May 16, 1996 | Backgrounder on International Organizations
Map 1: Countries Receiving World Bank Loans for 25 years or Longer
Table 1: Economic Growth Rates of Recipients of World Bank Loans, Algeria - Lesotho
Table 1: Economic Growth Rates of Recipients if World Bank Loans, continued, Madagascar - Zambia
Table 2: How Long Term Recipients of World Bank Loans Rate on Economic Freedom
Table 3: Economic Growth and Government Spending
Chart 1: Per Capita GDP Growth in Hong Kong, Singapore and Selected Long-Term Recipients of World Bank Loans
Appendix A: All Recipients of World Bank Lending, Albania - Ghana
Appendix A: All Recipients of World Bank Lending, Greece - Nigeria
Appendix A: All Recipients of World Bank Lending, Norway - Zimbabwe
President Bill Clinton has recommended that the United States give more money to institutions like the World Bank. The Clinton Administration has obligated the U.S. to contribute $800 million to one of the Bank's agencies, the International Development Agency.2 This is about $100 million more than was requested for the last fiscal year. Spending more on the World Bank ignores the overwhelming evidence that its programs have done little to promote economic growth in less developed countries. Moreover, it ignores the economic lessons of what really causes countries to develop.
Since its founding in 1944, the World Bank has been involved in over 165 countries. The Bank argues that less developed countries stand little chance to prosper economically without substantial subsidized loans from the developed world. It further contends that it is uniquely positioned to meet this challenge and that it must continue to transfer capital to poor countries.
The World Bank is wrong. The data show that most long-term recipients of World Bank money are no better off today then they were when they received their first loan. Many are actually worse off. Consider the following:
Former less developed countries that have prospered over the past 30 years did so by freeing up the productive forces of their economies. The best examples are Hong Kong and Singapore. Even though a country like Singapore received a small amount of money from the World Bank, the evidence shows that what most effected economic growth was not World Bank aid, but economic freedom.
Congress would do well to take a critical look at the World Bank's history and programs. If it does, it will find that the Bank's approach to economic development has not worked. Rather than let the Bank try to reform itself, as it claims it has tried repeatedly to do in the past, the U.S. should withdraw financial support altogether. Specifically, the U.S. Congress should:
What is the World Bank?
Officially named the International Bank for Reconstruction and Development (IBRD), the World Bank was founded in 1944 by the 44 nations that met at Bretton Woods, New Hampshire, to establish a new post-war international economic system. Today, the Bank has 178 members; only 12 nations are not members. The United States is the largest contributor, providing some $53 billion since 1944.3 Even though the U.S. has reduced its funding as a percentage of the Bank's total deposits from 29.3 percent in 1965 to 17.5 percent in 1995, it remains the Bank's largest donor and has pledged more money to the Bank than any other country.4
World Bank members provide contributions based on the size of their economies. The larger and wealthier the economy, the more the country is likely to give. A country's voting power is based on the amount of its contributions. Since the U.S. is the biggest donor, it therefore has the most voting power.
The World Bank is governed by several bodies. These are:
Arms of the World Bank
There are several institutions that make up the World Bank, each with a unique mission. Throughout its 50-year history, members of the Bank have created many arms, known collectively as "the World Bank Group."5 These are the International Finance Corporation (IFC), the International Development Association (IDA), the International Center for Settlement of Investment Disputes (ICSID), and the Multilateral Investment Guarantee Agency (MIGA). Each has its own mission and goals.
The United States also is the largest shareholder in the IDA, holding some 15 percent of the total votes in 1995. The U.S. has contributed some $21 billion since 1960,7 and contributed $1.1 billion in FY 1995 alone.
How the World Bank Makes Loans and Grants
Each year the Bank considers many loans. Though loan proposals officially are submitted by the president of the Bank to the executive directors, in reality the executive directors often work with the president's staff to develop proposals. Thus, the approval process is often merely a formality. The United States has no veto power over Bank loans, and the Bank frequently approves loans that the U.S. has opposed.10
The Bank's funds are derived from country contributions and from investments the Bank makes in financial markets. The Bank sells bonds and other debt securities to pension funds, insurance companies, corporations, other banks, and individual investors. Its original source of income is contributions by member countries. Countries receiving loans are charged an interest rate, currently 7.27 percent. This rate is adjusted every six months. Maturity on the loans is generally from 15 to 20 years, with a five-year grace period.
