57875 v2 THE WORLD BANK VOLUME TWO Perspectives THE WORLD BANK Its First Half Century DEVESH KAPUR JOHN P. LEWIS RICHARD WEBB Editors BROOKINGS INSTITUTION PRESS Washington, D.C. Copyright © 1997 THE BROOKINGS INSTITUTION 1775 Massachusetts Avenue, N.W., Washington, D.C. 20036 All rights reserved Library of Congress Cataloging-in-Publication data: Kapur, Devesh, 1959- The World Bank: its fIrst half century I Devesh Kapur, John P. Lewis, and Richard Webb. p. cm. Includes bibliographical references and index. ISBN 0-8157-5230-X (set). - ISBN 0-8157-5234-2 (v. 1). - ISBN 0-8157-5236-9 (v. 2) 1. World Bank-History. I. Lewis, John Prior. II. Webb, Richard Charles, 1937- HG3881.5,W57IA9 1997 332.1'532'05-dc21 97-21093 CIP 9 8 7 6 5 4 3 2 1 The paper used in this publication meets the minimum requirements of the American National Standard for Information Sciences-Permanence of Paper for Printed Library Materials, ANSI Z39.48-1984. Composition by Princeton Editorial Associates Scottsdale, Arizona, and Roosevelt, New Jersey Printed by R. R. Donnelley and Sons Co. Crawfordsville, Indiana THE BROOKINGS INSTITUTION The Brookings Institution is an independent organization devoted to nonpartisan researeh, education, and publication in economics, government, foreign policy, and the social sciences generally. Its principal purposes are to aid in the development of sound public policies and to promote public understanding of issues of national importance. The Institution was founded on December 8, 1927, to merge the activities of the Institute for Government Research, founded in 1916, the Institute of Economics, founded in 1922, and the Robert Brookings Graduate School of Economics and Government, founded in 1924. 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Johnson Vartan Gregorian Constance Berry Newman Chairman Teresa Heinz Maconda Brown O'Connor F, Warren Hellman Samuel Pisar Leonard Abramson Samuel Hellman Rozanne L. Ridgway Michael H. Armacost Robert A. Helman Judith Rodin Elizabeth E. Bailey Thomas W. Jones Warren B. Rudman Alan M. Dachs Ann Dibble Jordan Michael P. Schulhof Kenneth W Dam Breene M. Kerr Robert H. Smith Bart Friedman Donald F. McHenl)' Vincent J. Trosino Stephen Friedman Jessica Tuchman Mathews Stephen M. Wolf Henl)' Louis Gates Jr. David O. Maxwell John D. Zeglis Honorary Trustees Vincent ~t Barnett Jr. Robert F. Erburu J. Woodward Redmond RexJ. Bates Robert D. Haas Charles W Robinson Barton M. Biggs Andrew Heiskell James D. Robinson III Louis W Cabot Roy M. Huffington David Rockefeller Jr. Frank T. Cary Vernon E. Jordan Jr. Howard D. Samuel A. W Clause~ Nannerl O. Keohane B. Francis Saul II John L. Clendenin Thomas G. Labrecque Ralph S. Saul William T. Coleman Jr. James T. Lynn Henry B. Schacht lloyd N. Cutler WillJam McC. Martin Jr. Robert Brookings Smith D. Ronald Daniel Robert S. McNamara Morris Tanenbaum Bruce B. Dayton Mary Patterson McPherson John C. Whitehead Douglas Dillon Ariay Miller James D. WolfE'nsohn Charles W Duncan Jr. Donald S. Perkins Ezra K. Zilkha Walter Y. Elisha Foreword IN 1973, in connection with the World Bank's first twenty-five years, Edward Mason and Robert Asher wrote The World Bank since Bretton Woods, the first major authorized but independent history of the institution. Some years later, the Bank's retired senior executive, William Diamond, proposed that an overall history of the Bank's first half century be prepared by authors who, like Mason and Asher, would have full access to the Bank's people and papers but would write free of institutional control. It was decided the study should be seated administratively at an external organization, and, as a matter of fresh choice, not tradition, the Bank and the Brookings Institution agreed that, like the study by Mason and Asher, the new project would be based at Brookings. Again there were to be two authors, but this time one should <:orne from the North, the other from the South. In 1989 John Lewis of Princeton University in the United States and Richard Webb of Peru were recruited. Both had long known the Bank but neither had worked for it at great length. Webb had been on the research staff for five years in the 1970s before returning to Peru as governor of its central bank; Lewis, a veteran of USAID and OECDIDAC, had worked for and with the Bank in various consulting capacities. As research associate to the project, Brook- ings employed Devesh Kapur, an Indian national then pursuing a Ph.D. in public and international affairs at Princeton's Woodrow Wilson School. By mid-1993 Kapur had become so indispensable and so engaged in the writing that, by <:ommon consent, he was graduated to coauthorship. For two components of this project the authors sought and gratefully accepted reenforcement. The re<:ord of the Bank's subSidiary, the International Finance vii viii FOREWORD Corporation, was important but substantially separate from that of the mother institution. Jonas Haralz of Iceland, a World Bank economist earlier in his career and the Nordic executive director on the Bank board in the late 1980s, was well qualified to address the IFC. Robert Wade, originally of New Zealand, later of the Institute of Development Studies in the United Kingdom, and currently of Brown University in the United States, wrote the chapter on the Bank's relationship with the environment. From the beginning all parties to the project-the authors, the Bank, Brookings, and the international adviSOry committee recruited to help guide the venture- agreed that along with the main volume of history for which the authors themselves would be responsible, the work should include a second volume (edited by the authors of the first volume) consisting of views of the Bank from various external perspectives. The perspectives-a dozen in number-are those of close observers of the Bank's work and relations with its major shareholders, its interaction with financial markets and its Bretton Woods sister institution, the International Mone- tary Fund, its standing with the profeSSion of development economics, and country and regional experiences with borrowers. Brookings extends its thanks to the World Bank for the freedom and accessibility it has afforded the authors and adds its gratitude to all those whose help the authors acknowledge in the preface. Brookings gratefully acknowledges funding for the project, which was provided in part by The Ford Foundation, The World Bank, The John D. and Catherine T. MacArthur Foundation, Deutsche Bank AG, The Japan Foundation, Japan Center for International Finance, The Life Insurance Association of Japan, The Federa- tion of Bankers Association of Japan, Nikko Securities Company, Ltd., Nomura Securities Company, Ltd., Yamaicru Securities Company, Ltd., Daiwa Securities Company, Ltd., F. L. Smidth & Company AlS (Denmark), Haldor Topsoe AlS (Denmark), Landsvirkjun, The National Power Company (Iceland), Reykjavik Hot Water System (Iceland), Swedish Bankers Association, AlS Veidekke (Norway), Central Bank of Norway, Statkraft SF (Norway), Asea Brown Boveri AS, and Robert S. McNamara. The views expressed in this book are those of the authors and should not be ascribed to the organizations acknowledged above or to the trustees, officers, or staff members of the Brookings Institution or the World Bank. MICHAEL H. ARMACOST President July 1997 Washington, D.C. Preface THE FOREWORD has outlined the general development of the World Bank history project and the focus and organization of the two volumes. We wish here to elaborate a bit. It may be useful to know the division of labor in volume 1. John Lewis was the principal drafter of chapters 8-10, 17, and 18; Richard Webb of chapters 2-7; and Devesh Kapur of chapters 11, 12, and 14-16. Kapur and Lewis collaborated on chapter 1. Robert Wade was chosen to write a chapter on the subject of the bank and environmental protection, not only because of his record as a policy analyst but also because he undertook the assignment without having a position on the issues. He wrote well and covered the subject thoroughly, but the chapter was long and the phYSical balance of the two volumes was better if we included it in volume 2. Its location there satisfies the concept of volume 2 well enough, but it should be read as an integral component of volume 1, analogous to the chapters on agriculture, poverty, and the social sectors. Half the contributed chapters of volume 2 focus on the World Bank's relations with particular member countries. Volume 1 grapples even more with these rela- tions. It was clear as we progressed that the Bank's overall experience and perfor- mance had to be illustrated by its transactions with individual borrOwing countries. We could not possibly discuss the relations with each of them, but neither could we convey the texture of the experience without digging into country cases. We have done so fairly widely, selecting countries arbitrarily if not randomly. The result is a richer view of the record, but a lumpy one. In volume 1, along with fairly intensive discussions of Bank relations with fifteen or so borrowing countries during various portions of the fifty years covered in the story, we have one long chapter on the ix x PREFACE most challenging geographic region (sub-Saharan Africa) and another on a region (Latin America) that was involved in a particularly traumatic episode (the debt crisis). As a result, treatment of other areas-China is a major example-is thinner than we would have preferred. We must record one particular regret. The biggest hole in the study's covemge is the Bank's experience since 1990 in eastern Europe and the former Soviet Union. That we would face a problem in this regard was evident when the subject surged into prominence well after our plan for these volumes, and related allocations of time and aSSignments, had become firm. Although we recruited a highly qualified author to write a chapter on the subject for volume 2, the deadline for submission was not met. By then it was altogether too late to contrive any substitute for the missing material. We apolOgize to our readers. We acknowledge some of the volume 2 authors-among them S. Guban, Catherine Gwin, Jacques Polak, and Nicholas Stern-whose final drafts were completed long before volume 1 was finished. The prinCipal authors are most grateful to the World Bank for the combination of access and independence they have been afforded. It is hard to think of another instance in which a public or private institution has made its personnel, present and past, as well as its documents and files (recent as well as earlier, most of them nonpublic, many still explicitly confidential) so freely accessible to a group of outsiders and then exercised virtually no control over the conclusions of the re- search and the resulting publication. This is by no means to say that Bank people approved our work in all instances. Many objected to the dmfts we presented and wrote dissenting commentaries that were enlightening. But there was no instance in which the Bank sought to overrule one of our interpretations. From the beginning the Brookings Institution also afforded us a very large measure of autonomy. What it and the Bank regretted was the length of time the study consumed. Like our two principal sponsors, we started out expecting the entire exercise to occupy four or five years instead of the more than seven that it finally consumed, and there were extra costs, opportunity and otherwise, to seeing it through. But there was no good way to anticipate how long a thorough job would take. Although not disagreeing much with the conclusions of Edward Mason and Robert Asher's The World Bank since Bretton Woods, which was published in 1973, we needed to address various issues that had their roots at the Bank's inception. That meant twice as much time to cover. And in its second quarter century the Bank had become more complex: its emphases had changed, and its membership, clientele, and staff and the variety of its portfolio, as well as the span of its external relations, had grown exponentially. Moreover, a researcher needed to be careful. As we pursued the rare opportunity to look into the recesses of the institution, it often took several trial drafts to get our narrative straight. PREFACE xi In one respect our exceptional access to internal Bank sources skewed the selection of subject matter and references. Historians of the Bank are bound to deal in some measure with the political, economic, geographic, and cultural con- texts in which the institntion has operated. Some senior Bank personnel urged more attention to these aspects, and some academic readers would have preferred further citation of the nonofflcial studies that bear upon many facets of the present work. As members of the nonofflcial research community ourselves, we sym- pathized with such views. Yet if one really respects these stndies, it is clear that no history of the World Bank can pretend to be an adequate review of issues involving general development and development policy. Besides, our comparative advantage was to tell outsiders some of the content of internal Bank thinking and debate that they cannot readily obtain elsewhere. Our research method has been commonplace: we conducted hundreds of inter- views; read countless memoranda, minutes, reports, and other materials; traveled to developing countries to investigate