Kennan’s Warning on Ukraine
Ambition, Insecurity, and the Perils of Independence
The World Bank entered a new era when Paul Wolfowitz took over as its president on June 1, 2005. Wolfowitz's predecessor, James Wolfensohn, had served in the role for ten years, with a mission of transformation and a management style that placed great emphasis on his personal leadership. By the time he left the post, Wolfensohn had succeeded in giving the bank "a human face" and "a dream of a world without poverty," and in altering the institution's priorities to emphasize building institutions, improving governance, enhancing the voice and participation of the poor, strengthening the rule of law, and stamping out corruption. When he replaced Wolfensohn, Wolfowitz was quick to emphasize that he embraced the bank's antipoverty mission. At the same time, he has let it be known that he will forgo a big-bang presidency.
The annual meetings of the International Monetary Fund and the World Bank take place in the fall, and, in a tradition begun by Robert McNamara in Nairobi in 1973, the president of the bank is expected to use that occasion to share his vision for the institution and unveil new initiatives. Wolfowitz's maiden speech, delivered at the annual meeting in Washington, D.C., in September 2005, was crafted to present himself as a president who will focus on the management of the institution, in cooperation with its partners, and look for leadership within countries themselves, with an emphasis on results and accountability.
The term "the World Bank" is shorthand for "the World Bank Group," which consists of several institutions. These include, most prominently, the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA), which provide credit to governments, and the International Finance Corporation (IFC), which works directly with the private sector. The IBRD's function is to provide loans at market-based rates to middle-income countries and better-off poor countries; IDA focuses on assisting development in the poorest countries in the world, with highly concessional financing. As the bank enters what may well be a ten-year period of leadership under Wolfowitz, it is necessary to ask whether changes to this structure are needed if the bank is going to continue to flourish. Most important is the question of how -- or if -- the IBRD can remain relevant to the needs of its middle-income clients and adapt its own financial structure to the modern world of global finance.
During its over 60 years of existence, the World Bank has been a key part of the international institutional architecture. Along with the International Monetary Fund, it was established to promote an open and liberal international economy. Some of its greatest achievements, accordingly, have come from helping countries develop and grow through a liberalizing, outward-looking strategy. The bank's adversaries, meanwhile, are those who oppose the liberal trading system (this does not include those who argue that the liberal trading system could function better). On this issue, the bank simply cannot try to accommodate its critics.
Over time, the bank has evolved from an organization focused on growth through trade and investment to an organization set on achieving a world without poverty. Its core mission is no longer to partner with middle-income countries in their pursuit of balanced and externally oriented growth; it is to alleviate poverty in poor countries and in the poorest pockets of middle-income countries. That is the World Bank that Wolfensohn was chosen to create and lead, and the one Wolfowitz has now embraced.
The World Bank is also evolving into the institution of choice for working with developing countries on "global commons" issues, such as the environment and health. The mission of rebuilding war-torn states, which was ignored during the Cold War, has come back with a vengeance since the fall of the Berlin Wall. Wherever money and economic growth are crucial to reconstruction efforts -- in Bosnia, the West Bank and Gaza, post-tsunami Asia -- people turn to the bank. Climate-friendly energy security is also likely to become an important part of the bank's agenda.
When Wolfensohn took up the reins in 1995, he inherited an institution that was under assault on many fronts. Critics were charging that the bank was overemphasizing growth at the expense of equity and poverty alleviation; paying too little attention to environmental sustainability; focusing too much on large infrastructure projects that damaged both the natural environment and poor communities; and, by so enthusiastically endorsing globalization and liberalization, aligning itself with elites against the powerless. Wolfensohn never disavowed the bank's belief in the importance of growth, infrastructure, and trade. But during his tenure, these factors receded in favor of a new agenda built around the "social sectors" of education and health as well as empowering the poor.
