September 23, 2003, the World Bank Group and the Board of Governors
of the International Monetary Fund (IMF) will meet in Dubai to
discuss the work of their respective institutions in international
monetary and development issues. This meeting would be worth its
high expense if the discussion were centered on these institutions'
own reform rather than on how they should intervene in developing
examination of the record of IMF and World Bank performance in
developing countries shows that, far from being the solution to
global economic instability and poverty, these two international
institutions are a major problem. For one thing, their lending
practice deters growth because the money they loan removes
incentives for governments to advance economic freedom, and breeds
corruption. For these reasons, the vast majority of recipient
countries have been unable to develop fully after depending on
these institutions for over 40 years.
Bush Administration should support reform of these institutions'
lending practices. To that end, the Administration should use the
work of the congressionally mandated International Financial
Institutions Advisory Commission (IFIAC), chaired by Allan H.
Meltzer of Carnegie Mellon University, to establish a solid
framework for reforming the IMF and the World Bank.1 The reforms
should maximize their effectiveness, increase accountability for
their lending decisions, and limit their harmful influence in the
The 10 Steps for Growth and Stability
literature on economic growth,development, and prosperity mostly
agrees that the key to prosperity is economic freedom built on a
strong rule of law.
Economically free countries have a sound monetary policy, minimal
and transparent regulation, minimal state participation in economic
activity, and a strong rule of law that permits the enforcement of
property rights and regulations.
annual Heritage Foundation/Wall Street Journal Index of Economic
Freedom provides a
framework for understanding how free citizens of any given country
are to engage in economic activity; the degree of state
intervention in the economy (whether through taxation, spending, or
regulation); and the strength and independence of a country's
judiciary in enforcing rules and protecting private property.
Index is like a 10-step road map that, when followed closely, leads
to development and economic stability. Some countries have a
substantial degree of freedom in all factors; others have a degree
of freedom in just a few. One of the most important findings of the
Index is that economic freedom is required in all aspects of
economic life--that is, in all of the 10 factors--in order for a
country to achieve its economic potential, improve economic
efficiency, grow sustainably, and consequently improve the living
standards of its people.
Chart 1 illustrates the relationship
between economic freedom and income per capita. It shows that the
freer the economy, the higher the country's per capita income. Some
countries have substantial economic freedom, but not the per capita
income of a developed country. This may be the case, for example,
if a country is undergoing reform. Nevertheless, not a single
economically unfree or repressed country in the world has a high
income per capita.
10-step road map also refutes the false excuse of "free market
failure." It is very common to hear political leaders in developing
countries say, "We opened our markets, but it is not working for
us." However, in almost all of these cases, the Index shows that
those countries have economic freedom in only three or four
factors, as opposed to all 10.
clear example of this is the failure to reform the judiciary and
strengthen the rule of law in almost all the developing world. A
market economy is almost unthinkable without a strong rule of law
that protects property, enforces the rules, and punishes
corruption. As shown in Chart 2, countries with a moderate to very
low protection of property rights have an average maximum per
capita GDP of $4,900--clearly neither the per capita income of a
developed country nor one that promises a high standard of
Specifically, attempts in the 1990s to
"liberalize" mostly achieved deregulation of foreign investment and
capital flows, price liberalization, privatization, low inflation,
and a goal of fiscal balance. But almost no country in the
developing world improved its rule of law, deregulated the labor
markets, and reduced bureaucratic regulations on small and medium
business--all part of the 10-step plan. Just as a cake cannot be
made with just eggs and a hot oven, prosperity cannot happen with
only privatization and some deregulation.
Running Developing Countries Off The Road
debate on the ability of international financial institutions to
influence reform in other countries had its peak about five years
ago, when the U.S. Congress created the IFIAC. The IFIAC assessed
the role and effectiveness of the World Bank, the International
Monetary Fund, the regional development banks, the Bank of
International Settlements, and the World Trade Organization.
