The Lending Policy Of The World Bank In The 1970s

Analysis And Evaluation

Bettina S. Hurni

• Publisher: Routledge
• Year: 2020
• Print ISBN:
  9780367293505
• eBook ISBN:
  9781000302936
• Topic: Politics & International Relations
• Subtopic: Economic Policy
• Index: Politics & International Relations

This pilot study - the first to analyze the World Bank's lending policy in the Second United Nations Development Decade - concentrates on the Bank's shift in emphasis from traditional infrastructure projects to "new style†projects, especially in the area of rural development, and on the resulting changes in lending criteria in the 1970s. Basing her conclusions on two years of independent research and access to confidential materials, Dr. Hurni evaluates the World Bank's work; gives a good overall view of current development problems - including implementation of the "growth with equity†strategy - and their possible solutions; shows the effects of the new development goals in borrower and creditor countries, as well as on the institutional decision-making process; and offers recommendations for improvement of the Bank's evaluation methodology and operational structures. She presents a clear picture of the positive and negative aspects of the World Bank as a multilateral investment model and shows its bridge-building function in the great North-South controversy.

1
The Evolution of the World Bank’s Lending Criteria, 1945-1970

Pre-1970 Criteria and Their Application

According to its Articles of Agreement, the World Bank (officially named the International Bank for Reconstruction and Development, or IBRD) was founded in 1945 as one of the two Bretton Woods Institutions (the other being the International Monetary Fund, or IMF) to lend for “reconstruction and development.” Although this study is mainly concerned with the Bank’s lending criteria, it is nevertheless necessary to mention the basic principles of its capitalization as well: each member of the World Bank paid in 1 percent of its contribution in gold or U.S. dollars and 9 percent in its own currency, these sums creating a common liquidity pool called the “paid-in capital.” The rest of the members’ contributions (90 percent for each member) form the Bank’s “guarantee fund” or “reinsurance capital” and are held by the respective governments as “callable capital” to be used in case of default. So far, the callable capital has never been used, and it is unlikely that it ever will be. However, it constitutes a large reserve, which gives the Bank a high rating for its borrowings in the world’s financial markets (its bonds are rated “AAA” in the United States). This means that they are considered risk-free, gilt-edged investments. The Bank’s basic principle of lending is that the Bank borrows capital cheaper than it relends it, but its loans and credits are still advantageous to the borrowers, mainly because of longer maturities and grace periods than in commercial lending. In addition, the interest rates are sometimes lower than for private funds.

During the first years of the World Bank’s existence, the main borrowers were the countries of postwar Europe (the first three loans were made in 1947 to France, the Netherlands, and Denmark for reconstruction), and the main creditors were the government and the banks of the United States. Reconstruction had some priority over development, although the Bank’s contribution to reconstruction in Europe was minor compared to the Marshall Plan. This changed during the decolonization period (circa 1955-1965) as the World Bank gained the confidence of the private capital markets, and, after 1960, over 60 percent of its capital came from outside the United States.¹ In addition, the creation in 1960 of the Bank’s soft-term credit affiliate, the International Development Association, which focuses mainly on development lending to the newly independent countries, showed the shift in emphasis away from reconstruction. The lending criteria,² however, did not change: they were based on rather conservative market-economy and growth-oriented principles like sound financial returns on invested capital, the creditworthiness and economic performance of the borrower countries, their absorptive capacity, and the fact that no other sources of external finance were available to the borrower on reasonable terms (a rule that made the Bank into a “lender of the last resort”).

Moreover, in the Articles of Agreement, the founders of the Bank set a maximum limit on its lending: lending should not go over and above the total of subscribed capital (approximately U.S.$31,000 million in 1976 values), plus surplus and retained earnings, thereby setting a lending restraint more stringent than that for commercial banks. The Bank also kept a very prudent ratio of loans to capital and reserves of 1:1 and an equally prudent, high liquidity level, with a debt-equity ratio of 1:2.4 in 1976, compared to about 20:1 for commercial banks.³ Despite steadily growing nominal and real volumes of lending, the Bank always had its loans repaid and, since 1948, made a profit each year. Nonetheless, its adjusted financial conditions for lending, namely, its interest rates and maturities, were more advantageous to the borrower than those of commercial banks.