But public policy moves in cycles, as memories fade and new disappointments overshadow older failures. Now that the assault on growth-centered policies has scored a victory and the generation of bank employees that focused primarily on growth and liberalization has retired, growth is being reemphasized by those untainted by history, so to speak. Similarly, the bank has found it more and more politically permissible to increase its lending for agriculture and infrastructure (sectors in which the bank's efforts were once characterized by failure and controversy). This should not come as a surprise: for an institution that lends only to governments, a focus on voice and participation cannot hope to trump infrastructure and agriculture over the long term. New lending, however, will be crucially informed by the lessons of past missteps.
As the guard was changing at the front door, the bank's internal evaluation unit (which reports to the executive directors, who are the bank's shareholder representatives) was pointing the way. Its 2004 Annual Review of Development Effectiveness (ARDE), a study of the bank's contributions to poverty reduction, emphasized three points. first, the 2004 ARDE found that the bank was paying too little attention to issues of growth, in favor of a narrow concentration on social sectors, and called for more focus on productive sectors (as well as on the interaction of social and productive sectors) in order to achieve the growth that is essential for sustained poverty reduction. It also reported that although much knowledge has been compiled, there is little evidence that the bank's interventions on issues of governance have either improved governance or decreased corruption. Finally, the ARDE pointed out that the impact of the bank's social-development activities on poverty has yet to be demonstrated.
Wolfowitz's speech at last fall's annual meeting showed an appreciation of both his predecessor's legacy and of the challenges that remain. He considers growth essential, but he also knows that growth is dependent on civil society, the empowerment of women, and the rule of law. The bank will continue to emphasize the importance of governance and institutions but "cannot," as Wolfowitz noted, "be all things to all people. ... If we try to be experts at everything, we risk being successful at nothing." Wolfowitz then went on to name the sectors in which he intends to improve the bank's expertise: education, health, infrastructure, energy, and agriculture. His full agenda extends Wolfensohn's legacy; endorses last year's agreement by the G-8, the group of the world's leading industrialized nations, at Gleneagles, Scotland (to double aid to poor countries and cancel the debt of the poorest); and pays homage to the Millennium Development Goals. But it also embraces the private sector and the bank's history in its choice of priorities -- including boosting lending for infrastructure and agriculture to promote growth.
In the World Bank's first years of existence, the IBRD dominated the institution. Now, however, lending to middle-income countries has diminished in both size and emphasis, and IDA has become increasingly important. In Wolfowitz's speech, the bank's responsibility to middle-income countries received only lip service. Wolfowitz did little more than remind the world that a billion people live in poverty in middle-income countries and that "innovation and adaptation" will be necessary if the bank is to remain relevant.
The numbers are stark: the IBRD's gross disbursements have declined in the last 10 years from nominal levels of $13 billion to $14 billion a decade ago to about $10 billion in fiscal years 2004 and 2005. Although there is a good deal of volatility in private flows, the trend line is clearly upward, which is part and parcel of globalization. Private capital flows to emerging markets now total over $300 billion a year. The time when middle-income countries depended on official assistance is thus past, and the IBRD seems to be a dying institution.
To the extent that this demise is due to the success of the IBRD's clients and the opening of capital markets to their needs, it is reason for celebration rather than lamentation. Some countries that originally depended on IBRD lending are now wealthy; others no longer need the IBRD because they can get funding from private sources. In fact, in discussing the decline in importance of the IBRD, the emphasis is often on what impact the loss of middle-income customers will have on the bank -- in terms of maintaining its expertise, its net income, and its ability to champion the interests of the poor.
There are a number of ways in which the World Bank could become more relevant to the middle-income countries while also integrating them into global efforts to meet the challenges of the commons, such as epidemics and global warming. But serious reform from within the bank seems unlikely for a host of reasons related to the structure of the institution itself as well as the political and financial context in which it operates.
