GEI Newsletter Issue No. 3

The World Bank at Fifty (continued) - 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

Back to the begining of the article

5. Integrity

A related question is why the World Bank and the IMF take on the leadership role in debt service negotiations. Would it be possible for this role to be assumed by a large private sector creditor? A number of reasons suggests why these Global Economic Institutions assume this status: (i) their public sector or multilateral nature, (ii) their size, (iii) their proficiency in research and technical analysis, (iv) their comparative advantage in monitoring and control (the development agency function) and (v) their comparative advantage in enforcement through enhanced penalties. Indeed, it is the bundling together of these characteristics of the GEI’s which gives them a natural leadership status.

To see this, suppose the World Bank were split into its components. The institution which assumed the banking function would no longer have the same incentive to impose conditionality. Conditionality is a public good which benefits all creditors, but which would be under-provided in a world of only profit-maximizing private banks. The Bank’s successor banking institution would be no different to any other large private bank and therefore would be no more likely than any other institution to assume the focal leadership role. Hence, although other focal point equilibria might be sustained, these would be inferior to those resulting from the World Bank assuming the focal role.

6. Privatization

These arguments suggest that it is misconceived to argue that the World Bank should be split into component institutions, whether along functional lines or along current institutional divisions. Privatization would also be an inappropriate ‘reform’. The benefits from privatization are generally seen as deriving from altered incentives (within a principal-agent context), and from any associated increase in competition rather than from the change in ownership as such. The international credit market is already highly competitive so it is unlikely that privatization of the World Bank would have any effect on the industrial structure of world financial markets. A case would need to be made for privatization to result in improved incentives in this context.

If the current World Bank Group is privatized as a whole, it would be likely to evolve to become very similar to other large international banks involved in development finance. If its shares are held by members of the public rather than governments, it will be profit-maximizing and would thus be expected to evolve towards the same mix of activities as other international banks. The development agency and the development research functions would not fit in this structure. The Bank’s comparative advantage in enforcement would also be lost, as would its credit-rating function. Privatization would therefore maintain the Bank’s banking function, but everything else would be lost. The world would have one more international bank, but there would be less diversity in the financial system and functions which the Bank is currently uniquely fulfilling would go unfulfilled.

Neither is there merit in the proposal that the World Bank and the IMF should merge. I believe that this suggestion reflects a lack of clarity about the IMF’s objectives. The 1994/5 Mexican crisis indicates that exchange rate management problems, which formed the original raison d’être of the Fund are still present in the post-Bretton Woods world. Rather than merge with the Bank (perhaps into the Bank, given the relative size of the two institutions) the Fund should refocus its activities on exchange rate and balance of payments concerns.

Although complementarity among the Bank’s functions argues strongly against any proposal which would split the Bank. Privatization would also tend to weaken this complementarity. However, this does not imply that there is no merit in privatization of certain individual components of the World Bank Group. In particular, there does appear to be merit in the suggestion that the IFC might be privatized since this institution has relatively weak links with the other members of the Group, its lending does not depend on government guarantees and is not associated with conditionality. An advantage might be that privatization would produce an IFC board with a keener understanding of the need for market-based rather than politically-oriented development policies. An offsetting disadvantage would be the need to maintain the developmental objective. Partial privatization might be a means of simultaneously satisfying both these objectives.

7. Facilitation

Discussion of privatization is, however, a distraction from the major reform issues which are independent of ownership. It is important to acknowledge that, despite the advantages from bundling the banking and development agency functions, there are also major costs. Because World Bank funds typically go to governments and inevitably go through governments, they increase the political power and the patronage possibilities of these governments. This runs counter to the development philosophy that the Bank embraces. These features of Bank lending can give rise to the appearance that lending chiefly benefits the politicians and civil servants who negotiate successful loans, the consulting groups which provide the reports on the basis of which the loan decisions are made, and the Bank officials who bring long negotiations to a successful conclusion. In some cases, these appearances may not be misleading. Addressing this problem requires a major change in the Bank’s operating philosophy.

At its fiftieth birthday, the Bank should decide to move from seeing itself as a provider to become a facilitator . The concept of the welfare state, as institutionalized in much of post-war Europe, saw the state as providing services which the market either failed to provide or provided inadequately. However, both because of escalation of costs and the attenuation of individual incentives, states have tended to retreat from these commitments, and are coming to see their role more as facilitating the private provision of these services, either through the market or through community groups. I propose that the Bank should also now partially retreat from the welfarist approach and move towards seeing itself as augmenting, rather than substituting, for private sector investment.

The banking function of the Bank was initially conceived as that of remedying capital market imperfections, of which the most important arises from sovereign risk. These imperfections restrict access of developing country governments to development finance. The Bank’s traditional response has been to provide substitute funds. The alternative is to facilitate, where possible, access to private sector funds. Guarantees are an important instrument which can contribute to this process. This proposal has the implication that MIGA would become more important within the World Bank Group. A second implication is that there should be a shift in the balance of funding within the World bank Group towards the IFC and away from the IBRD, which by implication will involve a shift from supporting public sector investment projects to private sector projects.

There are also other important aspects of facilitation which fall under the title of ‘institution building’. To a greater or lesser extent, a market-based economy requires law and order, a legal system which allows aggrieved parties to seek redress, security from extortion and from preferential treatment, and standard reporting and accounting conventions. The creation and reinforcement of these institutions and practices will advance the date when the Bank’s current clients can raise funds directly on the private market.

This discussion relates to another issue which dates back to the Bank’s foundation – that of whether its operations should be seen as temporary or permanent. Provision of development assistance can result in the growth of assistance dependency, particularly when large parts of government depend on continuing assistance for routine funding. This is analogous to the welfare dependency problem which is at the centre of social policy debate in the developed economies. There are, of course, many countries which will require the provision of concessional assistance for a considerable time, but it is important that policy work towards ending this requirement. One might consider a three-stage process, starting with outright provision of development assistance for those countries most in need, moving towards facilitation and with the attainable objective of exit when World Bank intermediation is no longer required.

This is a separate question to that of whether the Bank as an institution should be a permanent feature on the international stage. The Bank’s functions have evolved over time in response to changing international requirements, and one should expect the same sort of evolution in the future. However, the Bank has also tended to grow as it evolves, and it is less clear that old functions were dropped as new functions evolved. There is now a strong argument for the Bank concentrating its activities in two areas: the LDC group of least-developed countries, many of which are in Africa; and reconstruction activities in eastern Europe and the ex-Soviet Union (perhaps shortly also in Cuba) where there are major capital and institutional infrastructure deficiencies. In other areas, the World Bank Group should be seeking to extract itself, handing over its functions to the IFC and to private sector banks. This could result in a significantly smaller and less expensive World Bank.

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