Because creditworthiness was the most essential lending criteria, it was very thoroughly assessed on both macroeconomic and microeconomic levels in the borrowing country. On the macroeconomic level, creditworthiness was assessed by means of general economic reports, as well as project preparation and appraisal missions using growth-theory parameters like annual per capita GNP increases, savings and investment rates, the balance-of-payments position, the “openness of an economy,” its resource and market potentials, its existing and future debt-service obligations, and the borrower’s own economic performance. More recently, the economic analysis also has tentatively appraised the national economic and social structures and the management capacities of the government and other institutions. On the microeconomic level, the criteria relate to the “quality of investment,” including social components and welfare effects, such as the target groups that will benefit directly from the investment and the local impact of loan disbursement. Since most lending has been earmarked for project financing, corresponding disbursements have been closely controlled; implementation has been checked and, since 1973, carefully monitored with built-in control mechanisms and evaluated upon completion.

A positive feature in this close supervision process is the fact that, in the 1970s, the borrowers were strongly encouraged by the Bank to set up their own control mechanisms. Close control also had and still has a problem-solving function, especially in agriculture. Such strict controls and the direct payment of invoices by the Bank for delivered goods avoided misallocation of funds and allowed for the necessary corrections during project life. In 1976, over 1,080 projects in the U.S.$50 to $60 million lending range were under supervision. In addition, the Bank never financed the full amount of project costs, but insisted on the borrower’s own efforts. However, because its financing should have a pronounced impact on developing economies and because smaller amounts of financing could be left to other local or regional development agencies, the Bank normally did not lend for project costs below U.S.$5 million (in 1970 values). The main method of procurement was and still is “international competitive bidding.” Like the votes weighed according to the amount of shares held, international competitive bidding is another “capitalist” principle of private business management. This form of procurement is most often used for the foreign exchange component of project costs – in 1973, it was estimated to have lowered procurement costs by up to one-third⁴ – and it also serves to avoid the different forms of tying aid.

Presented in such a general, concise form, creditworthiness based on economic performance appears to be a clearly defined lending criteria. This is misleading: neither the Articles of Agreement nor any economic project appraisal report contains a scientific, rigorous definition of the lending criteria applied or of the instruments to measure them. Paradoxically, such a lack of precision had beneficial effects: it allowed the Bank to adjust its lending criteria to what, in its own judgment, were bankable projects according to the newest insights of development theory or of practical experimentation. Therefore, it remained true to its main lending goal, namely, to “facilitate the investment of capital for productive purposes,⁵” in conformity with the then-popular theories of balanced growth and market equilibrium. During the early 1960s, President Robert McNamara’s predecessor, George Wood, was already concerned with the formation of human capital, as opposed to investment in physical capital only. Hence, the poverty orientation in lending after 1968, when McNamara became president, can be seen as a continuation of this gradual change toward the vision of social development more concerned with human than physical productive capacities.

For the application of the lending criteria, however, three characteristics of the lending rules must be stressed.

1. The responsibility for presenting bankable projects and determining their economic priority in a macroeconomic context rests with the government of the borrowing country. Paradoxically, the Bank, organized according to private business principles and created to promote private foreign investment,⁶ so far has mainly dealt with governments, ministries, public planning authorities, central banks, or other public agencies in its lending and, in the 1960s, mainly contributed to large public works in infrastructure, transport, and communications.⁷ Again, the hardware projects clearly dominated lending policy. The Bank’s success in these infrastructure projects shows how important the public sector became for economic development after decolonization and that, in the public sector, the productive use of resources could well be stimulated through foreign financial aid. Also, because private industries were not yet very developed in many decolonized countries, national infrastructure projects provided the needed basis for agricultural and industrial development. Hence, governments and other public agencies were, for the most part, the best organized counterparts and carriers of Bank projects. Compared to the “new style” projects, such infrastructure projects were relatively simple to evaluate through the usual cost-benefit analysis,⁸ had high foreign exchange components – which brought business to the creditors – and were normally import and capital intensive, while often geared to a growth path by means of export-oriented industrialization.