History of the World Bank
The World Bank has undergone a major transformation since it started in 1944. The Bank claims it has kept up with change to deal with the new challenges facing less developed countries. This contention is debatable, but it is true that the fundamental mission today is substantially different from what it was in 1944.
Lender of Last Resort
In the beginning, the Bank's primary mission was to loan money to the war-ravaged countries of Western Europe and Japan to help them get on their feet after World War II. These loans were intended to help rebuild roads, bridges, electrical plants, and other public facilities and enterprises.11 Japan and the European countries would use World Bank loans when private bank loans were not forthcoming. Many private commercial banks refused to lend these nations money because they were bad risks, some of them having defaulted on World War I and post-World War I debts.
From 1944 to the mid-1950s, most World Bank loans went to the developed countries in Europe that had suffered extensive damage in World War II. Therefore, even though the Bank loaned some $543 million for the reconstruction of Europe, the money was absorbed by countries that essentially were advanced developed economies with strong economic foundations in banking, property rights protection, the rule of law, functioning courts, and borders open to foreign investment.
Because these countries already had the basic building blocks of an advanced economy, they were able to put the World Bank loans to productive use. Yet U.S. private investment in post-war Europe played a larger role in reconstruction than the World Bank. The World Bank loaned Western European countries $543 million from 1945-1950, while U.S. private investment was $1.76 billion for the same period.12 Therein lies the real success story of Europe's recovery. While it is true that funding from the World Bank, other financial institutions, and the Marshall Plan helped rebuild war-torn Europe, the biggest impact on Europe's economic recovery came from private foreign investment.
An International Welfare Agency
By the late 1950s, it became clear that the World Bank had served its purpose. Europe and Japan were well on their way to recovering from World War II. Private foreign investment was pouring into these regions to take advantage of their renewed economic strength. America realized its economic dominance in the world as U.S. investment flowed abroad to fuel economic development and growth. At this time, the Bank faced a fundamental choice: It could dissolve because its major goal had been met, or it could evolve into something not imagined by its creators.
Eventually, the World bank decided on the second course. By the mid-1960s, the Bank began to transform itself from a lender of last resort to an international welfare agency to assist the poor and less developed countries of the world. In 1960, for example, the Bank created the International Development Agency (IDA), which makes subsidized loans to poor countries either unable to afford private commercial loans or regarded as bad credit risks. Even though the original mission statement made casual reference to the "less developed" world, the Bank's founders largely had envisioned this as purely advisory. Yet the Bank began to give more than advice to less developed countries; in the 1960s, it began to give them substantial loans.
The mastermind of this transformation was former U.S. Secretary of Defense Robert S. McNamara, who took charge of the World Bank in 1968. To fund McNamara's new international welfare clearinghouse, the Bank had to seek ever-increasing levels of contributions from donor countries.
Also under McNamara's watch, the Bank formulated a new concept, called "sustainable development," that became the IDA's principal mission. Stated simply, this means that less developed countries can achieve sustainable levels of economic development only if enough resources are transferred from wealthy countries to poor countries. If loans are any measure of success, McNamara was "successful" indeed. By 1981, when McNamara resigned as president of the World Bank, lending had grown more than tenfold, from $883 million to $12 billion. World Bank lending and grants continue to grow, today totaling over $20 billion.13
The World Bank remains fully committed to this kind of thinking, with most of its bureaucrats dedicated to the McNamara dogma. A book published in 1995 by the World Bank and the International Monetary Fund to commemorate their 50-year anniversary claims that "This institutional evolution has been matched by a changing approach to development. The early focus on discrete projects has evolved into a broader emphasis on policies, strategies, and institutions, and a more holistic approach to development.... [The World Bank] Group's primary concern is to help borrowers reduce poverty and improve living standards by promoting sustainable growth and investment in people."14 In other words, the World Bank is not the institution created in 1944 by the Bretton Woods Agreement; it has changed from lender of last resort to international welfare agency.