Regarding the IMF and the World Bank, the
IFIAC concluded that the work of these institutions left much to be
The IMF has given too little attention to
improving financial structures in developing countries and too much
to expensive rescue operations. Its system of short-term crisis
management is too costly, its responses too slow, its advice often
incorrect, and its efforts to influence policy and practice too
High cost and low effectiveness
characterize many development bank operations as well. The World
Bank's evaluation of its own performance in Africa found a 73%
failure rate.... In reducing poverty and promoting the creation and
development of markets and institutional structures that facilitate
development, the record of the World Bank and the regional
development banks leaves much room for improvement.
problem is not so much that the World Bank and the IMF are
ineffective as it is that they create disincentives in the
countries they are trying to help. Sending money to countries with
misdirected policies and weak rule of law increases the recipients'
debt without visible economic growth. Nevertheless, no significant
reform of these international institutions has taken place.
example, at the entrance of the World Bank building in Washington,
D.C., is a sign that reads "Our dream is a world without poverty."
To fulfill that dream, the World Bank employs over 10,000 people in
more than 100 offices around the world with an annual budget of
$1.5 billion. Despite such monstrous display of resources,
according to the Index of Economic Freedom, the Bank's money has
done nothing to improve economic freedom in recipient countries.
Predictably, those countries are still just as poor as they were 40
years ago when they started receiving World Bank loans.
International Development Association (IDA) is the branch of the
World Bank Group that lends money to the world's poorest countries.
For each of the IDA's top 10 recipients, Table 1 shows the
cumulative amount received from the Bank, the GDP per capita in the
country's first and last year of receiving funds, and the level of
economic freedom in its economy.
India, for example, remains poor despite
receiving $28.8 billion since 1961. That money did nothing to make
India open its economy, which remains "mostly unfree" according to
Similarly, Bangladesh is the World Bank's
third highest recipient of funds, despite being the world's most
corrupt country according to Transparency International (TI). This is not something
to take lightly. According to TI, corruption in Bangladesh caused a
loss of economic activity equivalent to 4.7 percent of GDP in 2001.
It is not difficult to guess, therefore, where the World Bank's
money may be going, since Bangladesh today is the world's third
Summing up the results in Table 1, after
receiving IDA funds for an average of 37 years, the economies of
all these countries are today "mostly unfree" according to the
Index--except for the economy of Uganda, which is only slightly
better than the rest. As a result, the recipient countries' per
capita income went from between $117 and $447 in the 1960s to
between $124 and $527 in 2002.
much for "a world without poverty."
IMF has had similar results. The Fund's goal is "to promote
international monetary cooperation, exchange stability...to foster
economic growth and high levels of employment; and to provide
temporary financial assistance to countries to help ease balance of
payments adjustment." However, financial crises around the
world have increased over the past 15 years, even as the IMF has
committed ever-greater resources to combat them. In many cases, the
recipients of IMF loans are worse off today (e.g., Argentina) than
before the IMF loans began to flow.
reason is simple. Financial crises are the result of poor
policymaking and corruption, not of some inexplicable evil design.
For example, if the IMF were to bail out a country called
Neverlearningland from an im-pending crisis, it would not allow
Neverlearningland's leaders to face the consequences of poor
policymaking and corruption. Hence, the leaders of
Neverlearningland would have no incentive to change the poor way in
which they run the country.
the same time, Neverlearningland's government bonds would be sold
in the market at a very high yield--reflecting the high risk of
default from poor policymaking. But because the IMF continuously
bails out Neverlearningland, regardless of continued corruption and
poor policy, buying the bonds would become a unique investment: a
high yield bond bearing no risk.
from achieving the IMF's stated goal, in other words, bailout loan
packages reduce the political risks associated with faulty economic
decisions, and recipient countries consequently end up with greater
debt, lower standards of living, higher unemployment, and less
each of the IMF's top 10 recipients, Table 2 shows the cumulative
amount received from the IMF, the GDP per capita in the country's
first and last year of receiving funds, and the level of economic
freedom in its economy.
