The Bear's Lair: An agenda for Wolfowitz

By MARTIN HUTCHINSON  |  March 21, 2005 at 11:14 AM
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WASHINGTON, March 21 (UPI) -- If Paul Wolfowitz survives the inevitable sniping from Europeans to emerge as President of the World Bank, he will at least represent a different approach from outgoing president James Wolfensohn. It's about time!

When Wolfensohn was appointed in 1995, those free market supporters who knew of his investment banking career at Schroders and Salomon Brothers hoped he would bring a breath of free market fresh air to the World Bank, focusing it more closely on private sector development and less on funneling huge resources through corrupt quasi-Socialist Third World governments.

Unfortunately, while Wolfensohn acquired a huge and impressive Rolodex at Schroders and Salomon Brothers, and apparently was very effective at the furious infighting that dignified most Salomon Brothers partners' meetings, he appears never to have learned much about the principles of free market economic development. Instead of being a breath of fresh air, he headed straight for the economic death-wish agenda put out by the major Non-Governmental Organizations, and for several years ran a World Bank/NGO lovefest that wasted tens of billions of dollars and very nearly wrecked world trade, bearing a high share of the responsibility for the Seattle trade meeting fiasco of 1999. Empowering lunatic ideologues, already feted by a media that loves conflict and couldn't care less about economic development, proved to be a developmental dead end, resulting inter alia in Argentina's 70 percent write-off of its international debt and huge losses for more or less innocent bondholders.

Wolfensohn was reappointed by President Bill Clinton in 2000 in spite of the strong doubts of Treasury Secretary Larry Summers, and has since played a more passive role, albeit one that included inspiring a media witch hunt against Treasury Secretary Paul O'Neill, who threatened the World Bank's empire by proposing that some of its loans should be replaced by grants. Both Wolfensohn's terms of office have been distinguished by a rapid expansion in the World Bank's bureaucracy, principally fueled by a policy of putting senior officers in the field in each country, while retaining essentially all decision making authority at Head Office, thus doubling up on the headcount without any measurable benefit to results.

Wolfowitz has a number of qualities that appear to make him well suited to running the World Bank. He is very determined, and prepared to stick by his agenda however hot the media opposition gets -- and if he does anything serious about the World Bank's failings, it will get pretty hot, as the NGOs play like violinists on the social consciences of naïve reporters. He has seen economic development close up, as Ambassador to Indonesia, a country that during his 1986-89 mission appeared to be conquering the problems of economic development, but in reality was already sliding towards the abyss of corruption that marked President Suharto's last years. He is probably less likely to be captured by the bureaucracy than most previous World Bank Presidents but may or may not have a clear idea of how the World Bank should clean up its act.

Which brings us back to the agenda. The World Bank consists of three organizations, the International Finance Corporation, which makes loans and investments to the private sector, the International Bank for Reconstruction and Development, which makes loans to governments and their entities and the International Development Association that provides subsidized long term credit for those countries not deemed able to tap the private market.

The IDA may or may not do any good, but there's no question that its credits generally have to be written off as country debt loads become too onerous -- thus the Heavily Indebted Poor Countries debt write-off initiatives of the last few years. Given this fact, pretending the debt is ever going to be repaid is simply Enron accounting. These loans should be replaced by grants, as O'Neill proposed in 2001, and the world's taxpayers given full disclosure on the amounts of money being so granted, rather than pretending that it is all "capital" that has some value. Wolfensohn resisted this, because it meant a possible diminution of his empire; one hopes very much that Wolfowitz will have more sense and integrity.

The IBRD provides much the largest volume of financing of the three entities, yet it must be highly questionable whether its money is well spent. Since it finances only through governments, it is subject to all the inefficiencies and corruption of which Third World governments are capable, yet as Argentina demonstrated its debt takes effective priority over private sector debt to the country concerned (and in most cases is considerably cheaper and of longer maturity.) This priority is the dirty secret of World Bank and International Monetary Fund lending; it allows those institutions to preserve their capital and their AAA bond ratings, and to pretend that Third World lending is risk free, while loading enormous additional risk onto private sector lenders and investors.

It is extraordinary that an institution founded in the dark days of 1944, by Maynard Keynes, who believed in government management of markets, and Harry Dexter White, an active Soviet spy, is still, more than 60 years later, helping the public sector and hindering private business in this way.