Decades of Failed Policies
While many of the Bank's economists are free to acknowledge the importance of macroeconomic reform in the recipe for economic growth, many of the Bank's officials continue to place too much emphasis on the importance of multilateral institutions to less developed countries. For example, former World Bank President Lewis T. Preston said in 1995: "Of fundamental importance, the Bank Group has evolved from being simply a financier of development to being also a trusted advisor on development, sharing its global experience of what does and does not work and helping its member countries to apply the lessons.... Fifty years of experience have validated the Bank Group's fundamental objective today: helping borrowers reduce poverty and improve living standards through sustainable growth and investment in people."15
Thus, the Bank seems to claim not only that it has been successful at reducing poverty and improving living standards in less developed countries, but also that its continued existence is vital to the economic prospects of less developed countries in the future. Yet all the evidence shows that this is not true. Since its inception, the World Bank has provided over $356 billion to countries around the world, mostly to the less developed world.16 But most recipients are no better off today than they were before receiving such aid. In fact, many are worse off. Consider the following:
While many countries are no better off today than before they received money from the World Bank, some have performed particularly poorly.
Why World Bank Programs Fail
The main reason for a lack of economic growth in these countries is a corresponding lack of economic freedom. A lack of economic freedom prevents countries from creating wealth and prosperity, and a recent worldwide survey of economic freedom finds that many World Bank recipients have economies that are mostly not free or repressed. The 1996 Index of Economic Freedom, published by The Heritage Foundation, analyzes the level of economic freedom in 142 countries.18 The study considers ten economic factors -- trade, taxation, government consumption, monetary policy, banking, foreign investment, wage and price controls, private property rights, regulation, and black markets -- and categorizes each country as having a "free," "mostly free," "mostly not free," or "repressed" economy. The findings of the study demonstrate that a majority of World Bank loan and grant recipients do not have significant levels of economic freedom:
Thus, most long-term recipients of World Bank loans and grants still do not have significant levels of economic freedom. Moreover, those recipients that hve performed particularly poorly are the least economically free:
Economic prosperity is not forthcoming in these countries because they do not have economic freedom. Rather, most have high taxes, barriers to trade, restrictions on foreign investment, banking systems in disarray, onerous government regulations, bad monetary policies, extensive wage and price controls, and large black markets. To be sure, 23 long-term recipients of World Bank aid do have mostly free economies, but most of these are in Latin America, an area which has benefited from several years of economic reform. Thus, their categorization as having mostly free economies is a recent phenomenon.19 It is good that they are making progress, but given the evidence elsewhere in the world, it would be difficult to attribute this progress to help from the World Bank.
Hong Kong and Singapore: Models of Growth Without World Bank Aid
The poor record of the World Bank in delivering on its promise of economic development can be demonstrated not only by listing its many failures, but also by examining some development successes that occurred without the Bank's help. Hong Kong and Singapore are the most successful of the so-called Asian Tigers, running up phenomenal economic growth rates that are the envy of the developed world. They did this largely without loans from the World Bank. Even though they were as poor 30 years ago as other countries that took World Bank aid, they eschewed World Bank loans and embarked instead on successful programs of economic liberalization. The evidence shows that there is a direct correlation between the economic freedom these countries enjoy and their tremendous economic growth over the past 30 years. Of one thing there can be absolutely no doubt: World Bank assistance was in no way responsible for creating the best development success stories the world has seen during this 30-year period.
In the 1960s, the U.S. foreign aid community and international lending institutions like the World Bank decided that the East Asian region was barren of economic promise and that they should focus their aid on Africa instead. Hong Kong received no aid from the World Bank and only a small amount in U.S. foreign aid -- $43 million, most of which was cut off after 1965. The World Bank admitted that many economists misjudged the economic prospect in Asia. In the commemorative volume marking the Bank's 50th anniversary, the authors state: "In the 1960s, many economists were more optimistic about sub-Saharan Africa than East Asia. Yet, East Asia proved to be the 'miracle' of the developing world -- and sub-Saharan Africa its most daunting challenge."20
While eschewing foreign aid after 1965, Hong Kong at the same time began a massive economic liberalization program. This included reforms in many sectors, including banking and financial services, government regulation of business, and foreign investment laws. Among the most important of these reforms was lowering barriers to international trade and making Hong Kong's trade laws consistent with international standards. The government eliminated virtually all tariffs, duties, licensing requirements, and other import barriers. It also set up export processing zones, or "free trade areas," that allowed manufacturers to cut through red tape to sell their products overseas.21 These reforms enabled Hong Kong to create a large export industry which provided much of the fuel for Hong Kong's economic growth.
Another critically important reform took place when Hong Kong established a tax structure that allows individuals and businesses to keep most of the wealth they create. For example, Hong Kong has a flat tax of 20 percent on incomes over $155,000. The worker making the average income of about $22,500 is taxed only 2 percent. Hong Kong's corporate tax rate is a flat 16.5 percent, compared to 35 percent in the U.S.22 These and other economic reforms helped turn Hong Kong into the economic powerhouse it is today.