Bank operations on site; and cross-referenced readers' seminars and comments. Bank staff members' support for the project was uneven. Some did not welcome intrusions on their work or thought the time was inappropriate for investigative reporting or simply lacked interest. Some forgot the research was under way. But these were far outnumbered by the many who were curious and responsive and volunteered their help. We do have some complaints. Although we benefited greatly from the Bank's extensive and admirably managed archives, we suffered, as will other researchers, from the institution's lack of a clear policy about ownership of offlcers' personal files. Some senior executives of the Bank have, upon retirement, taken with them large quantities of papers that by rights, it seems to us, should remain with the institution. We were fortnnate (and grateful) to gain access to some of these fIles. But the policy should be clarified. In addition, in its internal correspondence the Bank uses the classification "confidential" rather freely. This is understandable for facilitating operations, although greater restraint would be appropriate. What is less excusable is that there has been no regular regime for declassif)ing papers after a speCified time has passed or some other marker has been reached. In our work we have been counseled by two worthy committees. The first was a formal adviSOry committee formed at the start of the project that had three meet- ings and continued to comment on drafts and correspond with the authors. It consisted of Abdlatif AI-Hamad, Rodrigo Botero, Robert Cassen, William Dia- mond, Crauford Goodwin, Catherine Gwin, Gerald Helleiner, Takashi Hosomi, the late Philip Ndegwa, Widjojo Nitisastro, I. G. Patel, Helga Steeg, and John Williamson. The semnd ("guidance and closure") group was formed by Brookings to assist us in the final stages. It met quarterly during the later years of the project and consisted of William Diamond and Gerald Helleiner together \vith Jonas Haralz and Mervyn Weiner. We extend many thanks to the members of both committees. xii PREFACE At Brookings, we are grateful to former president Bruce MacLaury and former Foreign Pohcy Studies director John Steinbruner. For editorial work, we thank the staff of the Brookings Institution Press, Sam Allen, and Princeton Editorial As- sociates, and for verification, Christopher Dall, Maya Dragicevic, Gary Gordon, and Alexander Ratz. The volumes were typeset and indexed by Princeton Editorial Associates. In and around the Bank we are indebted to Jochen Kraske, before and after he became Bank historian, and to the godfather of the project, William Diamond, who has never lost concerned interest in it. The regional and joint Bank-Fund libraries, the Offices of the Secretary and General Counsel, the Opera- tions Evaluation Department, and the Bank's archives under Charles Ziegler are among the units to which we owe particular thanks. We would especially like to thank the staff at the Executive Director's Library (now renamed the Board Resources Center) under Kenlee Ray: Michael Dompas, Andrea Nash, and Herve Tien-Sing Young. We are also most grateful to Charles McCaskill for his help in steering us through the maze of data on the Bank's operations and William Silverman on personnel data. Concetta DeNaro and Wil- ham Katzenstein (both in the Planning and Budget Department) also assisted our access to data. We much appreciate the counsel of our predecessor, Robert Asher. It is im- possible to name all the people of the Bank, of various vintages, who have helped. But we must list those who were exceptionally generous with their time and attention: Warren Baum, Robert Calderisi, Barber Conable, Richard Demuth, Stephen Eccles, Nicholas Hope, S. Shahid Husain, Benjamin King, Burke Knapp, David Knox, Robert McNamara, Barbara Opper, Guy Pierre Pfeffermann, Eugene Rotberg, Ibrahim Shibata, Ernest Stem, Willi Wapenhans, Christopher Willoughby, and Peter Wright. We also gratefully acknowledge the help of these other past or present Bank personnel and executive directors: Yoshiaki Abe, James Adams, Bilsel Alisbah, Gerald Alter, Robert Ayres, Jean Baneth, Bernard Bell, Munir Benjenk, Hans Binswanger, Nancy Birdsall, Shirley Boskey, Pieter Bottelier, Mark Bowyer, Aron Broches, Shahid Javed Burki, Sven Burmester, Elkyn Chaparro, Roger Chaufour- nier, Russell Cheetham, S.H. Choi, Armeane Choksi, Lief Christoffersen, Anthony Churchill, A.W. Clausen, Kevin Cleaver, Roberto Cuca, P. N. Damry, Stephen Denning, Kemal Dervis, Dennis De Tray, Shantayanan Devarajan, Ashok Dhareshwar, Graham Donaldson, Robert Drysdale, Stanley Fischer, Edward Fried, Marie Gallup, Michael Gillette, Joseph Goldberg, Melvin Goldman, Mohan Gopalan Gopal, Julian Grenfell, Enzo Grilli, Ann Hamilton, Marianne Hang, Randolph Harris, James Harrison, John Holsen, David Hopper, Ishrat Husain, Gregory Ingram, Paul Isenman, Ruth Jacoby, Bimal Jalan, Frederick Jasperson, Edward V K. Jaycox, William Jones, Charlotte Jones-Carroll, Andrew Kamarck, Ravi Kanbur, Robert Kaplan, Shiv Kapur, Martin Karcher, Gautam Kasi, Basil Kavalsky, James Kearns, Timothy King, Ciao Koch-Weser, K. P. Krishnan, Anne PREFACE xiii Krueger, Olivier Lafourcade, Luis Landau, Kenneth Lay, Mark Leiserson, Enrique Lerdau, Robert Liebenthal, Johannes Linn, Richard Lynn, Dirk Mattheisen, Oey Meesook, Paul Meo, Marisela Montoliu, Ricardo Moran, Gobind Nankani, Binod Nayak, Julio Nogues, Lester Nurick, Michel Petit, Robert Picciotto, Lewis Preston, V. S. Raghavan, V. Rajagopalan, Luis Ramirez, D. C. Rao, Martin Ravallion, Chris- topher Redford, Helena Ribe, Peter Richardson, Ronald Ridker, Andres Rigo, William Ryrie, Francisco Sagasti, Joanne Salop, Hugh Scott, Marcelo Selowsky, Alexander Shakow, John Shilling, Gerardo Sicat, Richard Skolnik, Parita Soeb- saeng, Davidson Sommers, Rainer Steckhan, Ashok Subramanian, Sachi Takeda, Wilfred Thalwitz, Rene Vandendries, Adriaan Verspoor, Paulo Vieira Da Cunha, Frank YogI, Harry Walters, Dennis Whittle, D. Joseph Wood, Ngaire Woods, Hans Wyss, Lorene Yap, Montague Yudelman, and Manuel Zymelman. Among the non-Bank people consulted, we acknowledge, in particular, Edward Bernstein, David Cole, Vijay Jagannadakan, Alexander Kafka, Gustav Papanek, Judith Tendler, and Paul Volcker. The project has had a very small staff to whom the authors are greatly indebted and who have served mostly in series: as secretary-office manager-research assis- tant: Polly Buechel, Laura Powell, Deborah Jaffe, Alison Bishop, Seiko Kyan, and Kurt Lindblom; as research assistants: Karen Semkow, Chris Watkins, David Brindley, Esther Benjamin, and Sachiko Kataoka. Despite all the help, final responsibility for the outcome lies with the authors. Contents of Volume Two 1. The World Bank as a Development-Promoting Institution 1 Devesh Kapur, John P. Lewis, arul Richard Webb 2. The Republic of Korea's Successful Economic Development and the World Bank 17 Mahn-Je Kim 3. Five Decades of Relations between the world Bank and Mexic.,'O 49 Carlos M. Urzua 4. The World Bank and Cote D'Ivoire 109 Jacques Pegatrenan arul Bakary Ouayogode 5. The World Bank in Africa since 1980: The Politics of Structural Adjustment Lending 161 Carol Lancaster 6. U.S. Relations with the World Bank, 1945-1992 195 Catherine Gwin 7. Japan and the World Bank 275 Toyoo Gyohten xv xvi CONTENTS OF VOLUME TWO 8. The World Bank's Lending in South Asia 317 S. Cuhan 9. The World Bank as a Project Lender: Experience from Eastern Africa 385 Alex Duncan 10. The World Bank's European Funding 435 Hilmar Kopper 11. The World Bank and the IMF: A Changing Relationship 473 Jacques Polak 12. The World Bank as "Intellectual Actor" 523 Nicholas Stem with Francisco Ferreira 13. Greening the Bank: The Struggle over the Environment, 1970-1995 611 Robert Wade Contributors 735 Index 737 Contents of Volume One 1. Introduction 1 Poverty and the World Bank's Evolving Purpose: Chapters 2-7 2. The Bank for Reconstruction, 1944-1948 57 3. The Bank of the 19508 85 4. Approaching the Poor, 1959-1968 139 5. Poverty Moves Up 215 6. Waging War on Poverty 269 7. Demotion and Rededication: 1981 to the mid-1990s 331 8. Agriculture and Rural Development 379 9. Policy-Linked Lending: I 449 10. Policy-Linked Lending: II 513 xvii xviii CONTENTS OF VOLUME ONE 11. The Latin American Debt Crisis 595 12. The Weakness of Strength: The Challenge of Sub-Saharan Mrica 683 13. The International Finance Corporation 805 Jonas Haralz The Bank in the World Bank: Chapters 14-16 14. The Evolution of the World Bank as a Financial Institution 905 15. Riding the Credit Boom 951 16. Coping with Financial Turbulence 1019 17. IDA: The Bank as a Dispenser of Concessional Aid 1119 18. The Bank's Institutional Identity: Governance, Internal Management, External Relations 1161 Some Key Events in the History of the World Bank Group, 1944-1996 1217 Index 1235 ONE The World Bank as a Development-Promoting Institution The Editors AMID the celebrations for the fiftieth anniversary of the Bretton Woods Con- ference in 1994, a group of nongovernmental organizations proclaimed, "Fifty years is enough." The World Bank was under fire. International organizations with prominent and contested missions have ways of inviting that predicament; some also handle it well. But a good guess is that fifty years is not enough. From its inception the World Bank has put a premium on confidentiality. Though it has recently become more open with much of its information, the Bank has rarely invited study of the institution as an institution (as opposed to outside participation by consultants and others in its substantive analyses and assessments). Once before, at the twenty-fifth anniversary of the World Bank Group, Edward Mason and Robert Asher, ofHruvard University and the Brookings Institution, respectively, were invited to study the Bank. Their research produced The World Bank since Bretton Waack 1 When we were invited to prepare a study to coincide with the Bank's fiftieth anniversary, we (along with an international advisory board) decided that a multiplicity of perspectives offered in a complementary volume would contribute much to the main text. This volume of essays from development thinkers and practitioners around the world is the result. Each of the chapters offers a unique view of the Bank. Taken together, these outside perspectives in volume 2 fill out the acconnt fonnd in volume 1. Five of the chapters presented here address relations between the World Bank and individual countries; all of them address the World Bank's contribution to development. 1. Edward S. Mason and Robert E. Asher, The World Bank since Bretton Woods (Brookings, 1973). 1 2 THE BANK AS A DEVELOPMENT-PROMOTING INSTITUTION Borrower Country Cases: Korea, Mexico, and Cote d'!voire For a development bank, the bottom line is developmental contribution, client by client. The task of development is formidable. It takes decades; setbacks muddy the picture. More than an analysis of gross national product (GNP) is involved. Growth should be shared, indigence abated, natural resources and culture pre- served, and rules should be more predictable and participatory. Though it began with a primary focus on project promotion and selected inputs to GNP growth, the Bank has steadily broadened its own terms of reference. The World Bank can help in the drive to development but only to a degree- largely determined by a country's circumstances. Compared with the needs oflarge nations such as India, Brazil, Indonesia, or China, Bank loans are merely a drop in the ocean of need. Even a nation of medium economic size such as Colombia, Kenya, the Philippines, Morocco, or Malaysia must invest twenty or fifty times more than it is allowed to borrow from the Bank each year. In the smaller nations such as Guinea-Bissau, Honduras, or Chad, Bank disbursements of foreign exchange (before netting out repayments), in good years, cover some 10 to 15 percent of imports. In slaying the developmental giant, the Bank must emulate David, with influence as its sling. Far more than it can ever admit, its business is persuasion-teaching, backing "the good guys," plotting with other donors, and occasionally (when cold war politics called for it, or when a country is needed to right its international finances) playing hardball reform through loan conditionalities. In the development context, Albert Hirschman described this as "reform-mongering." Eugene Black, president of the Bank from 1949 through 1962, called it the "diplomacy of development.''2 Pity the auditor-and the historian. The official books keep track of loans and expenses, yet few records convey the full business of the Bank. Letters and memo- randums in the files provide glimpses, though presidential and vice presidential files tend to leave the Bank with their originators. Oral histories provide further glimpses, but memories weaken and are fallible. Even perfect records and excellent memories fall short of the mark. We know little about the workings of influence on decisions, or even of government measures on economies. Our ignorance is there to see in the vagaries of development fashion. Can the clients fill in the missing record? Are they not the best judges of the Bank's developmental contribution? Can they at least provide us with a fuller account of the Bank's dOings (above all as influencer and educator) in