiftieth birthday party therefore provides an opportune occasion for asking what the Bank should be doing in the coming decades, and what institutional arrangements this requires.

Harry White, the US official who in the 1940s had written the initial papers outlining the possible roles of ‘a World Bank’, saw its primary objective as to ‘provide or otherwise stimulate long-term, low-interest-rate loans for reconstruction and for the development of capital-poor areas’, and the Bank’s charter gave prominence to both these roles. Formally, the World Bank was the International Bank for Reconstruction and Development (the IBRD). Subsequently, the International Finance Corporation (the IFC, 1956), the International Development Agency (the IDA, 1960) and the Multilateral Investment Guarantee Agency (MIGA, 1985) have joined the IBRD to form World Bank Group.

1. Evolution

Reconstruction dominated the initial ten to fifteen years of the Bank’s life. The political priorities in this period were set by the intensification of the Cold War and the need to bolster the democratic world against the Soviet threat. Economically, the ‘dollar shortage’ implied that, at least until the mid-1950s, almost all countries outside North America remained capital-poor. And the ‘third world’, which was to become the main theatre for Bank operations, outside Latin America largely remained the responsibility of the colonial powers.

The world was a different place by the early 1960s. Prosperity had returned to western Europe making the Bank’s reconstruction role redundant; and currency convertibility permitted relatively free flows of capital throughout what was now being called the ‘developed world’. But decolonization, particularly in Africa, created in the ‘underdeveloped countries’ a new group of client states with the agenda of rapid development. It was natural, therefore, that the World Bank should shift its priorities from reconstruction to development and from Europe to the developing world. The 1960s also saw the start of a trend which is apparent to any visitor to Washington – the growth of the Bank. In 1961 the Bank had 400 employees, but by 1971 this became 1300. By 1995, this had grown to 6060. The IMF and the Bank are seen as the two major pillars of Bretton Woods, but the Bank is many times larger in terms of both budget and payroll (the World Bank Group reported 6185 employees in 1994 and had a 1995 administrative budget of $1429.3m against 2184 employees in the IMF where the 1995 administrative budget was $462.2m).

Development lending in the first twenty-five years of the Bank’s existence was concentrated on projects with clearly quantifiable pecuniary. The main rationale for development were those advanced by Harry White: the investments required typically had a longer horizon than would easily be financable on the private market, and private funds, if available, would only be offered at interest rates which would make these investments unattractive. In this period, therefore, the primary rationale of World Bank activity might be characterized as overcoming perceived capital market deficiencies.

The major evolution in the World Bank which has taken place in the second 25 years of the World Bank’s existence has been the shift to policy-based lending, in particular through the device of structural adjustment programmes. This shift was based on the realization that the pressing need at that time in many indebted developing countries was for balance of payments assistance rather than for project finance. Shifts in the perception of the riskiness of overseas investment can result in very large swings in international capital flows. Reversals of large outward movements of capital requires a much more rapid response than is available from the process of identifying and specifying financable projects, but also often requires a change in policies in the countries concerned to make them more attractive to investors.

The transition to sectoral adjustment loans reversed the pre-structural adjustment roles of lending and conditionality. In the first 25 years of Bank activity, conditionality was imposed in order to ensure the success of projects and to guarantee that their potential benefits were captured. By the mid-1980s, lending was often justified in terms of the benefits of the policies imposed though the conditionality clauses which, nevertheless, would impose adjustment and other transition costs which might be offset by the loans provided to the governments. The policies became the projects, with investment in economic infrastructure replacing investment in physical infrastructure.

2. Institutions

The World Bank is a large and complex organization comprising a set of imprecisely focused institutions with overlapping responsibilities. We may analyze it in terms of these institutions or alternatively in terms of the economic functions it fulfills. However, there is no simple correspondence between the institutional and functional analyses.

Consider first the institutional analysis. The IBRD is the original member of the World Bank Group, and its main function remains intermediation. It borrows funds and lends these on to qualifying governments for agreed projects at rates which reflect the substantial elimination of the sovereign risk premium these governments face when borrowing directly from the private sector. The IBRD is complemented by the IDA whose activities are confined to a group of 60 countries which fall into the Least Developed Countries classification (the LDCs). IDA lending is concessional, in the sense that interest rates are lower and terms are longer than the private market would offer even to first class borrowers. Thus while IBRD loans are typically over a period of 15–20 years, IDA loans can be for 35–40 years.

The IDA’s objectives are explicitly developmental and its loans are subsidized while IBRD lending is intended to be (and is) profitable and justified in terms of capital market imperfections which limit the availability of finance at normal rates. As a consequence, IDA lending is concentrated in Africa and South Asia while IBRD lending dominates in Latin America, the Middle East and North Africa, and in East Asia. In the official history written to celebrate the first 25 years of the World Bank, Mason and Asher describe the IBRD-IDA separation as ‘an elaborate fiction’, and it is true that the staff of the two organizations are almost entirely co-extensive. Nevertheless, it would be wrong to claim that the distinction between these two parts of the World Bank group is little more than an accounting device since the criteria for obtaining funds are quite different. The consequence being that there remains considerable excess demand for the limited quantity of IDA funding subscribed by developed country governments, while there is currently no effective ceiling on IBRD lending since additional funds can be borrowed for this purpose.

The limited degree of separation between the IBRD and IDA contrasts with the IBRD’s relationship with the IFC. Whereas the IBRD either lends or guarantees loans to member governments or to public sector institution against governmental guarantees, the IFC lends to private sector institutions without any governmental guarantee. The IFC’s articles emphasize its separate identity from the IBRD but also indicate that the IFC should be able to draw on IBRD staff and facilities for administrative support. In practice, this seldom happens, although IBRD and IFC staff work closely together when there are mutual benefits from so doing. The IFC is therefore a separate organization working together with the IBRD under the umbrella of the World Bank Group, while the IDA and the IBRD are essentially the same organization applying somewhat different criteria in different geographical locations.

