Montenegrin parliament is delaying approval of the government's
package of free-market measures, designed to improve the investment
environment and encourage informal small and medium businesses to
enter the formal market. The package includes a reduction of
employers' payroll taxes and contributions to pension and health
care. This time, however, reform is being held up by the World
Bank, not by local interests or politics. The World Bank is
narrowly focusing on estimates of how the tax cut might affect
government deficits and has threatened to withhold three loans if
the parliament passes the package without World Bank approval.
World Bank's dealings with Montenegro illustrate how World Bank
officials use their power to advance their own interests, not those
of the country that they are presumably trying to help. In fact,
the mere presence of the World Bank and other international
financial institutions (IFIs) severely undermines any serious
domestic effort to implement reforms, often while politicians
around the world use IFIs to enrich themselves at the expense of
their people. The Bush Administration should end the harmful
activities of IFIs and set an agenda for effectively reforming the
lending practices of these institutions. Countries like Montenegro
will have far better prospects of advancing reform and developing
their economies without the IFIs standing in their way.
Since 2003, the government of Montenegro has been
discussing a bold pro-business reform package. The main item in the
package is a 20 percent reduction in employers' payroll taxes and
contributions to workers' pensions and health care. These
reductions would be implemented in two phases: 10 percent
retroactive to April 1, 2004, and the other 10 percent on September
1, 2004. Reducing taxes and contributions is intended to encourage
more investment and greater business participation in the formal
economy. The Montenegrin government believes that these rate cuts
will broaden the tax base and collect more tax revenue.
World Bank disagrees with the Montenegrin government. It argues
that it is too late in the fiscal year to change the budget plan,
that reductions in tax rates and contributions are too steep, and
that these actions will cause revenue to fall, contributing to a
budget deficit. The World Bank distrusts the government's dynamic
budget projections (i.e., that tax revenues will increase by
broadening the tax base) and refuses to give its "blessing" to the
plan until it makes its own projections. Meanwhile, reform is
Cutting taxes may or may not generate a
deficit in the short term. Broadening the tax base will offset
part, if not all, of the initial drop in tax revenue. However, a
short-term deficit does not merit such coercion by the World
Montenegro is imitating the success of
countries such as Ireland, Estonia, and Russia in slashing their
top tax rates. It is trying to provide opportunities for small,
medium, and large businesses to stay in business, invest more,
create jobs, and contribute to higher growth rates while attracting
informal businesses to the tax rolls.
Without the tax cuts, economic opportunity
in Montenegro is severely limited. By limiting economic
opportunity, the World Bank's misguided policy would keep
Montenegro mostly poor. If the World Bank's coercion becomes too
onerous, Montenegrins would be better off to forgo World Bank loans
and implement their own reform package.
World Bank's attitude toward the Montenegrin initiative brings up
an important, often overlooked point in developing economics:
reform sustainability. Only reforms coming from inside a
country--not those imposed by outside institutions--are sustained.
For that reason, conditions and mandates imposed by the World Bank
and other institutions are rarely met or sustained. Therefore, if
the World Bank is really concerned about poverty, in this case
poverty in Montenegro, it should support the government's
initiative to reduce taxes instead of imposing its own thoughts of
what may or may not work in the country.
What the Bush
Administration Should Do
Economic opportunity in Montenegro and other poor
countries would flourish if the World Bank did not exist. However,
if eliminating the World Bank is not now a viable alternative, the
Bush Administration should at least address the World Bank's
failure to provide the developing world with incentives to move
toward economic freedom.
Administration should use the work of the International Financial
Institutions Advisory Committee (IFIAC) to establish a solid
framework for reforming the World Bank's lending practices. The
IFIAC advocates a new system of performance-based grants for the
World Bank's social programs, with institutional preconditions that
countries must meet to qualify for a 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 economic instability around the
world will decline only in an environment that promotes the
efficiencies and benefits of open markets.
Administration should also support the Montenegrin government's
efforts to advance pro-market reforms and use these efforts as
example for other poor economies. Poor countries have a far better
chance of raising the living standards of their people by opening
markets and creating opportunity than by following the mandates of
The Montenegrin government is trying to implement tax cuts
and other reforms to create more opportunity for businesses and
thus foster economic growth. However, by threatening to withhold
the next three loans, the World Bank, which disagrees with the
effects of the proposed reforms, is coercing Montenegrins into
raising taxes to avoid public deficits. This coercion will both
undermine Montenegro's economic prospects and weaken any reforms
imposed from outside.
Bush Administration should end the World Bank's counterproductive
activities and set an agenda for effectively reforming the lending
practices of this institution. Countries like Montenegro would have
far better prospects of advancing reform and developing
economically without World Bank intervention.
Ana Isabel Eiras is Senior Policy
Analyst for International Economics in the Center for International
Trade and Economics at The Heritage Foundation.