their countries? If bias is unavoidable, a borrower's point of view might at least offset the material, biased in favor of the Bank, that is the prinCipal and usual source for accounts and judgments about the institution. Indeed, even criticism is largely the Bank's self-criticism, or based on it. 2. Eugene R. Black, The Diplomacy of International Development (Harvard University Press, 1960). THE BANK AS A DEVELOPMENT-PROMOTING INSTITUTION 3 In chapter 2, Mahn-Je Kim, former deputy prime minister and minister of economic planning for South Korea, provides an insider's perspective on Korea's relations with the Bank. What influence did the Bank exert in Korea? Although the govemment borrowed heavily from the Bank in the 1970s and 1980s (accounting for nearly half of Korea's external public borrowing during this period), perhaps attesting to the value placed on the Bank's technical project advice and intellectual support, Kim is subdued on that score. He is more forthcoming in crediting Bank help in "selling" the country's economic leadership to its own people. The effect of the Bank's recommendations was also greater extemally, through the Bank's efforts in the consultative group for Korea, in promoting Korea to the outside world. Yet in the end Kim attributes his country's success to a cultural phenomenon: Con- fucianism. He believes the quality of a government dominates the way it imple- ments policies. Three studies of borrOwing countries are presented in this volume: Korea, Mexico, and Ivory Coast. Of these three nations, only Mexico sent a representative to the Bretton Woods Conference, and Mexico's relations with the Bank are most extensive. Tapping into this rich history, Carlos M. Urzu.a finds that the Bank's relations with Mexico fall into two distinct periods: before and after the debt crisis. From its first lending in 1959 until the early 1980s, the Bank maintained a stable, low-key relationship with Mexico, contributing modestly through resources and advice. Later-during the 19705, with the govemment awash in oil revenues and private capital and with the quality of its economic policy deteriorating-the Bank lent vigorously. But with regard to policy, the Bank was little more than a bystander, except in poverty-oriented sectors. That seeming idleness came to an end in August 1982, when Mexico announced that it was unable to service its extemal debt. At that point, the Bank became both financier and intimate policy adviser to the Mexican govemment as the nation went through a wrenching structural adjustment. The resolution of the debt crisis did not Signal the end of Mexico's problems. Urzua criticizes the undisceming support the Bank gave the Mexican reforms in the early 19905. He contends that the Bank became too close a policy adviser and influence to remain an effective critic. Complacent with economic policies and closely identified with the incumbent administration, the Bank was overconfident about Mexico, and this contributed to the peso crisis of December 1994. Like Korea, Cote d'Ivoire began borrOwing from the Bank in 1968. Unlike Korea, and more like many of its Sub-Saharan African partners, Cote d'Ivoire fell prey to radical swings in its fortunes. In chapter 4 Jacques Pegatienan and Bakary Ouayogode (former head of the government's research establishment) examine the painful story of the stark decline of a country that, as late as the early 1980s, was one of Africa's brightest economic stars. Pegatienan and Ouayogode's view inteIweaves the perspective of the academic with that of the practitioner. The authors place the blame for Cote d'Ivoire's decline on its late president, Felix Houphouet-Boigny, and on France, arguing that the Bank was too deferential 4 THE BANK AS A DEVELOPMENT-PROMOTING INSTITUTION to both in the face of failing economic policies. Bolstered by his country's early success, Houphouet-Boigny-backed by France-became obstinate and failed to recognize and adapt to changes in the world economy. Oddly enough, many critics aCCllse the Bank of heavy-handedness with its weaker African clients and of turning a deaf ear to its non-Western members. When the Bank began asserting strong pressure on Cote d'Ivoire's leaders at the end of the 1980s, the damage was, for the most part, irrevocable. Taken together, these chapters cast light on the myriad factors that affect Bank-country relations and the dilemmas inherent in conducting them. The Bank's primary role-and one bolstered by accumulated experience-has been that of lender and adviser to governments-more specifically, central governments. As such, the Bank has been most effective in countries with strong leadership com- mitted to economic development. Yet, as evidenced by the Korean case, the Bank's assistance is less needed in such instances. This dilemma is equally true within countries. In meting out its resources, should the Bank invest in the sector or region where its potential influence would be greatest because of the receptivity of a particular ministry or regional govern- ment? Or should it go where borrower management is most dynamiC, thereby ensuring successful implementation? Alternatively, should the Bank direct its ener- gies where the need for change appears greatest? Unfortunately, the three criteria rarely coincide. \Vhen differences arise between borrOwing governments and the Bank, whose priorities should preVail? Borrowing governments argue that their priorities reflect national interests and should therefore be paramount. Yet what constitutes "national interests" is often a matter of heated debate and can be a cover for much more parochial concerns. The Bank's shifting intellectual advice (for example, its support for Cote d'Ivoire's public enterprises in the 1970s, which it pressed to privatize in the 19808), produces its own difficulties. Is the Bank being inconsistent, at the peril of its borrowers; or is this a reflection of its intellectual flexibility and willingness to learn? Another tension arises when borrowers face fmancial emergencies, as in COte d'Ivoire and Mexico, which renders it difficult to reconcile the Bank's long- term developmental mission with shorter-term considerations. Too often the Bank is attributed powers that it does not possess. These chapters illustrate the Bank's limited capacity for leverage over governments. But we also see that the institution's leverage and power of persuasion shift with a borrOwing country's economic success. The Bank's broad range of activities allows for a greater horizon of opportunities to influence, with inevitable trade-offs and compromises. External players also enter this playing field, as is evident in Cote d'!voire and Mexico, where the interests oflarge shareholders (namely, France and the United States) intrude on relationships between the Bank and borrOwing countries. The Korean case challenges several elements of conventional wisdom. The Bank supported Korea's massive investments in industrial development in an THE BANK AS A DEVELOPMENT-PROMOTING INSTITUTION 5 economy strongly controlled by the government. Indeed, much of the Bank's lending went for physical infrastructure, whereas governance issues such as weak benefiCiary participation, excessive military spending, and self-reliance (dictated by security concerns) received short shrift from the Bank. The three countries examined here also challenge the Bank's more recent promotion of participation and openness as a crucial ingredient of economic de- velopment. All three had more or less authoritarian regimes; however, perfor- mance varied widely both across countries and over time. In Korea and Mexico, the lack of openness helped forge trust between the Bank and national officials, whereas in Cote d'Ivoire, it had the opposite effect. Sub-Saharan Mrica The plan for this volume had been for Carol Lancaster to collaborate with her longtime friend, Philip Ndegwa, the distinguished Kenyan former civil servant and business executive, on a joint chapter on the Bank in Sub-Saharan Africa. With Lancaster appOinted deputy administrator for the United States Agency for Inter- national Development in 1993 and Ndegwa heavily engaged in Nairobi, the col- laboration was not yet fully realized when Philip Ndegwa died suddenly in January 1996. We are retaining his voice by publishing (in slightly edited form) the exten- sive commentary he provided in 1994 on an early draft of chapter 5. Lancaster, from the point of view of a political scientist, focuses on the politics of the Bank's structural adjustment lending (SAL) in Africa. Her sketch of the early days of development in postindependence Sub-Saharan Africa amplifies chapters on this subject in volume 1. In the SAL era, whose rationale for Africa was laid out in the 1981 Berg Report, the Bank is seen as exchanging conditioned program loans for "agreed economic policy reforms."3 Reforms were needed to repair the domestic macroeconomic policy errors that, although aggravated from outside, were the principal source of unmanageable payment deficits. As Africa's lead donor for structural adjustment (albeit with a shared role for France and the International Monetary Fund in francophone Africa), the Bank's task was to persuade both borrowing countries and other external interveners to implement coherent adjustment programs. Lancaster draws a sharp contrast regarding the Bank's comparative success with the two sets of addressees. Many African borrowers asserted that they were treated abrasively, subjected to stereotypical reform formulas, and had dubious reforms pressed on them. In contrast, Lancaster finds a high degree of Bank success in holding substantive sway over donors. But she also recognizes the cost. By the early 3. World Bank, Accelerated Growth in Sub-Saharan Africa: An Agenda for Action (Washington: World Bank, 1981). This report is commonly named after Elliot Berg, coor- dinator of the African Strategy Review Group. which produced the study. 6 THE BANK AS A DEVELOPMENT-PROMOTING INSTITUTION 1990s, the Bank found itself increasingly insecure with being far out front in Africa with an adjustment policy lead falling short of its earlier billing. In his comments on Lancaster's draft, Ndegwa reminisces about Robert McNa- mara's 1969 visit to Kenya when Ndegwa was permanent secretary for agriculture and about Bank arrogance and the African appetite for constructive, politically feasible structural adjustment. He concludes with some penetrating observations about key African personalities and about some Bank personnel. The U.S. Role Arguably, the international community was not about to commit as much access to power as it did to the new Bretton Woods institutions unless the new bodies were controlled by the economically (and militarily) weightier countries. Moreover, in the aftermath of World War II (especially after the Soviet Union withdrew from Bretton Woods), politicoeconomic weight was so overwhelmingly centered in the United States that there was no way America could have avoided dominating the new International Bank for Reconstruction and Development (IBRD). The task of the historian is to determine how much and in what capacity the United States came to dominate the Bank. As the Bank's largest donor and often most vocal partner, the United States has received considerable treatment in volume 1 of this history. As a chronicler of the U.S. role in the Bank, Catherine Gwin takes the obliga- tions and responsibilities of the United States seriously. In chapter 6 she carefully and critically examines U.S. performance. As leading owner of the Bank, could the United States have been less (and less characteristically) overbearing? Has U.S. leadership-constructive at the beginning, when it played a heavy hand in drafting the rules of the house-decnned? The United States gained benefits from the Bank, which increased American leverage over programs and events, especially in the developing world. But has the Bank been a good foreign policy bargain? Most of the U.S. administrations during the Bank's first fifty years insisted they were acting in behalf of global welfare, especially that of developing countries. But did the United States take its role in the Bank seriously enough? In what ways, apart from the political, does the United States exert influence on the Bank? Gwin's review of the Bank's launch and subsequent evolution up to the Mc- Namara accession in April 1968 does not differ notably from various discussions in volume 1. Her analysiS becomes more distinctive with respect to the 1970s. Gwin provides a vivid picture of the turbulence of Bank-U.S. interaction (centering particularly on the actions and voice of U.S. treasury secretary William Simon) in the early 1970s and the first oil shock. Gwin was a senior member of the Carter administration's bilateral aid team, and her chapter has an almost confessional quality about that administration's failure to achieve better relations with the Bank. THE BANK AS A DEVELOPMENT-PROMOTING INSTITUTION 7 She underplays the seismic force (unexpected by Bank players and watchers) that Robert McNamara brought to the institution. In due course, this bulldozed a reluctant Republican administration into renominating him. In the late 1970s Bank management, while continuing to expand the scale of Bank operations at an unprecedented rate, jousted with its largest owner, particularly over the