Brazil, for example, has received $53
billion from the IMF since 1958. That money did nothing to open
Brazil's economy, which remains "mostly unfree" according to the
Index. Consequently, Brazil has been unable to grow sustainably,
and 49 percent of the population therefore remains poor, with Brazil's huge
debt burden crippling growth prospects.
Argentina is the third highest recipient
of IMF funds and perhaps the most obvious example of IMF failure.
Over $26 billion in IMF loans since 1958 has not encouraged
Argentina to move toward substantially open markets. At first
glance, the few changes that Argentina has undertaken appear to
have made it "mostly free" according to the Index, but it is still
on the cusp of being a "mostly unfree" economy. As a result,
Argentina's GDP per capita has not changed much since 1958.
lending practices in Argentina have had two negative consequences
that apply, in fact, to all IMF lending. First, the IMF assistance
became predictable, eliminating investor risk through repeated
bailouts: Investing in Argentina would bring a guaranteed profit
regardless of how poor the economic conditions were. Second, the
Argentine government had little incentive to reform; the money
would still come in. These lending policies are a major cause of
Argentina's worst economic, social, and institutional crisis.
sum, after receiving IMF funds for an average of 42 years (except
Russia, which first received funds in 1992), the economies of most
of the IMF recipients are today "mostly unfree" according to the
Index--except Mexico and Argentina, which are only marginally
better. As a result, the recipient countries' per capita income
went from between $259 and $5,419 in the 1960s to between $494 and
$6,579 in 2002. South Korea is the only country that grew and
developed to a significant degree, today enjoying a per capita
income of $14,280; but the reasons for that development are an
extensive opening of the economy and the preservation of a strong
rule of law--a very different story from other IMF recipients.
Reforming the IMF and World Bank Should Be
of the main causes of continued poverty in the world is the work of
the World Bank and the IMF. In order to foster a more stable and
peaceful world, the Bush Administration should address the failure
of these institutions to provide the developing world with
incentives to move toward economic freedom. To that end, the
Administration should restrict the ability of international
financial institutions to interfere in the international economy,
particularly through the IMF's lending habits.
President's Millennium Challenge Account (MCA) is a step in the
right direction for reforming the World Bank. The MCA differs from
other aid programs in that its recipients must meet certain
criteria to qualify for funds. Those criteria have been selected
based on the "evidence that they contribute or are complementary to
long-term growth and prosperity rather than on subjective,
political motivations unrelated to development."
Administration should rely on the work of the IFIAC to establish a
solid framework for reforming the IMF and further reforming the
World Bank. The IFIAC advocates a new system of preconditions that
countries must meet to qualify for an IMF loan. These include sound
fiscal policy, freedom of entry and operation for foreign financial
institutions, and adequately capitalized commercial banks.
Dependence on foreign loans and future economic crises around the
world will decline only in an environment that promotes the
efficiencies and benefits of open markets.
upcoming World Bank-IMF high-level meeting in Dubai will better
serve the world if these institutions begin to discuss reforming
themselves to create incentives for countries to increase economic
freedom. Because the work of these institutions deters economic
freedom, the vast majority of recipient countries have been unable
to develop fully after over 40 years of dependence.
Bush Administration should strongly and actively support reforming
these institutions' lending practices. To that end, the
Administration should continue to support its MCA initiative, but
also use the work of the IFIAC to establish a solid framework for
reforming the IMF and the World Bank.
Specifically, reforms of the World Bank
and the IMF should maximize these institutions' effectiveness,
increase accountability for their lending decisions, and limit
their harmful influence in the developing world. Such reforms would
bring more stability, economic growth, and peace around the
Ana I. Eiras is Senior Policy Analyst for
International Economics in the Center for International Trade and
Economics at The Heritage Foundation.