The Argentina and Russia defaults demonstrate the folly of this approach; the World Bank and International Monetary Fund got their money back, while private sector lenders, often dealing with private sector borrowers, suffered enormous losses. By effectively subordinating the private capital markets to these unaccountable public sector monopolies, the proper allocation of capital is hindered and the cause of economic development fatally compromised.

It is not surprising then that outside Europe and recently India and China, the two great successes of economic development have been Latin America in the nineteenth century and East Asia in the late twentieth century. Nineteenth century Latin America was developed by private sector capital, merchant banks acting as advisors to countries and borrowers and arranging bond issues accordingly. Consequently, while there were defaults, capital remained in general moderately scarce, and it remained in the interest of Latin American countries to use it properly.

Since World War II, Latin American countries have been among the most active borrowers from the World Bank group -- and, perhaps even more notably, among the heaviest recipients of World Bank advice. It cannot be a coincidence therefore that Latin America's economic performance has been greatly inferior to its performance in 1860-1914. Far too much money has been poured into public sector boondoggles, while the private sector has been hampered by capital that is either lacking or, courtesy of World Bank/IMF "tight money" policies, impossibly expensive, as in Brazil.

As one example, I was involved in 1980 with a modest Eurobond issue, supplemental to a billion dollar World Bank-led financing for a massive expansion at the Venezuelan steel company SIDOR. Apart from using outdated technology, the SIDOR expansion was located 400 miles up the Orinoco River from the nearest market, and was unable to use the river for transportation because the unions at other river ports wouldn't let the government build new port facilities for it. Instead, structural steel for construction in downtown Caracas was conveyed 400 miles by trucks along a narrow un-modernized road through a series of mountain ranges. Needless to say, SIDOR, then and later, made staggering losses. It must be emphasized: this huge waste of money could not have got financing had the World Bank not been involved!

At the other end of the spectrum, the East Asian countries such as South Korea, Taiwan and Thailand have not been major borrowers from the World Bank; better still they have relied primarily on their ample domestic sources of capital for development, focusing expansion almost entirely in the private sector. Consequently, over the last 50 years, they have had the highest economic growth rates in the world. The World Bank and IMF became involved after the 1997 debt crisis, but it is remarkable how quickly these countries repaid their World Bank and IMF funding and returned to the private capital markets.

The agenda for Wolfowitz is thus clear. The IFC, lending to and investing in Third World private sector operations, competes with the private sector banking system, but is doing something generally of value. It should thus continue doing so on a modest scale, providing additional capacity and scarce expertise to this highly worthwhile market, but avoiding public sector subsidization or control of its operations.

The IDA must be converted to a grants agency; to do otherwise is simply to indulge in self-deluding accounting.

The World Bank's operations should be reduced greatly in size, and refocused on financing only those needs that the private sector does not readily provide. Of those needs, the most important is the safeguarding of middle class savings, which are the principal source of finance for small business in all countries, but which quasi-Socialist Latin American and other governments typically regard as a piggy-bank, to be raided through inflation or direct looting every time the government gets into financial difficulty. Unlike in Argentina, which was encouraged by the IMF to "pesify" domestic savings in order to prop up the banking system, looting attempts on middle class savings should immediately be met with a cut-off in all funding to the public sector from international lending agencies until middle class savings have been restored.

More positively, the World Bank can usefully operate deposit insurance schemes for approved local banks, providing assurance to savers in Third World countries that their savings are safe from expropriation in banks for which World Bank deposit insurance is in effect. By doing this, and encouraging the marketing of Internet banking services to attract deposits from rural savers, the World Bank can ensure that the pool of small business capital in the economy is nurtured, and saving is encouraged. This, far more than "microfinance," will ensure that small business gets financing -- if microfinance comes from local savers, and not from a distant bank, the controls on what happens to it are better and the chances of the small business succeeding are much better.

If Wolfowitz follows this approach, he will attract hostility from the NGOs, and very probably from the media, and mulish resistance to change from the more recalcitrant members of the World Bank's staff. He will also sharply reduce the size of his fiefdom, something that his Pentagon experience has no doubt taught him to abhor.

He will however revolutionize Third World financing, revitalize private sector lending to and investing in emerging markets and, in the long run, do more than any one man to lift the Third World out of poverty. It is to be hoped that the distant vision of that enormously important goal will make it worthwhile for him to overcome the difficulties he will inevitably face.


(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long '90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)


Martin Hutchinson is the author of "Great Conservatives" (Academica Press, 2005) -- details can be found on the Web site

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