issue of human rights. But the Bank remained in accord with the United States over antipoverty and policy strategy. ewin's chapter is notable for several of its emphases. First, as a donor member, the United States is important not just because of its size: its government is nonparliamentary and its power divided. The U.S. Congress thus has had an endlessly complex and prominent role to play vis-a-vis the Bank, and not just because the Bank is headquartered in Washington, D.C. ewin captures this in a colorful and informative way. But her contention that relations between the Bank and the U.S. Treasury Department have been equally exceptional can be chal- lenged. Such relations would be similar even if the United States were a parliamen- tary democracy and Treasury were a ministry of fmance. In addition, as relative U.S. material inputs to the IBRD and the International Development Association (IDA) diminished during the 1980s, the executive branch reasserted its leadership. The American voice, represented partially by default by Treasury undersecretary David Mulford, became harsher and shriller than in earlier years. ewin also provides a careful and balanced review of cases in the 1970s and 1980s in which the United States was widely alleged to use political muscle-not just its votes in the Bank's board room-to influence institutional decisions. These included both substantive choices (for example, concerning investments in oil production and distribution) and those, positive and negative, with respect to borrower regimes (such as Chile and Vietnam). Finally, in the eyes of the editors, ewin can be charged with one count of underem- phasis. She does not dwell as much as she might on the casualness of the process by which the United States has wielded its prerogative (thus far successfully asserted) to select the World Bank preSident. The most influential (McNamara) was also the most accidental. For however long the United States has the de facto entitlement, it is likely to treat the office with less respect than it deselVes as long as, in the eyes of most Americans (official and otherwise), the United States is so vastly more important than the World Bank. This estimate is a frustration the Bank in varying degrees encounters in dealing with other member countries. It surfaces again in Bank relations with Japan. Japan: Borrower and Donor No other country has progressed through as many stages in its dealings with the World Bank as has Japan. Starting as a project and sectoral borrower and a 8 THE BANK AS A DEVELOPMENT-PROMOTING INSTITUTION recipient of technical assistance, Japan moved swiftly to become a major market for Bank loans and a leading aid donor. It surmounted frictions that delayed its becoming the Bank's second-largest shareholder. It struggled with the problem of winning representation in the Bank's anglophone staff, but, in the 19905, par- ticipated more and more in debates over Bank development doctrines. Toyoo Gyohten, as Japan's vice minister of finance, rose to the top of the Japanese career service, dealing ,vith development and multilateral matters. Having declined offers of senior positions in the World Bank and the Asian Development Bank, Gyohten was preparing to become chairman of the board of the (commercial) Bank of Tokyo as this World Bank history was being shaped. He was ideally cast in intellect as well as by experience to review the Japan-World Bank story. Gyohten makes a sweeping job of it in chapter 7. He reviews the circumstances under which Japan joined the Bretton Woods institutions before it jOined the United Nations and was bumped from the Export-Import Bank of the United States to the World Bank as a project borrower. He goes on to discuss Japan's rapid graduation from its dozen years of heavy borrowing from the Bank (1955-66), then to the mode for Bank borrowing from Japan that President McNamara entered into with the Japanese Ministry of Finance, through which the Bank became a mentor of Japan's financial market development. The review details Japan's polite struggle to win a larger share holding to match heavier contributions to the Bank Group. One of the innovations, in response to the country's burgeoning payments balance in the 1990s, was the 1990 Policy and Human Resources Development Fund, the Bank's largest bilateral trust fund and virtually the only one that remains untied. Gyohten also refers to coflnancing as a positive-sum venture for the World Bank and the Japanese government. Gyohten writes as a student of developmental political economy as well. Countries that are currently developing, he argues, should fmd Japanese experi- ence between the world wars (not just since World War II) illuminating. He prOvides an extensive examination of the Bank's East Asian Miracle study as an attempt to reconcile the more interventionist Ea~t Asian mode of developmental policy with Bank orthodoxy. Gyohten compares the intellectual environments from which the two views arose. 4 In the final section Gyohten becomes unabashedly prescriptive. Speaking for Japan's policy elite, he addresses an extensive set of recommendations (critical but supportive, on balance) to the World Bank and another list to his Japanese com- patriots. Gyohten's analysis reflects Japanese frustration with the Bank. However, despite Japan's major role in the Asian Development Bank, that institution striking- ly resembles the World Bank. 4. World Bank, The East Asian Miracle: Economic Growth and Public Policy (Oxford University Press, 1993). THE BAKK AS A DEVELOPMENT-PROMOTING INSTITUTIOK 9 Project Lending in South Asia and East Mrica What is often called the Bank's bread-and-butter work-the financing of economic and social infrastructure projects-is the subject matter of two chapters in this volume. Each takes a regional focus. S. Cuhan, emeritus fellow at the Madras Institute for Development Studies in India, has written on project lending in South Asia; and Alex Duncan, program director of the Food Studies Croup at Oxford University, examines the equivalent experience in East Africa. Project lending is mandated in the Bank's Charter. Its Articles steer the Bank toward "productive" and "specific project" loans, restricting non-project lending to "exceptional circumstances."5 For the fledgling institution, the injunction proved a convenient shield against political pressures and an attractive selling point when it came to marketing bonds to cautious postwar investors. Project lending took a firm hold and came to be seen as the Bank's metier. From the late 1940s to the early 1980s, more than 90 percent of Bank lending to developing countries consisted of project loans. Even during the 1980s-when the Bank sought to increase its influence on macroeconomic policies and then responded to debt problems with a spate of non-project-based structural adjustment loans-the greater part of its lending com- mitments (some two-thirds) continued to be in the form of project loans. If the Bank's financing were packaged as projects, most of its advisory and tutelary assistance was also delivered in the course of and along with such lending. Any Bank lending was, to begin \vith, conditioned on country "creditworthiness," which was equated with sound credit and fiscal and monetary behavior and with export policies that promised a capacity to pay. "Policy dialogues" on such matters were thus a major and continuous order of business in Bank-client relations. But project loans were particularly suited to the transfer of technical expertise, especially engineering and managerial skills related to specific productive ac- tivities. Rolling up their sleeves to work with local and sectoral authorities, Bank officials used projects as opportunities for how-to demonstrations and for discus- sions of international experience and best practice with respect to the choice, deSign, preparation, implementation, and subsequent upkeep of investment projects. Even more broadly, the appraisal and negotiation of project loans became a way of persuading borrowers of ways to improve sector-wide policies and institu- tions. Project lending thus became the vehicle and the lever for the Bank's wider developmental agenda. Seeking projects to finance, the Bank looked beyond rates of returu, output priorities, and productive bottlenecks, scouting for opportunities to influence development policies and practices in particular sectors. The reader should not be surprised, therefore, that the two chapters on the World Bank as project lender focus as much on poliCies and institutions as on investment projects in the narrower sense. The question of this larger developmen- 5. Articles of Agreement of the International Bank for Reconstruction and Development, Article I (I); and Article III, Section 4 (vii). 10 THE BANK AS A DEVELOPMENT-PROMOTING INSTITUTION tal influence is especially pursued by Cuhan in chapter 8, who notes: "As a development lender, the Bank has been interested in extending the benefits of its project lending beyond the successful completion of the project itself to improve- ments in implementation capacity, long-term sustainability of projects, diffusion and replication of the learning experience in project execution, institution building, and sectoral policy reforms." Tracing project lending sector by sector and country by country, Cuhan repeatedly asks whether the Bank succeeded in projecting itself beyond the investment project itself to influence the broader development context. The converse influence-from the policy and institutional environment to project performance-also concerns both authors. But it arises most forcefully in Duncan's discussion of East Africa. In chapter 9, he argues that a pronounced deterioration in project performance was largely the result of a worsening in that environment. Regarding project performance, both chapters conclude on a critical note. In his summary Duncan states: "Projects alone have proven not to be the key to Africa's development in the way that for perhaps twenty of the years under review the Bank assumed they were." The failure, he argues, was less one of project design than of weakness and neglect of policies and institutions. As a result, "the Bank has found itself impelled ... upstream from project-specific concerns, to involve itself closely with budgetary processes, and with the planning and management of public institu- tions at the heart of government." Likewise, Cuhan concludes, "the Bank's project lending in South Asia has fallen short of the expectations, and often the claims, placed on it by the Bank." What is perhaps most remarkable about these criticisms is that, written and circulated (as drafts) in the early 1990s, they were not at all remarkable. Similar and even more severe criticism was becoming common currency within the Bank. To some extent, the Bank was carrying on a tradition: few institutions bave practiced self-evaluation to a similar extent, or with a comparable degree of openness. But the process became intensified during the 1990s as the Bank responded to bad news from project audits and to an escalation of external pressures. The severely self-critical Wapenhans Report of 1992 drew much attention. 6 Indeed, though both Cuban and Duncan provide considered, independent critiques based on direct experience of Bank project work, their views are reinforced by the substantial body of self-evaluation the Bank conducted. This is especially the case with Duncan, who shares the generalized picture of East African project failure drawn by internal reports and who is more concerned with the explanation of that result than with speculation about the complex and multiple effects of long-lived projects. Has there been a rush to judgment? Certainly, cycles of self-criticism, innova- tion, and rededication have been a constant source of energy for the Bank. Yet 6. World Bank, «Effective Implementation: Key to Development Impact." Working Paper R92-195 (Washington: November 3, 1992). Willi Wapenhans served as chairman of the Portfolio Management Task Force that produced this study. THE BANK AS A DEVELOPMENT-PROMOTING INSTITUTION 11 project evaluation is an imperfect exercise. This is all the more true when judg- ments are essentially projections, made early in the productive life of a project-as is the Bank's usual practice-and when project objectives include noninvestment externalities, such as training and policy influence. 7 Thirty years ago Albert Hirschman studied the behavior of development projects and picked a number of World Bank investments for the purpose. He did so even though, as he wrote: exclusive reliance on World Bank projects could of course be criticized on the grounds that the resulting sample was likely to be highly biased because the Bank insists on very high standards and picks only the best ventures available. Fortunately (at least for my research!) I found, upon looking more closely, that not one of the projects I had selected had been free from serious problems. It quickly became apparent to me that all projects are problem-ridden; the only valid distinction appears to be between those that are more or less successful in overcoming their troubles and those that are not. 8 With his determined "bias for hope," Hirschman found it difficult to arrive at definite judgments about projects. But his plea for "modesty with respect to general- ized evaluation and quantification" and his suggestion that such effort would be better spent exploring the twists and turns of project experience were probably not possible for an official institution, particularly one specifically charged with project investment. 