President George Bush recently proposed that the World Bank's International Development Association (IDA) begin extending performance-based grants to poor countries instead of loans that they have little chance of repaying.1 A similar proposal was made by the congressionally appointed International Financial Institution Advisory Commission (the Meltzer Commission) in March 2000.2
Rather than welcoming this proposal as a show of support for poor nations, some representatives of the World Bank have criticized it. Jeff Lamb of the World Bank, for example, claims the idea does not "resonate with conservative economics."3 Beverly Warmington, spokeswoman for the British government's Department for International Development, also dismissed the proposal noting that "The World Bank is actually a bank and there are development agencies to give grants. It's important that the World Bank work alongside them instead of competing with them."4
Yet the World Bank has shown little commitment to applying "conservative economics" to its lending policies. On the contrary, poor countries that receive World Bank loans are likely to remain poor despite repeated World Bank loans, and many are so burdened by the development loans that debt forgiveness has become a common topic at the Bank's regular meetings. Moreover, there is no shortage of projects that need funding, poor who need medicine, or children who need education; and the notion of organizations fighting for an opportunity to provide funding for these purposes would be welcomed by developing countries.
In truth, the President's proposal is about increasing the effectiveness and accountability of World Bank assistance to poor nations. The Administration will need leverage to overcome opposition to the plan at the World Bank. The means to do so is available: the appropriation of $803.4 million for the IDA in the Foreign Operations, Export Financing, and Related Programs Appropriations Act for 2002 (H.R. 2506), which the House passed on July 26. The Administration should work with Congress to ensure that future IDA appropriations are tied to that organization's adoption and implementation of the President's grant proposal.
A common misperception is that foreign aid primarily involves large gifts of money to nations in need. In reality, most aid involves providing funds at a subsidized rate and, therefore, cheaper than rates available in international financial markets. The World Bank does so by extending subsidized loans. Its International Development Association, for example, offers virtually interest-free loans with a delayed repayment schedule to extremely poor nations.
After studying the operations and effectiveness of the key international financial institutions, the Meltzer Commission proposed that the World Bank replace subsidized loans for development with performance-based grants on a sliding scale, according to a country's wealth. In other words, the poorer the country, the greater the portion of grant financing from the Bank. Many experts had testified to the ineffectiveness of the current lending system, particularly with respect to spurring economic growth in poor nations.
neither the World Bank nor the regional development banks are pursuing the set of activities that could best help the world move rapidly toward [the Bank's stated goal of "a world without poverty"] or even the lesser, but more fully achievable, goal of raising living standards and the quality of life, particularly for people in the poorest nations of the world.5
The economic performance of IDA recipients--the world's poorest countries that are most in need of economic growth--over the past two decades clearly supports the Commission's conclusion. As Table 1 shows, IDA loan recipients between 1980 and 1999:6
During deliberations on how to address the failures of the current development lending system, the Meltzer Commission proposed an ingenious idea to capitalize on the dramatic growth in capital markets worldwide in order to finance development in poor countries, increase accountability to improve results, and eliminate the possibility of Bank loans contributing to unsustainable debt burdens. Specifically, the Commission advocated focusing World Bank assistance on the poorest nations through a system of grants. This would be a dramatic departure from current Bank practices in which the world's 90 poorest countries receive only 40 percent of its funds.10
Under the Commission's proposed system, the Bank would award grants on a sliding scale depending on the recipient's per capita wealth and ability to attract private sector resources. Countries with access to capital markets (those with investment grade bond ratings) or a per capita income greater than $4,000 would not be eligible.11 Eligible countries would receive grants for up to 90 percent of the cost for delivering services. The grant portion would decline to 10 percent for the wealthiest eligible countries. Recipient countries would be responsible for paying the remaining portion of the projects, from a minimum of 10 percent to a maximum of 90 percent.
A contract to deliver services would be submitted to open, competitive bidding. The government agency, non-governmental organization (NGO), charity, or private sector business that submitted the cheapest bid would win the contract, thereby ensuring that each dollar awarded would have the greatest effect.
The Commission recommended an important change to the current system--recipients and the Bank would not pay for the approved projects up front, but rather would pay as results were delivered through service contracts. The agent implementing the project would borrow the stipulated funds from capital markets at interest rates that are cheaper than would otherwise be available by using the Bank service contract (backed by the elite credit ratings of Bank donors) and the recipient country's service contract as collateral. Payments would be made only after an independent auditor had verified results. No results, no payment.
The Benefits of Performance-Based Grants. Critics dismiss this proposal as a backdoor attempt to reduce the amount of assistance available to poor countries. Nothing could be further from the truth. Replacing loans with performance-based grants is superior to the current system in that it would:
In all respects, the grant system proposed by the Meltzer Commission would be superior to the current World Bank lending system. The Bush Administration recognizes this fact, and on July 17 proposed that "the World Bank and other development banks dramatically increase the share of their funding provided as grants rather than loans to the poorest countries."15 This proposal, a variation of the Meltzer Commission proposal, reportedly would dedicate a portion of annual International Development Association assistance to grants for low-income countries.
