Sebastian Mallaby on the World Bank and Wolfowitz

Sebastian Mallaby is very smart, and there are few people on the outside more knowledgeable about the World Bank than he, so this column from the Washington Post, Monday, May 14, 2007, A14, is must-reading. As is his 2004 book, The World's Banker: A Story of Failed States, Financial Crises, and the Wealth and Poverty of Nations. Mallaby is a hard-headed, tough-minded journalist and policy analyst in the area of development and global poverty reduction, one of the smartest and best informed outsiders.

Sebastian - I know him a little bit - appears to have been reacting in his WP column to this George F. Will column, also in the Washington Post. Will is not an expert on the Bank or international development; his column appears to have been written after some discussion with one or more of the Bank's critics. Mallaby appears to be out to marshall a lot of facts about the Bank and its work that Will and his readers are not likely to know much, if anything, about.

In taking down Will's column, however, Mallaby sacrifices a lot of legitimate criticism and the possibility of radically rethinking the Bank - radical criticism that he himself is much more willing to consider in his book. I understand that an 800 word column does not allow much room for subtlety. Still, that acknowledged, I don't quite think the column admits what Mallaby himself otherwise would say about the shortcomings in the Bank's business model. I fear that in this column, Mallaby is, alas, simply channeling the Bank.

(I leave aside as unserious the column's opening argument that one can look at the Bank simply like any other company and therefore the board of directors should fire Wolfowitz for having lost their confidence and having lowered share price. The remainder of the column, after all, is one long argument as to why the Bank cannot be treated merely as any private company. If it were a private company, after all, well, it wouldn't exist. As to the bizarre analogy to falling share price, it is inapposite not just because the Bank doesn't have one - rather, the larger point of the remainder of the article is that the Bank cannot, by definition, be measured according to such criteria. It is nearly as idle as the analogy sometimes bandied that US voters are "shareholders" who should fire Bush as "company president.")

Mallaby points out that approximately half of the Bank's outflows last year went to poor(er) countries if one includes, as properly one must, the Bank's soft loans and grants programs - these being the general evolutionary trend of the Bank. This is his main point of attack against the Will column; the (almost certainly correct) dangling implication is that Will has no idea about this. There is, in other words, a story beyond the statistic Will cites that 27 middle income countries received 90% of the regular lending of the Bank.

Fair enough. But one might conclude that this is precisely this statistic that should cause one to wonder why the Bank exists as a bank. Sebastian defends the middle income lending - which, after all, still amounts to over half the Bank's outflows - with the throwaway line that much of it goes to countries like China or Brazil that have many, many poor people. Sure, but how that regular lending really, genuinely, measurably affects outcomes for those very poor people is very murky - perhaps someone more expert than I can explain it, but I haven't seen measurable data to that effect - in large part because of the question of what role it plays in countries that do indeed have access to private capital that far exceeds the capital flows of the Bank.

It is far from clear, at least to me, that such regular lending to middle income countries has positive longterm impacts for the very poor of those countries. In part this is because money is fungible. In order to demonstrate that these funds make a difference to these poor people, it is not enough to show that it increased aggregate capital flows. It is not even enough to show that it was, in the first instance, specifically targeted toward those poor people - because, after all, the inflow of Bank funds, might simply have allowed other funds to be siphoned away. Anyway, the incentives from a financial statement point of view for the Bank to want to make loans to those safe middle income countries is a strong reason at least to wonder what the economic benefit is for the very poor in Bank lending to middle income countries and to want to see strong, reliable evidence for it. Perhaps it is there and, although I do tend to follow this literature, perhaps I have simply missed it - and Sebastian knows this literature, I'm sure, as well or better than anyone, so I would be happy to be pointed toward the papers on SSRN or elsewhere.

But assume for a moment, arguendo, that the criticism I make above about middle income lending is so. In that case, Mallaby's argument falls back on the fact that slightly less than half of the Bank's outflows come in the form of soft loans and grants. But that fact is lukewarm at best and really cuts both ways. The argument radical reformers of the Bank make is that there is little reason why the Bank should not be reorganized to give up the private capital market-intermediation-subsidized lending to middle income countries altogether, and focus entirely on the soft loan-grant programs, to the poorest countries. Of course private capital markets cannot do everything, as Mallaby says - but that is not the argument that the radical reformers make and is surely a straw man.