9 Yet the reviews carried out by Guhan and Duncan suggest that much could be learned by more examinations of project behavior in the Hirschman style. European Funding How the World Bank funds its operations, project and otherwise, is often overlooked or (what is worse) misunderstood. Of its four sources of funds-paid-in capital, retained earnings, prepayment of loans, and borrowings on world markets -borrowings represent the greatest portion. As such, the Bank's lending capacity is directly related to its ability to borrow. The intricacies of this story are detailed in volume 1 (chapters 14-16). In chapter 10 in this volume, Hilmar Kopper, chairman of Deutsche Bank, the Bank's largest European commercial bank partner, focuses on IBRD borrowing in one of its principal markets: Europe. 7. The principal basis for Bank evaluations, used in tum by non-Bank authors and critics, has been a project rate of return estimated by the Operations Evaluation Department (OED) as part of its Project Performance Audit Report (PPAR). The PPAR is carried out when project implementation (construction and setting up) and corresponding loan disbur- sements are completed. For the great majority of projects the PPAR rate of return estimate is the last evaluation carried out by the Bank, so it is at this moment of project birth that most projects are defined by the Bank as a "success" or "failure." 8. Albert o. Hirschman, Development Projects Observed (Brookings, 1967), pp. 1-3. 9. Ibid., p. 188. 12 THE BANK AS A DEVELOPMENT-PROMOTING INSTITUTION Although the Bank initially kept out of war-tom European markets, it quickly branched out of the United States and into England and Switzerland in 1951. With a striking lack of partisanship, the Bank has sought the highest return and maxi- mum effiCiency by diverSifYing markets, currencies, and types of placement and maturities. (The Bank entered the Swiss market when rates there were lower than in the Uuited States, even though Switzerland became an official member only in 1992.) Capital market restrictions and higher interest rates in nearly all European countries kept the IBRD's European borrOwings confined mainly to Germany (dominated by Deutsche Bank) and Switzerland (under the cartel of the three largest commercial banks-Swiss Bank Corporation, Credit Suisse, and Uuion Bank of Switzerland) for nearly three decades. The Bank forged its way into European capitals through aggressive marketing and lobbying (similar to its iuitial efforts in the United States). As European countries gradually liberalized, their central banks subscribed to the Bank's nonmarket borrOwings before allOwing market borrOwings. The Bank's overall volume and share in Europe rose almost continuously during this three-decade period, from roughly 10 percent in the 1950s to nearly 25 percent in the 1960s and (with brief interruptions follOwing the two oil shocks) to about 40 percent in the 1970s. Just as the markets were diverSifYing, so too were the Bimk's borrowings. A combination of factors-rapid capital market liberalization, the advent of swaps, an explOSion in financial product innovation (including the rapid growth of Eurobond markets in the 19705), and tax privileges (hard fought for by the Bank)-led to a substantial broadening of the Bank's European funding base in the 1980s. Euro- bond markets alone accounted for almost one-fifth of the IBRD's borrowings in the 19808. Charting the Bank's trajectory of increasingly diverse market activity not only in Europe but also throughout the world, the more recent appearance of "global" bonds (which allow the Bank to borrow Simultaneously in prinCipal capital markets worldwide) seems a metadiversification. No longer is the Bank confmed to specific geographical market segments. Moreover, changes in the IBRD's currency policies at the end of the 19805, along with stagnating IBRD borrOwings, indicate that the Bank's European borrowings are not likely to expand as quickly as they had in the institution's first fifty years. The International Monetary Fund Of all the outside "looks" at the Bank represented by the chapters in this volume, perhaps none is as inherently intriguing as that of the view from across the street: from the International Monetary Fund. In chapter 11, Jacques Polak, the author of The World Bank and the IMP, writes as a former official and director of THE BANK AS A DEVELOPMENT-PROMOTING IKSTITUTION 13 the Fund's research department (1958-79) and former IMF executive director for the Netherlands (1981-86). He has also served as an occasional consultant to the Bank. Polak's identification with the IMF is even greater than that suggested by his length of service: his name is attached to what has long been the Fund's core analytical framework, the Polak model. This is worthy of interest for two reasons. One is that the two institutions are known to have an intimate relationship based on the circumstances of their birth- John Maynard Keynes dubbed them the "twin sisters"-and on their overlapping purposes and operational contact, all enhanced by physical proximity. Another is IMF secretiveness, which makes any informed and reasonably open statement from a (former) senior Fund official, and bearing on a major aspect of the Fund's work, an unusual occurrence. Polak centers his chapter on the sensitive issue of turf. As could be expected from a former Bretton Woods delegate, he provides a rich historical account of the way in which the separation and overlap of tasks has evolved over fifty years. He traces that evolution from the respective charters through the institutional respon- ses to a changing world economy to the more circumstantial contributions of some individuals. Both organizations moved from being "world" institutions to a more restricted role as lenders to less developed countries. Both encroached on the other's original turf-the Fund becoming a concessionallender to poor countries, the Bank moving to provide (more openly than in the past) balance of payments support. The relationship is marked by an ongOing liveliness, up to more recent developments-a concordat reached in 1989 and the pending issue of a hypotheti- cal merger, a proposal that draws a resounding "no" from the author. Polak has preferred not to mention what to many must appear to be the most surprising turn of events: the Fund's recent reassurances that poverty alleviation-including the mitigation of possible short-term adverse effects of reform and adjustment programs on "the poor and vulnerable"-is among its fundamental objectives. to Though much is brought to light, there is one aspect of the relationship between the Bank and the Fund that is discreetly downplayed in this chapter: their common owner(s) have been continually responsible for many, if not most, key decisions. Principal ownership has shifted over the decades-from the United States, to the Group of Five, and now perhaps to the Group of Seven. It remains for a later historian to unravel the extent to which national interests, in contrast to institution- al autonomy (and interests), have determined the major turns of events recounted by Polak. The U.S. interest, for instance, is necessary to understand the conflicting ver- sions that are given with regard to the cause celebre incident over Argentina in 10. Address by Michel Camdessus, Managing Director of the International Monetary Fund, at the UN World Summit for Social Development, Copenhagen, Denmark, March 7, 1995, p.l. 14 THE BANK AS A DEVELOPMENT-PROMOTING INSTITUTION 1988, an incident Polak uses to illustrate Bank-Fund mnflict. That year the Bank broke with precedent, approving a large package of balancc-of-payments support for Argentina despite IMF disapproval. Polak's account of the reasons for and the effects of that decision should be contrasted with those given by Bank president Barber Conable and Shabid Husain, the Bank's vice president for Latin America and the Caribbean. Polak sees a strictly institutional interest and an operational "failure"; Husain cites political motivations (such as fear of a coup d'etat) and claims success on that score. A fuller, though not necessarily complete, account of this complex decision, including political motivations, is given in chapter 10 of volume 1. Intellectual Contribution Admirers and critics of the World Bank commonly agree on a surprising view of the institution: the principal function of each loan is to serve as an ideolOgical Trojan horse. It is the critic who \vill term this ideological and having pejorative intent. The admirer ,vill make the same point using different language, speaking of the Bank as not a mere bank but a "developmental agency," citing the technical assistance, training, and advice that it provides, as well as its contributions to development research. Both critic and admirer see loans as levers and packaging for the transrnission of those ideas. As historians who are both its admirers and its critics, we share this sense of the importance of the Bank's nonfinancial role. More concretely, we subscribe to the view (as does the Bank itself) that ideas and expertise have been at the heart of the Bank's mission. That view is evident in many of the chapters of volume 1 of this history.l1 It also helps explain why the Bank does not suffer criticism gladly with regard to its intellectual leadership. Nicholas Stern (with Francism Ferreira) provides another (and more focused) examination of the Bank as a source and as a transmitter of thinking on economic development in his essay on the Bank's intellectual activity. In chapter 12 Stern is an observer who wears two hats. As a university economist, he looks for originality and scientific power in the Bank's work as a creative center of development studies. As an institutional historian, Stern examines the way in which ideas about develop- ment have been part of the Bank's practical, operational life-including that large part of "operations" that mnsists of doctrinal persuasion. As it turns out, Stem the academic gets short shrift. Despite the Bank's early start as a development practitioner (its first development loans in the late 1940s antedated the birth of development as a field in university curricula) and the early 11. Especially the accounts of poverty and the Bank's evolving mission (chapters 2 to 7), of its policy-based lending (chapters 9 and 10), and of its lending for agriculture and rural development (chapter 8). THE BANK AS A DEVELOPMENT-PROMOTING INSTITUTION 15 association of eminent development economists with the Bank (notably Paul Rosenstein-Rodan and Albert Hirschman), and despite its massive budgetary presence in development research during the 1970s and 1980s, Stern is unable to cite any Significant, pioneering scientific contribution. Loosening the criteria, Stern does speak of the Bank's "intellectual leadership" with respect to structural adjustment during the 1980s: It "became a prominent champion" and "was seen to be leading the charge." But, Stern admits, the Bank's analytical role was not path breaking, the underlying theories and views "were not new"; indeed, they had "long lain at the heart of the whole subject of economics." Similarly, Stern recalls the Bank's role as a champion for equity and poverty under McNamara, but points out that here, too, it was adopting the ideas of others. It is Stern the institutional historian who bears the burden of the account of the Bank as intellectual actor. In that capacity he examines a broad range of Bank activity and economic work in project design and evaluation, in judging creditwor- thiness, in recommending development policies to borrowers, and in acting more generally as an educator and champion of particular economic doctrines. On this ground, and though his account is more detailed, Stern covers many topicS that are discussed in the first volume of this history. The reader might find that much of the interest of Stern's chapter lies in contrasting his perspectives on those topics with those provided in volume 1. The Bank and the Environment Robert Wade's closing essay for this volume is much more than an account of a particularly contentious issue in the Bank's history. For one, the clash between the environmental movement and the Bank, beginning in the early 1980s, became, in itself, a major piece of the institution's "modern history." For another, behind the arguments and counterarguments regarding the environmental impact of speCific Bank projects and the adequacy or inadequacy of the Bank's environmental proce- dures, two fundamental matters of governance were at stake. One concerned the social priorities that should gUide the institution: what weight should be attached to particular human values--environmental preservation and protection from for- cible resettlement-as distinct from the discounted present value of additional production. The second point of contention was the right to a voice in decision- making, along with the related matter of access to information-were decisions to remain the province of G-7 ministries of finance and the Bank's senior, career officials, or would