If the Administration's plan is financed in a manner similar to the Meltzer proposal, one-third of the IDA's 12th replenishment ($3.63 billion) invested in market instruments would provide $290 million annually for grants, assuming a conservative return of 8 percent. If every grant dollar replaces 17 loan dollars, the $3.63 billion endowment would support $4.9 billion in programs for poor countries.16 Even if the average grant financing of IDA projects is 75 percent (the equivalent to the gift component of current IDA credits), implementing the grant proposal would provide resources equivalent to the original $3.63 billion with one critical difference--the funds would be self-sustaining, without relying on the recipient country's ability to repay.17 Moreover, the assistance would be more effective because accountability and transparency would be enhanced through ongoing independent audits.
If all IDA funds were invested to provide earnings for grants, IDA resources would, at worst, be equivalent to current levels. After a transition period allowing the repayment of existing loans,18 the IDA would provide $108.1 billion for an endowment (paid-in capital and retained earnings) in market instruments, which would yield annual income of slightly less than $8 billion for grants with a conservative 8 percent return.19 This would support at least as much as the current maximum $108 million in lending programs. Additional benefits include reducing the risk of debt accumulation by poor countries and self-sustaining aid resources without risk of loss.
Clearly, the time has come for the World Bank to implement performance-based grants. In order to move its proposal forward, the Administration will need to pursue a two-track authorization strategy. The first step should be to make sure that new IDA funding is used for the grant proposal. Second, the Administration should seek support among fellow IDA members to use existing IDA resources for the grant proposal as they are repaid. Specifically, the Administration should:
Ideally, however, the legislation also should prohibit funding until the IDA implements the grant proposal. Moreover, it should stipulate that the IDA adopt independent performance audits and greater transparency. The Administration should work with the Senate to ensure that the current language remains or is strengthened during deliberations.
Authorization for the IDA to implement the grant proposal requires the approval of a two-thirds majority of IDA voting stock. The United States, which controls 14.86 percent of the voting stock, must gain support from an additional 51.14 percent of the voting stock. If the Administration gains support from the next largest contributors (Japan, Germany, the United Kingdom, and France), it still must gain support from at least six other voting groups.21 While gaining the support of IDA recipients is important (and easy, as most recipients are in favor of grants), the key players are the major IDA donors (only 39 of the 161 member countries are donor countries). A coalition of European countries and Japan could block the grant proposal. However, if the countries that provide IDA funding support the grant proposal, the recipients will go along.22 Because the U.S. cannot unilaterally implement the grant proposal, the Administration must:
The 11th and 12th replenishments offer precedent for using donor funds for grants, and the Administration should use this authority as a model. IDA members have already authorized the use of 11th and 12th Replenishment donor funds to finance IDA development grants in the context of the Heavily Indebted Poor Country Debt Initiative. The net income transfers from IBRD for fiscal years 1997, 1998, and 1999 also authorizes the use of such funds for IDA development grants.26
Bank staff are certain to mount stiff resistance, and the Administration must be prepared to counter their arguments. For instance, the Bank rejected the idea of grants on the basis that the IDA is a bank and its members expect it to act like one. This defense is a smokescreen; in reality, the IDA is an aid agency in all but name. A bank is a middleman between suppliers and users of funds, which pays interest to suppliers and charges interest to users based on risk (the higher the risk, the higher the interest rate). By contrast, IDA charges no interest on its "loans" to the world's least creditworthy clients.27 Instead, it assesses a tiny service charge of 0.75 percent on 35- or 40-year loans that have a 10-year grace period. IDA loans already have an overwhelming grant aspect in the difference between the 0.75 percent service charge and a market interest rate, and in the 10-year grace period, which lowers the net present value of the loan. Of course, this assumes that IDA recipients actually repay their loans, an assumption disputed by Bank data showing IDA recipients becoming ever more indebted to the organization. (See Table 1.)
The real concern for opponents is the increased transparency and accountability at the heart of the President's proposal. The World Bank and corrupt governments fear increased transparency and accountability, albeit for different reasons, while liberal groups are suspicious of the proposal's reliance on free markets. If forced to compromise, the Administration should yield on the issue of the substitution of grants for loans before yielding on its demands for truly independent performance audits and halting disbursements if results are not verified. Taxpayers in donor and recipient nations deserve to know how their money is being used, and greater transparency and accountability would alleviate, if not end, some of the debt issues by lessening the likelihood that IDA loans could be wasted.
The World Bank has not been successful in catalyzing economic development, especially in the world's poorest nations. President Bush's proposal to replace International Development Association loans with performance-based grants is a reasonable recommendation, which addresses the failures of the current system. His plan would create a self-sustaining source of funds for grants that would not add to the debt burden of poor countries, but that would impose more stringent accountability on the system to protect U.S. taxpayer dollars and ensure that boondoggles are not funded endlessly.