2. Through the conditions stipulated in the individual loan agreements and their application throughout the whole project cycle,⁹ it becomes evident that the Bank has considerable economic and fiscal leverage in the borrower countries, influencing the aforementioned government responsibility for economic priorities in the macroeconomic development planning process and in the microeconomic project selection. Contrary to the often expressed criticism of the World Bank’s leverage as interventionist, neoimperialist, etc., this does not necessarily mean that “he who pays the piper can call the tune” for the simple, but very essential, reason that no external project financing can be successful without very strong, permanent local and national commitments. Several projects in Mexico are among the best examples of a successful symbiosis between the Bank and local and national institutions, implying a coordinated teamwork effort. Such development consultancy is different from the more substantial, centralized leverage of the IMF which allocates funds mainly to cover balance-of-payments deficits, a function the Bank fulfills only under exceptional circumstances. This means that the IMF really has a more powerful, but less diversified, political leverage than the Bank. Countries getting IMF assistance are mostly in great need of foreign exchange and usually have used up all other sources of funding. The IMF is also entitled, through its Articles of Agreement, to be a somewhat strict guardian over the general economic and budgetary policy of its borrowing members. By comparison, the Bank’s political leverage should be seen as a consultanťs role, a dialogue of development diplomacy with a realistic give-and-take in the art of the possible in development lending. The Bank has often suggested tax reforms, exchange-rate and price corrections, and other internal measures like setting up institutions and – the most controversial issue – the use of expatriate consultants approved by the Bank before its commitment to disburse a loan. Moreover, the Bank can suspend or cancel a loan as a sanction. The fact that suspension has been only very rarely decided upon, and no cancellation has occurred as yet, could be a token of the generally beneficial leverage of the Bank if it is interpreted to mean that the Bank’s macroeconomic loan disbursement conditions have been successfully met and have helped the borrowing countries to repay their debts.

3. As stipulated (Art. IV, 10, of the Articles of Agreement of the IBRD and Art. V, 10, of those of IDA), the Bank has to remain apolitical and therefore did not suffer the negative effects of politicization that now paralyze so many ventures of the United Nations and of its other specialized agencies. It is true that, due to its businesslike management with voting weights according to the amounts of shares held, the United States wielded much intellectual and practical influence: the president of the Bank has always been an American, and, at present, 29 percent of the staff is American. However, in the period 1945-1970, this influence declined and still continues to decline, whereas that of the other four most important shareholders (United Kingdom, Federal Repulic of Germany, Japan, and France) increased, as well as that of the newly rich oil countries. The other most essential institutional and practical features of the Bank that avoid politicization are the following:

• The habit of consensus votes for approving loans in the Board, the highest executive body where the main shareholders’ Executive Directors each have their own seat and votes are weighed according to the amounts of shares held. The Executive Directors of the other borrower and creditor countries each represent a group of countries with very different economic and political tendencies. This normal procedure of consensus is all the more astonishing because the votes are weighed and, yet, no power blocs have emerged to “combine for a majority vote” and the votes of the Executive Directors representing borrowers and creditors have not been split or divided between creditors and debtors, which shows a certain unity of purpose inside their group and inside the Board as a whole.
• Precisely this grouping of countries represented by one selected Executive Director (for instance, Cyprus, Israel, the Netherlands, Romania, and Yugoslavia are represented together by one Executive Director and his alternate; and Austria, Belgium, Luxembourg, and Turkey are also represented together). This avoids the power bloc politics that occur in UNCTAD (United Nations Conference on Trade and Development) or sometimes in the ILO (International Labour Organisation).
• A technostructure with high professional qualifications preparing projects stressing their economic criteria.
• Promotion of scientific research through a very high level brain trust and the consultant system increasing the Bank’s professional prestige and, hence, apolitical credibility, not only in the borrower but also in the creditor countries.
• The longest experience in large-scale development lending compared to similar international and regional organizations.
• Avoidance of attaching political conditions to loans (such as human rights issues).
• Development diplomacy during project preparation and loan negotiations, still leaving the main responsibility for any borrowing to the developing country.
• The flexibility to adjust to new, worldwide, economic power structures (like the “graduation” of countries from borrower to creditor) and to a more liberal interpretation of the Articles of Agreement without amending them.