The financial markets of today bear virtually no similarity to those of 1944. The IBRD was created to provide credit to its member countries, and in those days, that credit was often the only kind available to them. Those days are over. The whole concept of a lending institution with a big balance sheet tied up in long-term loans has been overtaken by securitization, in which loans are just the starting point for packaging together securities that can be sold and traded in the marketplace. Looking ahead ten years, the growth of the market for credit derivatives will most likely mean that credit to middle-income countries will be just another derivative financial instrument -- to be bought, sold, and managed in private portfolios.
In politics, as in finance, the bank is outdated. As many have noted, its executive board and its share structure are at odds with the distribution of power and influence in the global economy -- and they are becoming more so every year. Since the redistribution of shares is a zero-sum game, reform through internal bargaining is highly unlikely. Governments recognized this reality in the wake of the Asian financial crisis by creating a new "Group of 20" (G-20), made up of the finance ministers and central-bank heads of the systemically significant countries.
There are some potential changes that might garner widespread support, such as nonsovereign lending, new instruments for promoting private-sector involvement, or wholly new uses of bank capital for global-commons programs (for example, the vaccine initiative or research for environmentally friendly technology). But the IBRD's Articles of Agreement are intertwined with its financial structure to make each reform effort tortuous. The World Bank needs a way to start over, with a clean slate.
The hope is that in the long term, countries presently borrowing from the IBRD will graduate to a level of wealth that makes them ineligible for such support (as happened to Japan, Spain, and South Korea). At the same time, one hopes that IDA countries will move to IBRD income levels, and so the question of making the World Bank relevant to them will remain on the table.
Any advocate of reform must be frank about the bureaucratic interests that currently want the IBRD to survive as long as possible. The IBRD has become a crucial source of financial support and clout for the development community. IBRD income helps sustain the World Bank's administrative budget of $2 billion and finances large off-budget transfers of money to IDA countries ($600 million in the last fiscal year alone). If the bank undergoes major change, the timeline for reform must permit an orderly reconfiguration of support for the ongoing work on poverty. If there is no provision for such a reconfiguration in the blueprint, there will be fierce bureaucratic resistance.
The G-20 should convene a group of eminent persons from outside of government, led by a distinguished former finance minister or head of government from a middle-income country, for the purpose of considering the ideal institution to meet the needs of middle-income countries, including as those needs relate to high-priority efforts in the global commons. The group would consider the option of stopping loans from the IBRD within 10 years. If the last 15-year loan were made 10 years from now, the IBRD would cease to exist in 25 years. In the meantime, as the IBRD's balance sheet shrank, increasing amounts of capital would become available for a new financial structure or for an endowment to produce income for grants. The IBRD's usable capital and reserves presently stand at more than $32 billion, with potential accretions from annual net income (which was $1.3 billion in the last fiscal year).
In providing the option of an orderly and consensual way to shut down the IBRD, the group of eminent persons would gain the leeway to think with as much creativity and freedom of action as were available to the original framers at Bretton Woods. The group could easily appoint a team of able and prudent financial engineers, headed by a retired central-bank governor, to elaborate a set of modern financial designs for meeting whatever needs the group envisions, such as grants for technology research or a credit backstop facility using derivative instruments to insure loans made to developing countries.
Once there is an orderly path toward winding down the IBRD, much becomes possible in terms of establishing a new institution for the benefit of middle-income countries. A new set of articles of agreement would be required to govern its use of resources. The new institution would be free to join its operations with the IFC and the Multilateral Investment Guarantee Agency to promote private-sector involvement in novel ways. No sovereign guarantee would be required, and lending, investment, or guarantees could occur at the local, regional, or even global level -- to support initiatives for the global commons, for example.
The World Bank is a great institution with major contributions to make in alleviating poverty in middle-income countries, in creating and disseminating knowledge about development, in supporting the evolution of a fair and open trading system, in backstopping private capital flows to emerging markets under conditions that minimize moral hazard, and in promoting international initiatives in the global commons. But the world has changed dramatically since the bank's founding over 60 years ago; the bank must change, too, if it is to flourish for another 60 years.