The Administration should work with Congress to tie future IDA appropriations to implementation of the President's grant proposal. At the same time, the President should direct the Secretary of the U.S. Treasury to work with other countries to change policy at the World Bank.
President Bush's grant plan would benefit the people in poor nations at the expense of unscrupulous government officials who could no longer use international assistance for their personal benefit and World Bank bureaucrats who would be forced to provide results instead of platitudes. Neither of these constituencies should stand in the way of reform that would transform the World Bank from a development hindrance to a contributing component of assistance to the poorest of nations.
Brett D. Schaefer is Jay Kingham Fellow in International Regulatory Affairs in the Center for International Trade and Economics at The Heritage Foundation.
8. Albania, Angola, Mongolia, St. Lucia, St. Vincent and the Grenadines, and Tonga did not receive disbursements for 10 years during that time period, but all joined the World Bank after 1980 and received disbursements from the IDA for at least half of the years they were eligible.
9. Brett D. Schaefer, "Debt in Developing Countries: History, Structure, and Efforts to Address Unsustainable External Debt Burdens," paper presented to the International Financial Institution Advisory Commission, January 4, 2000.
13. The IDA has had 11 replenishments since it was founded in 1960. Members have been making contributions to the 12th replenishment (1999-2002) of SDR 8.65 billion ($10.92 billion) since 1999, and deliberations for the 13th replenishment (2003-2005) began in 2001. World Bank financial data are in Special Drawing Rights (SDRs), the IMF unit of account. On August 3, 2001, the conversion rate was SDR=$1.26236. See "IDA13 Replenishment Documents," World Bank Group, at http://www.worldbank.org/ida/ida13docs.html.
16. This calculation estimates that the average grant element of World Bank projects would be 50 percent. See Lerrick, "A Better Way to Lend a Hand," p. 37. If the grant element is increased to 75 percent (equivalent to the present value in an IDA credit), a grant dollar equals an IDA loan dollar. See Lerrick and Meltzer, "The World Bank Is Wrong to Oppose Grants."
18. In fiscal year 2000
(which ended June 30, 2000), the IDA committed $4.4 billion to new
loans and disbursed $5.2 billion on preexisting loans. Most of the
IDA's resources are currently tied up in loans. Currently, the IDA
has $3.3 billion in undisbursed funds that would provide $264
million for grants in the upcoming year at an 8 percent return. As
IDA loans are repaid, the amount available for annual grants will
grow with the endowment. See World Bank, "What is IDA?" at
21. The United States, Japan, Germany, the United Kingdom, France, Saudi Arabia, China, and the Russian Federation cast their votes independently. The voting stock of these individual countries ranges from 14.86 percent for the United States to 0.28 percent for the Russian Federation. The remaining IDA members join one of 16 voting groups whose voting stock is cast by a representative selected by the group member nations. Voting stock of the groups ranges from 4.87 percent to 1.88 percent. See World Bank, "Executive Directors and Alternates of the World Bank and Their Voting Power," Appendix 2 of the World Bank Annual Report 2000, at http://www.worldbank.org/html/extpb/annrep/pdf/appndx/wb_a2.pdf.
22. For the 12th replenishment of the IDA's fund, the major donors were Japan, Germany, France, the United Kingdom, Italy, and Canada. See World Bank, "What is IDA?" at http://www.worldbank.org/ida/idao.html.
23. According to the IDA Articles of Agreement (Article V, Section 2): "(a) Financing by the Association shall take the form of loans. The Association may, however, provide other financing, either (i) out of funds subscribed pursuant to Article III, Section 1, and funds derived therefrom as principal. interest or other charges, if the authorization for such subscriptions expressly provides for such financing; or (ii) in special circumstances, out of supplementary resources furnished to the Association, and funds derived therefrom as principal, interest or other charges, if the arrangements under which such resources are furnished expressly authorize such financing. (b) Subject to the foregoing paragraph, the Association may provide financing in such forms and on such terms as it may deem appropriate." Authorization requires approval of two-thirds of the voting stock, according to Article III, Section 1d. See International Development Association, Articles of Agreement (Effective September 24, 1960), at http://www.worldbank.org/ida/idaart.htm.
24. SDR 8.65 billion converted at the August 3, 2001, rate of SDR=$1.26236. World Bank Group, "Additions to IDA Resources: Twelfth Replenishment," at http://www.worldbank.org/ida/ida12/ida12execsum.htm.
27. Although the IDA claims that credits are given only to countries with an annual per capita income of $885 or less, the world's 66 poorest countries with per capita income of less than $1,445 in 1999 and Tonga with a per capita income of $1,720 are currently eligible for IDA credits. An additional 12 countries with per capita incomes between $310 and $3,770 are eligible for partial IDA assistance along with IBRD loans. See World Bank Group, "Country Eligibility for Borrowing from the World Bank (IBRD/IDA)," at http://www.worldbank.org/html/extdr/about/eligibility.htm.