shouting, prying, emotional, generally self-appOinted "voices of the people"-for the most part western NGOs-to be admitted into the discourse? In both cases the answer was a compromise. The struggle over the environment changed the Bank. The 1990s institution is more open to a broader social agenda and more directly responsive to NGOs, project beneficiaries, the media, and other 16 THE BANK AS A DEVELOPMENT-PROMOTING INSTITUTION voices and constituencies. The process of accommodation leaned heavily on semantic innovation: terms such as "sustainable development," "participation," and "stakeholders" became part of the Bank's 1990s language. The choice of author for this assignment was particularly difficult. The topiC demanded objectivity on the issues at stake, knowledge of the Bank, and a sense for the mechanics of deciSion-making. Wade's chapter provides a detailed and closely documented examination of the Bank's bureaucratic processes that is unmatched elsewhere in this two-volume history. TWO The Republic of Korea's Successful Economic Development and the World Bank Mahn-Je Kim THE SUCCESSFUL economic development of the Republic of Korea (ROK) over the past few decades can be attributed to many factors, persons, and institutions. The World Bank, which was founded a few years before the official birth of Korea in August 1948, is one of those major institutions to which the Korean economy owes much of its success. The Republic of Korea officially joined the Bank in 1955. In 1961 Korea became a member of the International Development Association (IDA), the Bank's af- filiated institution established in 1960, and in 1964 Korea joined the International Finance Corporation (IFC), the financial subSidiary of the Bank. Korea received its first loan from the World Bank in 1962. It is largely accepted that the Korean economy started its rapid industrialization in the early 1960s. The active working relationship with the Bank begun during this period created the opportunity for the Bank to play an influential role in Korea's economic development. The objective of this chapter is to describe and evaluate the part the World Bank has played in the course of Korea's economic modernization. In doing so, it is useful to briefly review the effects of foreign aid on the Korean economy in the earlier I appreciate the valuable and detailed comments by Dr. R. Webb, Dr. R. J. Goodman, and Dr. D. Kapur. Dr. D. W. Nam, former prime minister of the Republic of Korea; Mr. S. K. Lee, former vice minister of the Economic Planning Board; and Dr. S. W. Nam, vice president of the Korea Development Institute, also provided valuable information for this chapter. I also would like to acknowledge the assistance of Dr. T. Kwack. The views expressed or implied here are of course my personal ones. None of the individuals listed above shares my responsibility for any remaining deficiencies. 17 18 KOREA AND THE WORLD BANK phase of the Republic's economic development before discussing the financial aspects of the Bank's role in Korea's industrialization. Among the institutions and nations that provided public loans to Korea, the Bank was the most important in terms of both the amount and number of loans. The Bank also helped Korea Critically in accessing other sources of foreign capital financing, and its project loans and other financial assistance not only provided Korea with needed foreign currency capital, but also facilitated the transmission of important management techniques. Equally important has been the role of the Bank in Korea's policymak- ing. Through various missions to Korea, publication of reports on the Korean economy, personnel exchange programs, and informal contacts and discussions with Korean government officials and researchers the Bank has influenced Korea's economic policymaking. In concluding the chapter an attempt is made to identify factors that explain why relations between the Republic of Korea and the World Bank have been so successful, and to identify Korean social, political, and cultural characteristics that help to account for that success. Provision of Financial Resources by the World Bank The very first systematic foreign assistance to Korea was given in September 1945 by the U.S. military government on the Korean peninsula, an occupied area at the time. l Under the first assistance program, called Covernment and Relief in Occupied Area (CARIOA), a total of $502.5 million was prOvided to Korea over the period 1945 to 1949. The program's main purpose was to prOvide fiscal resources and relief goods to the poverty-stricken occupied area on a short-term basis. The long-term strategy of the United States was to build a strong, independent, and democratic nation on the Korean peninsula that could serve as a balancing factor in the East Asian region and as a showcase of free democracy to be emulated by other Asian nations. 2 This long-term perspective was not fully reflected in the CARIOA program mainly because it was assumed that the peninsula, which was divided at the thirty-eighth parallel, would soon be unified and that long-ternl plans could then be worked out. The short-term perspective of the program was well reflected by the items imported: between 80 and 90 percent of the items were consumer goods for relief purposes. In 1948 the Republic of Korea was formally launched and the Economic Co- operation Administration (ECA) took over management of U.S. aid to Korea. By 1. This section draws heavily on Edward S. Mason and others, The Economic and Social Modernization of the Republic of Korea (Harvard University Press, 1980), chapter 6; and on Korea Development Institute, A Forty-Year History of Korean Public Finance, vol. 6 (Seoul: KDI, 1991), chapter 4. 2. See William A. Brown and Redvers Opie, American Foreign Assistance (Brookings, 1953), pp. 372-73. KOREA AND THE WORLD BANK 19 this time the possibility of unifYing the Korean peninsula had faded, so the ECA concluded that assistance should be directed toward development projects rather than immediate relief. The ECA's plan, however, was frustrated by the outbreak of the Korean War in mid-1950 and ECA aid was concentrated on immediate relief rather than on reconstruction or long-term development. Wartime aid was organized by the Civil Relief in Korea (CRIK) plan under the United Nations flag. In December 1950 the United Nations Korean Reconstruc- tion Agency (UNKRA) was created to assist in the reconstruction of a unified democratic nation on the Korean peninsula. The plan was to be funded by volun- tary contributions of United Nations members. These two U.N. aid plans were funded mostly by the United States. The CRIK plan supplied a total of $218 million between 1950 and 1956, and UNKRA supplied $120 million between 1951 and 1960. A more formal economic cooperation or development assistance program by the United States began with the establishment of the Foreign Operations Administra- tion (FOA) in 1955, at the suggestion of the Tasca Mission's report to U.S. Presi- dent Dwight D. Eisenhower.3 Almost Simultaneously, the Office of the Economic Coordinator (OEC) was opened in Seoul In 1959 this organization became the U.S. Operations Mission to Korea (USOMIK ), later changed to USAID/Korea. This organization played an important role in the post-Korean War period until the end of the 1960s. The Korean economy depended heavily on foreign grant aid during the 1953-61 period.4 Most efforts were concentrated on reconstruction of the economy, but rapid and sustained growth had not yet begun. Aid from CRIK and UNKRA rapidly declined; major aid was provided through the International Cooperation Administration. In 1956, the import of surplus agricultural products under U.S. Public Law 480 began. A total of $2,580 million was provided during this period as economic aid. The inflow of grant aid peaked in 1957 and then rapidly declined. By the end of the 1950s U.S. foreign aid policy had switched from the focus on grants to one on loans. The first public loan agreement with the United States was Signed in 1959.5 During the 1953-61 period some 70 percent of the ROK's total imports were fmanced through foreign aid. This amounted to about 70 percent of Korea's total investment during the period. But in spite of such a heavy input of foreign re- 3. Henry J. Tasca, on a special mission for President Eisenhower, visited Korea for about six weeks in the spring of 1953. His so-called Tasca Report of July 1953 proposed replacing multinational UN-managed aid with an assistance system managed solely by the United States. FOA was the organization deSigned to take over the assistance operations managed by the UN. It was later known as the International Cooperation Administration (lCA). 4. For a more detailed discussion of grant aid during this period, see KDI, Forty-Year History, vol. 6, pp. 129-35. 5. Ibid. 20 KOREA AND THE WORLD BANK sources the economy was recovering rather slowly. During this time U.S. officials seemed to have little confidence in the future of the Korean economy. Domestic politics was rather unstable, and political leaders and high-ranking government officials had little experience with policymaking for economic development. Both aid officials and domestic policy authorities were focused on short-term macro- economic stabilization problems. Thus aid resources were largely spent on import- ing consumer goods for the stabilization of domestic inflation. U.S. aid during the period was composed of project aid and program aid. Program aid was 80 percent of total aid, and 50 percent of that aid was in surplus agricultural products. Other aid was mainly in petroleum products and fertilizers. Project aid was heavily allocated to transportation, electricity, and a few key manufacturing industries. In addition to economic aid, $1,561 million was provided to Korea as military aid. 6 Military expenses are usually classified as consumption. However, many posi- tive effects resulted from military aid to Korea, especially during the 1950s. U.S. military assistance contributed Significantly to training military personnel to be- come able managers, administrators, and technicians. A substantial portion of military investment, such as the construction of military roads, bridges, and other infrastructure, could be productively used by the private sector. There was an important negative element related to aid grants, however. In general, grant aid tends to make a receiving party more dependent on the aid. Although concrete evidence is difficult to identifY, it has been argued that post- Korean War foreign aid to the ROK contributed to orienting domestic policy to short-run maximization of the availability of disposable resources. 7 Korean officials by that time were more concerned with getting the aid amount increased or at least not decreased and did not pay due attention to using resources more productively from a long-term perspective. (Once an economy, a household, or an individual becomes accustomed to an easy solution, it tends to cling to the easy way.) The Korean economy during the 1953-61 period invested approximately 12 percent of GNP, 71 percent of which was financed through net foreign savings, most of it grant aid. s Of course, Koreans were poor at the time and could not save much. But at the same time the authorities were not doing enough to maximize domestic savings mobilization. To the U.S. aid authorities, in spite of the substantial amount of aid poured into Korea, the economy was not making satisfactory progress. Growth rates were below 5 percent and inflation was accelerating. In 1957 a strong and comprehen- 6. See Mason and others, Economic and Social Modernization, p. 182, table 35. 7. See D. C. Cole and P. N. Lyman, Korean Development: The Interplay of Politics and Economics (Harvard University Press, 1971), p. 170; and A. O. Krueger, The Development Role of the Foreign Sector and Aid: Studies in the Modernization of the Republic of Korea, 1945-1975 (Cambridge, Mass.: Council on East Asian Studies, Harvard University, 1979), pp.79--80. 8. Bank of Korea, National Accounts (1987). KOREA AND THE WORLD BAKK 21 sive stabilization plan, suggested by U.S. aid authorities, was implemented to curb inflation and encourage private sector investment. This program succeeded in stabilizing inflationary pressure, but economic growth slowed down in the late 19508. It is difficult to determine whether the assistance to Korea in the post-Korean War period was a success or a failure. The survival of multitudes of Koreans depended on U.S. assistance. But many specialists, including U.s. officials who were involved with the Korean economy in the 1950s, commented that the money spent in Korea did not produce satisfactory returns. 9 Several reasons for that lmsatisfactory performance may be identified. One is that the two parties--the Korean government and the U.S. aid authorities--did not get along very well. Korean president Syngman Rhee was a stubborn diplomat and did not yield to U.S. pressure. On the other hand, U.S. authorities were often suspicious of the Korean governments policy actions and wanted to maintain some control over Korea's allocative decisions. This lack of mutual trust is a critical point that distinguishes U.S.