After these economic reforms were in place, Hong Kong's economy indeed took off. GDP increased 9.2 percent a year from 1970 to 1980. From 1980 to 1993, it increased an additional 6.5 percent.23 Overall, over the past 35 years, Hong Kong's per capita GDP has grown an astonishing 530 percent, with most of this growth occurring since the beginning of economic liberalization.24
Singapore also exhibited little economic promise in the early 1960s, according to the economic forecasts of the day. In fact, it was often referred to as "Asia's Cuba."25 The World Bank gave most of its loans to Singapore -- some $93 million -- before 1970. Singapore received its last World Bank loan in 1975.
As World Bank loans were drying up, Singapore, like Hong Kong, embarked on a course of economic liberalization -- with the same stunning results. Starting in the late 1960s and continuing into the 1970s, Singapore instituted a series of economic reforms aimed at achieving two major goals. The first was to promote increased foreign investment and higher levels of exports. To this end, Singapore opened its market to foreign investors. By 1970, some 80 to 90 percent of all manufactured exports were derived from foreign investment.26 Why did foreign investment pour into Singapore? There are many reasons. One surely was that Singapore's legal system, based in British common law, provided rule of law, an efficient legal system, and a way for investors to achieve protection of their investments through contracts. Equally important was the fact that Singapore established a foreign investment code, free of local content or production restrictions, that guaranteed equal treatment under the law for both domestic and foreign firms.
The second goal was to reform Singapore's tax system. Singapore adopted a tax system that reduced the burden on most of the people. For example, while the top tax rate is 30 percent, the tax on the average income level of $21,000 is little or none. In fact, the average Singapore worker must make almost $30,000 before paying taxes. For that first tax bracket, the rate is 19 percent.27 In addition, Singapore resisted the implementation of onerous business regulations; abolished trade restrictions on imports (the average tariff rate now is about 0.4 percent, compared to 3.3 percent in the U.S.); and has kept inflation below 3 percent a year since the mid-1970s.
These economic reforms helped increase Singapore's gross domestic product. From 1970 to 1980, GDP increased by 8.3 percent a year. From 1980 to 1993, it increased an additional 6.9 percent. Overall, Singapore's gross national product has increased by over 6 percent a year since 1965.28
Hong Kong and Singapore have achieved the highest levels of economic prosperity to be found anywhere among the world's recently developed countries. In fact, they have achieved phenomenal economic growth rates that are the envy of the developed world. The evidence suggests that their policies of economic freedom are the principal reason for this success. There is a direct correlation between the economic freedom these countries have achieved and their tremendous economic growth over the past 30 years.29 There is also a direct correlation between this growth and a lack of aid from the World Bank. World Bank assistance was in no way responsible for creating the best development success stories the world has seen over the past 30 years (see Chart 1):
Phasing Out Support for the World Bank
The facts show that the World Bank's approach to economic development is a failure. The facts also show that countries which adopt free market economic reforms can develop without aid from the World Bank or any other institution. Promises by the World Bank to reform have made little difference. The U.S. therefore should begin withdrawing its financial support. Specifically, Congress should:
1) The economic performance of recipients of World Bank aid;
2) The effectiveness and efficiency of World Bank programs in meeting their stated goals;
3) The influence the World Bank has on encouraging recipient countries to adopt specific economic policies; and
4) Conducting an audit of the World Bank's financial records.
Since 1944, the World Bank has spent $346 billion trying to advance economic development around the world, and not all of this money has been repaid. While it played an important role in getting Europe on its feet after World War II, the World Bank has drifted away from its original mission to become little more than a clearinghouse for international welfare. Most recipients of loans and grants are no better off today than when they first received them. In fact, many are worse off.
Clearly, the World Bank's approach to economic development is a failure. But while recipients of World Bank loans continue to wallow in poverty, countries like Hong Kong and Singapore continue to experience unprecedented growth.
While there is overwhelming evidence to show the futility of such aid, the U.S. continues to support this failed institution, providing over $50 billion to the Bank in 1995, including both monetary allocations and commitments. American policymakers should admit this failure and begin phasing out U.S. financial support for the World Bank over seven years. Not only will billions in U.S. taxpayer dollars be saved, but countries in the less developed world may be able finally to break the economic chains that have kept them impoverished.