Because of the Bank’s relative success in the application of its rather conservative, capitalist financing principles, by 1970 it had emerged as a respectable, trusted development institution, especially in infrastructure projects like power and transport, and as an investment agency with the greatest financial asset diversification and highest equity in the world.

Reasons for the Change in Development Theory and Corresponding Changes in the Development Policy of the World Bank

An analysis of the changes in development theory must remain schematic and simplified, only focusing on the mainstreams of thought. The first generation of development problems consisted mainly of problems of economic growth or accumulation. The basic and most well-known theories are the “big push” by Rosenstein-Rodan and the four stages of economic growth by Rostow. The “big push” is seen as a massive, concentrated, rather short-term capital investment, which would push off an economy into self-sustained growth. This push can be seen as the equivalent of the “take-off stage” in Rostow’s theory, during which one of the three main conditions is a significant increase in productive investment (like a “big push”); the two others are the development of the manufacturing sector and the creation of a social, political, and institutional framework that takes advantage of the expansion impulses and allows for the mobilization of capital. These conditions for take-off were considered seriously in the 1960s, along with the concept, furthered by Galenson/Leibenstein and Schumpeter, that industrialization was the most important engine of growth. Boeke/Lewis broadened these assumptions in their “dual economy theory,” which showed that growth in a developing economy took place in the modern industrialized sector, whereas the traditional agricultural sector was left behind, and eventually the gap between the two sectors would widen. (This “dual economy theory” was developed further by Sir Arthur Lewis, winner of the 1979 Nobel prize in economics.) Papanek was the first to give the development of agriculture absolute priority over industrialization. And these notions of the dual economy and its dangers, as well as the priority of agriculture in a developing economy, were the theoretical background for the Green Revolution.

From 1945 to about 1970, there was a firm belief in external capital investment as a “locomotive” of growth. Nurkse’s “investment bundles,” massive capital outlays into the key sectors of the economy, can be taken as further refinements of the “big push” and the take-off theories. The dual economy theory was enlarged by the expectation of backward and forward linkages between the modern industrialized and the traditional rural sectors. The theory also assumed the illimited supply of capital and labor as well as the illimited mobility and employability of labor up to the point where the ideal of factor price equalization was reached. These assumptions turned out to be too strict in practice, and the factor price equalization did not come about as foreseen by the theory. Linked to the belief that massive investment was the main growth factor was the “trickle-down theory," stipulating that the accumulated output and wealth would spread downward and reach the nondeveloped, poorer segments of society, which would eventually benefit from it.

Simple models can be seen as the rudimentary beginnings of national development planning: the Harrod/Domar model established the relationship between savings/investment and the capital/output ratio, again clearly geared to economic growth and accumulation. This model was later refined by the ICOR (incremental capital/output ratio) developed by Chenery as a measure of the additional investment needed to create an additional unit of output, equivalent to the opportunity costs of capital as a public investment criterion. The aim in the application of this concept was again the maximization of national income with an ICOR as low as possible, resulting in a high capital turnover. (For a schematic presentation of this traditional strategy of economic growth see Figure 1.)

But the national planning method should also have taken into account the refinement of Lewis’s economic dualism concept into “double dualism,” where the traditional rural sector and the industrial sector each have their own traditional and modern branches. Such double dualism could become im...

Table of contents

• Cover
• Half Title
• Title
• Copyright
• Dedication
• Contents
• List of Figures and Tables
• Acknowledgments
• Foreword
• Introduction
• 1. The Evolution of the World Bank’s Lending Criteria, 1945-1970
• 2. The New Lending Criteria of the World Bank in the 1970s
• 3. The World Bank as a Multilateral
• 4. Conclusions
• Notes
• Bibliography
• Appendix: IDA and World Bank Statistics and Information
• Index