-Korean relations in the 1950s from Korea-World Bank relations in the 1970s and 1980s. Under such circumstances even policy advice given with good intentions may not be welcomed. The advising party may also not supply the best policy advice. Lack of trust results in difficulties in communication. Without an efficient information flow, it is difficult to work out the best development plan or policies. Another important element that prevented a satisfactory economic performance was the excessive reliance on an import substitution industrialization strategy. Many factors explain this choice. The Korean government insisted on an over- valued domestic currency. Undervalued foreign currency was rationed by the government among the importers. This was an important source of governmental power over the business sector. U.S. aid authorities advised depreciating the Ko- rean currency, but having the hard currency at hand, the government was reluctant to implement measures that would weaken the power of its allocating hand. This situation illustrates one of the greatest weaknesses of grant aid and public loans: the aid money Simply strengthens the hand of the government, thus causing various economic distortions. Even if the market is not perfect, when money is rationed entirely by government discretion the most probable result is excess ineffiCiency and inequity. In Korea, when the exports by private firms later became the major source of foreign currency, direct government intervention with resource allocation hecame relatively less problematic. But with exchange rates distorted as they were in the 1950s and early 1960s, the industrial sector naturally favored import substitu- tion projects. Import substitution firms operated inefficiently because their profita- bility depended heavily on their privileged access to undervalued foreign currency and on the general restriction of imports. 9. See, for example, Mason and others, Economic and Social Modernization, pp. 204- 05. 22 KOREA AND THE WORLD BANK Another fundamental source of inefficiency was the regime's lack of ability in economic planning and development management. The government's limited ex- perience and knowledge of economic policymaking hampered economic growth. These weaknesses, along with ineffective, corrupt political leadership, prevented Korea from pursuing a reasonably efficient growth path. lO Transition to New Economic Cooperation When the military government led by President Park Chung Hee took power in 1961, various macroeconomic variables were performing poorly. The new regime emphasized long-term development to get out of the vicious cycle of poverty. The fiscal stabilization plan introduced in 1957 was abolished in 1961 and an aggressive investment policy was pursued, which resulted in severe inflation during 1963-64. Moreover, the economy was suffering from a severe shortage of food grain because of a bad crop in 1962, and foreign exchange was running out. Deteriorating economic conditions weakened the position of the military government at the negotiation table with U.S. aid authorities. When the United States asked Korea to tighten fiscal management and to depreciate the Korean currency by as much as 50 percent, Korea had to accept the suggestions to secure the required food grain supply. The Korean government began to realize that such a dependent relation- ship could not continue. At the same time, domestic financial needs grew and became more diversified, and Korea felt the need for development financing. The military government's desire for development naturally transferred its economic focus from short-term macroeconomic stabilization to longer-term industrialization. Such changes in perspectives and financial needs influenced the attitudes of both the U.S. and the Korean governments toward economic assistance. Koreans no longer insisted on getting only grant aid. For example, before President Park held a summit talk with U.S. president Lyndon B. Johnson in 1965, Korean leaders debated whether Korea should ask for more grant aid or accept a development loan of $150 million; the conclusion was to take the loan offer. On their part, U.S. aid authorities in the mid-1960s began to emphaSize such basic issues as research and statistics, economic planning and policymaking, and the design of various market systems. In the mid-1960s a larger portion of grant aid to Korea supported research projects on economic systems and policy issues. Korean leaders, realizing that the inflow of grant aid could not be maintained and that money was needed for investment, sought alternative sources of finance to 10. I am not arguing here that the economy should be planned and managed by the government. I do not believe either that laissez-faire is the best solution. I believe ap- propriate government intervention can be ,,-cry helpful especially in the earlier stages of industrialization. The Korean government in the 19505, however, did not understand the basic market mechanisms and often chose a "wrong set of policies. KOREA A~D THE WORLD BANK 23 implement development. In January 1960 the Foreign Capital Inducement Law was promulgated to attract investment capital to Korea. The law was revised in 1962 and again in 1966 to strengthen its appeal. The first direct investment project, a joint Korean-U .S. project for nylon fiber manufacturing, was approved in 1962 by the Korean government. Under pressure from and through the intermediation of the United States, economic talks between Korea and Japan were promoted, in spite of strong resis- tance by Korean students and opposition leaders. In the 1950s and 1960s, Japan was no better friend than North Korea in the eyes of the South Korean public, so it was politically risky for the Korean military government-still a stranger to the public-to promote reconciliation with Japan. Nevertheless, the talks finally suc- ceeded in 1965. Under the terms of the agreement, Japan was to prOVide the ROK with $300 million in grants and $200 million in public loans over the 1965-75 periodY Both the ROK government and the United States understood, however, that an array of economic relations with Japan, extending beyond financial assis- tance, would be essential for Korea's economic development. The Korean government also sought to develop more practical relations with international development organizations. In addition to becoming a member of the IDA in 1961 and the IFC in 1964, Korea Signed a standby agreement with the International Monetary Fund (IMF) in 1965. In 1966 the ROK government per- suaded the World Bank to organize the International Economic Consultative Organization for Korea (IECOK), whose members were donor countries. In pro- moting the organization of IECOK, both the World Bank and the U.S. Agency for International Development (USAID) played active roles. 12 This organization, which lasted until 1984, played an important role in facilitating Korea's foreign borrowing. At the time of these changes in the mid-1960s Korea was having its first round of success in exporting labor-intensive light manufacturing products, which sig- naled auspicious development for the Korean economy. Pursuing more aggressive development policies requiring larger financial resources, the regime sought di- verse sources of finance on both political and strategic grounds. Rapid increases in the demand for development investment funds later justified the need for diver- sification of financial sources on economic grounds. From the mid-1960s on the inflow of foreign capital increased dramatically. Although the inflow of grants continued until the mid-1970s, their relative impor- tance declined. In particular, the composition of U.S. aid changed drastically from grants to development loans. In 1963 nongrant aid was 17 percent of total U.S. aid amounting to $252 million; in 1970 the nongrant share was 59 percent of total U.S. 11. Charles R. Frank, Jr., Kwang Suk Kim, and Lany E. Westphal, Foreign Trade Regfmes and Economic Development: South Korea (New York: National Bureau of Economic Re- search, 1975), p. 106. 12. R. J. Goodman, commenting on this section, notes that credit should be given to the United States for pressing the Bank to form such a group. 24 KOREA AND THE WORLD BANK aid of$182 million. In 1975 only $0.9 million of a total of$277 million was provided in grantsP The dominant form of capital inflow, however, was in loans (borrowing) rather than direct investment. In 1965 only 17 percent of the total $121 million of net nongrant capital inflow was in direct investment. In 1970 a total of $61 million, or 13 percent, of the total $481 million in net nongrant capital inflow was direct investment. In 1974 the total net nongrant capital inflow jumped to $1,311 million, but the direct investment amount increased to only $140 million dollars, its share dropping further to 11 percent. 14 Thus although its quantity increased, direct foreign investment did not quickly become a major substitute for public transfers (see table 2-1). These changes meant that the Korean government's relationship with the U.S. aid authorities became less important, whereas its relationships with international financial institutions, especially the World Bank, became increasingly important. To say that foreign capital played a critical role in Korea's successful economic development is to state the obvious. IS Capital was the binding factor; it was much more important than some growth accounting studies of the Korean record sug- gest. If the input of factors had been evaluated at their correct shadow prices, the results of growth accounting would have changed substantially in favor of capital. In addition, technical progress was closely connected with capital, either through direct investment or through the import of capital goods in which advanced tech- nolOgies were embodied. Moreover, a substantial portion of total factor produc- tivity can be explained by changes in the country's industrial structure. In Korea, rapid structural changes were promoted at least in part by the discretionary alloca- tion of public investment by the government. And investment in primary education in the 1950s, which reqUired substantial aid funds, is believed to have played a critical role in labor-intensive industrialization in the 1960s. 16 Investment in higher education proved to be helpful in alleviating shortages of technicians and engineers during development of heavy industry and the chemical industry in the 1970s. Initial invest- ment in educational hardware such as school buildings and laboratories played an essential role in directing more material and nonmaterial resources to education. In the 1950s the investment-to-GNP ratio was around 13 percent, and most investment was financed by foreign savings. During the First Five-Year Economic Development Plan (1961-66) the ratio was about 16 percent. The ratio jumped to almost 26 percent during the Second Five-Year Plan (1967-71), with almost one- 13. Mason and others, Economic and Social Modernization, p. 199, table 41. 14. See KDI, Forty-Year History, vol. 6, p. 13. 15. For example, Kim and Park suggest that the average growth rate of7.1 percent during the 1972-83 period was accounted for by a 3.5 percent labor input, 2.1 percent capital input, and 1.5 percent total factor productivity growth. See Kwang Suk Kim and Joon-Kyung Park, Sources of Economic Growth in Korea: 1963-1982 (Seoul: KDI, 1985), pp. 61-62, table 4-6. 16. See Yung Bon Kim, "Education and Economic Growth," in Chong Kee Park, ed., Human Resources and Social Development in Korea (Seoul: KDI, 1980), pp. 243-52. KOREA AND THE WORLD BANK 25 Table 2-l. (Arrival)": 1945-91 Public loan Commercial Year Grants the Bank) loan FDI Total (Million dollars) 1945-49 525.4 0.0 H 0.0 0.0 525.4 1950-53 520.7 0.0 H 0.0 0.0 520.7 1954-61 2,106.7 5.6 H 0.0 0.0 2,112.3 1962-66 805.1 136.0 (14.0) 196.5 25.1 1,162.7 1967-71 508.1 902.9 (245.8) 1,514.9 151.7 3,077.6 1972-76 142.9 1,881.2 (976.0) 2,610.6 417.7 5,042.8 1977-81 60.8 5,734.1 (2,213.5) 7,469.9 532.5 13,797.3 1982-86 12.5 6,699.5 (3,092.5) 5,334.0 1,100.5 13,146.5 1987-91 0.0 3,338.5 (835.3) 3,435.6 4,402.5 11,176.6 (Percent) 1945-49 100.0 0.0 Hb 0.0 0.0 100.0 1950-53 100.0 0.0 H 0.0 0.0 100.0 1954-61 99.7 0.3 (0.0) 0.0 0.0 100.0 1962-66 69.2 11.7 (10.3) 16.9 2.2 100.0 1967-71 16.5 29.3 (27.2) 49.2 4.9 100.0 1972-76 2.8 37.3 (51.9) 51.8 8.3 100.0 1977-81 0.4 41.6 (38.6) 54.1 3.9 100.0 1982-86 0.1 51.0 (46.2) 40.6 8.4 100.0 1987-91 0.0 29.9 (25.0) 30.7 39.4 100.0 Source; Korea Development Institute (1991), table 5-3. p.13; Bank of Korea (1992). a. Includes government-guaranteed loans. Short-term capital and financial transactions are not included. b. Ratios of the loans from the Bank to total public loan amounts. third of total investment financed by foreign savings. But as a result of recession in the early 1970s the ratio remained at 26 percent during the Third Five-Year Plan (1972-76). During the Fourth Five-Year plan (1977-81), however, the ratio increased to 32 percent. In the 1980s the ratio remained above 30 percent. A substantial portion of such high investment was financed by foreign savings in the 1960s and in the 1970s; in the early 1960s, almost half of the total investment was financed by foreign savings. During the Second Plan period, about one-third of the total investment was financed by foreign savings. In the third and fourth plan periods-until the early 1980s-from 10 to 20 percent of investment was due to foreign savings. 