MIGA is the fourth organization in the World Bank Group. Its creation was a response to the debt crisis of the 1980s. Those events gave prominence to sovereign risk problems as causes of the high interest rates many developing countries were obliged to pay in order to borrow, and of the lack of access of countries to markets for new loans even at high rates. This suggested that an important means by which the global economic institutions might encourage a renewal of private sector flows into the indebted developing countries was by offering guarantees against the sovereign element of the investment risks. The original 1946 IBRD charter envisaged that the IBRD might offer guarantees as an alternative to lending funds. In practice, the Bank decided relatively early in its history to lend directly rather than to guarantee. The creation of MIGA reopens this operational issue.

3. Functions

The alternative way to look at the World Bank is in terms of the functions it exercises. Here I distinguish three broad economic functions:

• the World Bank as a bank ,
• the World Bank as a development agency , and
• the World Bank as a development research institution .

The principal banking role played by the World Bank is that of direct intermediation. The same function is performed to a lesser extent through the provision of credit guarantees. The Bank has AAA status and is able to borrow on the finest terms. Its client governments either have very limited access to international capital markets or can only borrow on less advantageous terms owing to sovereign risk. By intermediating, the Bank is able to substantially reduce the cost of capital to borrowers. The viability of this function relies on the Bank’s ability to mitigate the effects of so-called capital market failures. The most important of these is through reduction of the premium arising from sovereign risk. When private-sector loans are guaranteed the Bank is able to take on this risk at relatively low cost. In either case, its ability to bear these risks stems from a claimed comparative advantage in enforcement. I also include under this head the Bank as a credit-rating agency . This function stems from the willingness of private-sector banks to take Bank (and Fund) lending to a government as an indication of that country’s credit-worthiness.

The development agency role of the World Bank is the monitoring and control of government and other public-sector decisions with the objective of promoting ‘good development practice’. Monitoring generates the substantial information flows from permanent and regular visiting missions which relate not only to specific Bank investment projects, but also to the overall economic and political climate in the borrowing country. This function also includes the provision of technical assistance, but more generally involves the Bank’s activities in development education. Governments, whether in developing or in developed economies, often fail to adopt economic policies which will clearly benefit the majority of their citizens. World Bank pressure, exerted through conditionality and programme lending, are instruments which can assist governments in moving in this direction. In particular, externally imposed conditionality can help weak governments to escape from prisoners’ dilemma problems in which competing pressure groups each endeavour to raise their share of public expenditure.

The Bank’s role as a development research institution in part reflects the activities of the Research Department, and also those of the economists working in operational divisions. It is these research activities which inform the development agency function. On the narrowest interpretation, Bank staff have a comparative advantage in identifying profitable projects and/or projects which will contribute substantially to the development process. More generally, Bank staff have developed an unrivalled practical experience in good development practice which allows them to advise on policy.

4. Bundling

Recognition of this multiplicity of functions is important because simple discussions of World Bank reform tend to isolate only the one or two functions which fit the solutions the authors wish to advance. Alan Walters, for example, has argued that because no dividends are paid, all Bank lending is subsidized. He thereby implicitly dismisses the Bank’s banking function. He also regards conditionality as ‘merely window-dressing’. By contrast, I argue that the three functions I have identified are complementary. In particular, the promotion of development-oriented reform improves the prospects for contractual debt service, and by the intermediation of funds, information provision is enhanced. In these ways, the banking and development agency functions become mutually reinforcing.

The substantive issue is whether it makes sense to bundle together the functions of the World Bank. One simple argument for bundling the banking and development agency functions is that similar skills are required to identify and assess potential investment projects as those required to analyse the more general development needs of a borrowing country. This implies the existence of economies of scope in the provision of these two functions. But although this argument may have some validity, it is insufficiently strong to act as an explanation for the Bank’s structure.

A stronger argument is that the success of the banking function derives, first from the strong enforcement powers of the Bank in ensuring contractual lending terms are met, and second from the conditionality that the Bank is able to impose (although borrowing countries have a mixed record in conditionality compliance). This can be seen in a standard sovereign debt game framework in which debtor governments are able to threaten default unless debt service is ‘rescheduled’ in their favour. Creditor banks are, however, able to impose penalties on defaulting governments by preventing future access to credit markets. These penalties are likely to be more painful in states of the world favourable to the debtor countries during which they would wish to borrow to finance new investment. The result is an equilibrium in which debtors pay in ‘good’ states of the world (the first half of the nineties) but obtain rescheduling in ‘bad’ states (the first half of the eighties). The effects of policy conditionality is to raise the penalties associated with default on debt service by raising expected investment returns.

In this framework, conditionality will raise expected repayments both to the World bank, as the enforcer of conditionality, but also to private sector banks. It therefore generates an externality. The World Bank’s comparative advantage in enforcement arises through internalizing this externality, both because it values development per se , and because it values governments servicing private sector borrowing in order to maintain future credit market access. Private sector banks would only be concerned about their own repayments, and indeed may even try to obtain these at the expense of repayments to other banks (through assertion of seniority).

The World Bank’s development agency function also benefits from the banking function in at least two ways. First, countries may be more willing to provide accurate information where potential financing is an issue. Second, reform may face fewer impediments when undertaken as part of a lending programme. The link between the banking and development agency functions may therefore be seen as stemming from complementarity of these functions in the Bank’s production function.

Continued - 5. Integrity

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