The problem of the Bank qua bank is that it seeks to intermediate private capital markets (with a subsidy), to try and do precisely what Mallaby suggests private capital markets cannot do because capital markets cannot solve all of poverty's problems. The reformers would suggest that the subsidy in the case of the Bank's ordinary lending to middle income countries is not really enough to compete with the functioning of the private markets; the Bank's lending really is a fifth wheel, and it should give that up in favor of activities for which it is not merely a fifth wheel. (As for crisis lending to middle income countries that Mallaby mentions, well, what is the IMF for? And - I don't know the answer to this - how great was the role of the World Bank in liquidity terms in the Asian crisis compared to the Fed?)

In the case of the poorest countries, however, lack of capital is genuinely an issue. So is the ability to repay any loan. So is technical assistance, and so is any improvement in governance. Why not cause the Bank, therefore, reorganize without the middle-income country intermediation-banking function, and focus solely on soft loans/grants and, let us not forget, technical assistance and governance advising. And focus on countries, societies, that are the poorest. Why endorse half measures?

For if that's what the real value added is, it is far from clear why anyone needs the Bank's goldplated operations -they cost what they cost in part because they are designed to interface with the private capital markets, and to pay the people who do those functions a respectable civil servant salary commensurate with financial professionals in the public sector. In my experience, it is not what one would pay program officers in a foundation dealing with local poverty matters on a grant-making basis, who do not have and do not need the banking credentials on which the Bank prides itself. There are comparably serious skill sets that these anti-poverty program officers need, yes, but frankly they can be obtained at a lower cost, in part because they are not so readily placeable in the private sector. Why not reorganize at a cheaper cost along the lines of far more efficient, far more locally oriented (because less capital markets oriented), far cheaper in terms of transaction costs European aid agencies? (I do not suggest under any circumstances modelling anything on US AID, which is a waste of oxygen.)

If these functions were being carried out by the Dutch, the Swedes, the Norwegians, the Swiss, through their national development aid agencies, how would they do it and what would they pay? Would they pay for a whole banking staff when in fact the operation is aimed at grantmaking anyway, and the money would come from governments in any case, not from the capital markets and relent at a subsidized interest rate? They would - they do - engage in a certain amount of on-lending in which they really do expect to get repaid, but that is far from being the core, let alone over half, of their work.

Why, in other words, should the World Bank continue simply for historical reasons as a bank, a bank designed in cost structure, skill sets, etc., to interface with private capital markets? Why share the pleasure Mallaby takes in noting that slightly under half the bank's outlays went to soft loans and grants - why not think those things should essentially be the whole thing? Why take pride in half-measures that continue precisely the sins that Sebastian correctly sees in thinking that it all can all be done by capital markets? Why not sever the relationship to the capital markets altogether and concentrate on poverty reduction as such?

(ps. The column also mentions in passing that Bank salaries, once you take into the account the tax adjustment and long summer vacations, are comparable to academic salaries. I'm told there is a link to a paper by an economics professor in the online version, which I will look up. But as someone who is a college professor, and who is married to someone who used to work in an international organization with similar salary structures and arrangements and who, hence, paid very close attention to comparative salary issues - well, at least if you were not an American and not subject to tax on your salary, it was a very favorable deal. The tax break was amazing for non-Americans. I simply don't understand what Mallaby is suggesting here - it is not our experience at all. As for summer vacations - every dean and professor I know understand perfectly that summer vacation is simply the research semester, it's not vacation, at least if you plan on getting tenure, getting a promotion, getting a raise. It's a 12 month job like any other. And now I have to get back to it.)

(pps. Or consider this short op ed by AEI resident scholar Desmond Lachman, here. It argues for a World Bank that gives up the middle income lending function altogether, along with the proliferating mandates at the Bank that increase its unaccountability.)