17 The inflow of foreign capital is outlined in table 2-1. As indicated, in the late 1940s and in the 1950s nearly all foreign saving was in the form of grants. The first borrOwing, as noted, was the Development Loan Fund (DLF) loan of $2.2 million in 1959. Until the first half of the 1960s almost 70 percent of the foreign financial resources made available to Korea were grants; public and commercial loan shares were 12 percent and 17 percent, respectively. The total amount of foreign capital 17. Calculations are from Bank of Korea, National Accounts (1987). 26 KOREA AND THE WORLD BANK inflow, however, decreased significantly compared with the inflow during the post-Korean War period in the 1950s, a result mainly of a rapid decrease in grants. During the Second Five-Year Plan the share of grants dropped to 17 percent, and the main source of foreign financing became commercial borrowing, which ac- counted for about half of the total. The share of public loans jumped to 29 percent, and that of direct foreign investment more than doubled to 5 percent from 2 per- cent. Supporting aggressive investment during the 1967-71 period, the total amount of foreign capital inflow almost tripled from what it had been in the 1962-66 period. During the Third Five-Year Plan, the share of public loans in- creased to 37 percent, the share of grants was reduced to 3 percent, and the share of direct investment increased to 8 percent. The total amount of capital inflow increased rapidly during the Fourth and Fifth Five-Year plans, reflecting mainly emergency borrowing during Korea's balance of payment crisis in the early 1980s. Since then the share of direct foreign investment has increased dramatically. It can be concluded from table 2-1 that the share of public loans in total foreign capital has been high during all periods of Korea's rapid economic growth, except during the early 19605. The World Bank was the most important prOvider of such public loans during these periOds. Financial Relations with the World Bank Particularly in the 1970s and early 1980s, the money borrowed from the Bank amounted to almost half of the total public loans. Thus the Bank helped finance a Significant portion of investment funds during Korea's high-growth decades. The yearly amounts and composition of the loans from the Bank are sum- marized in table 2-2. During the years 1963 to 1990, a total of 87,264.8 million was provided by the Bank in the form of public loans. About 26 percent of the total, or $1,920 million, was allocated to the transportation sector. It is noteworthy that transportation-related loans were distributed rather evenly over the whole period after 1963. The next largest share of the loans went to development finance institutions, mainly to the Korea Development Finance Corporation (KD FC). This institution, established in 1967 by the Bank's subSidiary International Finance Corporation, supplied funds to various industrial investment projects. Loans to development finance institutions, to industry, and to small-scale industry, taken together, indicate an allocation of $1,969.5 million, or about 27 percent of total Bank loans, to industrial sectors. Most loans for industrial investment were re- ceived in the 1970s and the early 19808. About 9 percent of the total was allocated for agricultural and rural development projects, mostly during the 19708. The amount was not inSignificant, and the impact of such loans on agricultural productivity was substantial. Many argue that Korean agricultural policy was a failure on the grounds that the sector still depends Table 2-2. World Bank Loans by Year and Sector Millions of U.S. dollars Agricultural Population, and rural health, and Nonproject Fiscal Year Urbanization nutrition Education loans Total 1963 14.0 14.0 (14.0) 1968 11.0 5.0 16.0 (11.0) 1969 45.0 3.5 20.0 14.8 83.3 (3.5) (14.8) 1970 55.0 55.0 (15.0) 1971 7.0 54.5 30.0 91.5 (7.0) 1972 58.5 58.5 (25.5) 1973 120.0 40.0 43.0 203.0 (20.0) 1974 20.0 25.0 47.0 92.0 1975 100.0 60.0 15.0 22.5 100.0 297.5 1976 75.0 90.0 85.0 75.0 325.0 1977 144.0 80.0 67.0 152.5 443.5 1978 131.0 120.0 165.0 23.0 439.0 1979 29.0 143.0 100.0 125.0 397.0 1980 50.0 115.0 94.0 90.0 6.5.0 30.0 100.0 544.0 1981 50.0 250.0 90.0 390.0 1982 50.0 50.0 30.0 90.0 250.0 470.0 1983 70.0 247.0 255.0 100.0 672.0 1984 230.0 78.5 60.0 100.0 300.0 768.5 1985 25.0 50.0 111.0 222.0 95.0 53.0 556.0 1986 230.0 208.0 38.0 150.0 626.0 1987 200.0 200.0 1988 50.0 116.0 30.0 196.0 1989 200.0 16.4 216.4 1990 34.0 76.6 110.6 Total 655.0 284.0 181.0 345.0 1,920.0 1.504.5 460.5 763.0 30.0 396.3 725.0 7,268.4 Source; World Bank. Note; Figures in parentheses are International Development Association loan amounts. 28 KOREA AND THE WORLD BANK critically on government grain management programs and the absolute protection of the domestic rice market. 18 As for the cause of such failure, there is no consensus. Some argue that too little investment was made in that sector; others argue that continued protection delayed structural adjustment in the sector. If money supplied by the Bank had not been earmarked for the agricultural sector, that money poSSibly would have been redirected to other, more urgent, sectors. It is hard to judge which was the better path, but the rapid rise in productivity in rice farming provided important groundwork on which a consistent and stable industrialization could be pursued. As noted, the KDFC was the main channel through which the Bank supplied financial resources to Korean industries. The Bank also supplied various managerial and operational techniques to the KDFC. In particular, industrial project evalua- tion techniques acqUired from the Bank contributed greatly to improvements in the quality of development financing services. The Bank also initiated and sup- ported several technology-related projects, among them the Korea Technology Development Corporation (KTDC). The Bank was especially interested in promoting small- and medium-scale industries. In the mid-1970s, when a drive to develop heavy industry and the chemical industry was in full swing, the Korean government was unable to pay attention to small- and medium-scale industries, and they were not given due priority. However, those industries led the export-oriented rapid growth in the 1960s and exported a great deal even in the 19708. These industries also created relatively more employment than did capital-intensive heavy industry and the chemical industry. From the late 1970s the Bank directed loans toward small- and medium-scale industries through the Small and Medium Industry Bank and the Citizen's National Bank, helping to improve management of these institutions. Although the Bank's direct financial investment was not insignificant for the Korean economy, the Bank's indirect role in Korea's foreign borrOwing for develop- ment was more important. The International Development Consultative Organiza- tion for Korea was a key instrument through which the Bank exercised influence on donor institutions and countries. In IECOK meetings the Korean government usually presented an outline of a five-year plan and projects to be carried out to achieve the plan's goals, as well as estimates of financial requirements. Donor countries and institutions got information about the Korean economy that usually evoked confidence in the economy. The Bank's affirmative evaluation of the Korean economy and its decision to supply large loans to Korea prOvided a guaran- tee to other potential lenders, including commercial lenders. Thus although Korea had no proven credibility in international financial markets, it did not face serious difficulties in finanCing its development projects. The influence and positive role of the World Bank in attracting foreign currency for Korea's capital financing was illustrated when the Pusan and Muckho harbor 18. The grain manangement program proVides a price support system for rice and barley. KOREA AND THE WORLD BANK 29 project, initially financed by the Bank, suffered cost overruns in the mid-1970s.1 9 The Bank could not make additional loans to make up the cost overruns, but the project could not be left unfinished. Lee Sun Ki, then assistant deputy minister of Korea's Economic Planning Board, negotiated a $75 million loan for the project from the Saudi Fund for Development, but Saudi Fund officials were not willing to accept the guarantee of the Korean government and asked for an endorsement and cosignature by the World Bank. Because of the urgency of the project and the lengthy procedure for obtaining Bank endorsement of a loan, Lee flew from Jeddah, Saudi Arabia, to World Bank offices in Washington, explained the situation to Bank vice president I. P. M. Gargill, and was able to return to Jeddah with the Bank's Korean division chief, David Loos, to sign the contract. Loos's cosignature was by no means a Bank endorsement, but the loan was made. The money was more than enough to complete the harbor project; leftover money was used to construct the Taegu-Masan highway. The role of the World Bank in Korea's financing was so important that Bank officials visiting Seoul were treated extremely well by Korean officials, including President Park. For example, Ray Goodman, then Asia-Pacific director of the Bank, was invited to have lunch with President Park whenever Goodman visited Seoul; this was exceptional treatment. Beyond such tactical considerations, many Korean leaders were also eager to learn from World Bank economists. President Park in particular was a pragmatic person; he thought that there was no better tutor in economic development policy than the Asia-Pacific director of the Bank. It is known that President Park and Goodman came to like each other vel)' much. It is said that Mr. Goodman often told Korean friends that he had never met a leader of a developing countl)' who was so sincerely devoted to the economic enhancement of his nation. Good personal relations between Korean leaders and influential Bank officials played valuable roles in making the developmental experiment in Korea a successful model. Finally, projects financed by the World Bank were chosen and managed vel)' carefully. The Bank's project appraisal techniques were transferred to Korea through its project selection practices. Cost-benefit analysis, introduced to the Economic Planning Board in 1970,20 was intenSively used in the evaluation of heavy industry and chemical projects in the 1970s. In this process a few World Bank- trained economists at the Korea Development Institute (KDI) played a critical role. This technique was later disseminated among development finanCing institu- tions, mostly through the KDFC. Cost-benefit analysis was not a perfect technique, but its careful application in investment decisionmaking enhanced the efficient use of foreign capital borrowed from the Bank. In addition, the Bank-financed projects were managed so carefully and honestly that the quality of the output, in general, 19. This episode is based on the author's interview with S. K. Lee. 20. See S. H. Jo, A Study on the Development of a Manualforthe Analysis of Investment Projects (Seoul: Sogang University, 1971). 30 KOREA AND THE WORLD BANK was considerably higher. Korean officials, fully understanding that Korea would have to depend on the Bank for continued economic development, did their best to meet the standards and requirements specified in the loan documents. Such sincerity in carrying out Bank-financed projects contributed greatly to the develop- ment of friendly relations between Korean and Bank officials. Through such practices, Koreans also mastered basic project management techniques. The U.S. Role in Korea's Economic Policyrnaking The American military administration in the 1940s and U.S. aid authorities in the subsequent two decades played critical roles in laying the foundations for the development of the Korean economy, at least in its earlier stages of industrializa- tion. In the 1940s U.S. influence was absolute in designing the educational system and in promoting agricultural land reforms, both of which had Significant and lasting influence on Korea's economic and social development. In the 19508 and 1960s the U.S. aid authorities contributed greatly to bUilding the economic in- frastructure in many areas. They were closely involved in financial and tax reforms. Basic economic statistics such as national income accounting and input-output tables were compiled by the U.S. authorities from early years. In the 1950s U.S. aid authorities were mainly concerned with short-term stabili- zation issues. As representatives of the country that was providing Korea with substantial grants, and as trained economists, the U.S. officials more or less as- sumed the role of guardians or supervisors of the Korean policymakers. Korean officials were not happy about their role, especially in the late 1950s when the strong stabilization policy of 1957 was overshadowing the economy. Relations between Korean and U.S. officials, which were based more on game players' strategies and tactics than on mutual trust, became uncomfortable. Leaders of the Korean military government, especially President Park, were welcomed by U.S. officials for their straightforwardness, at least in the early years of the military regime. But when the military government abolished the fiscal stabilization plan in 1962 and adopted the aggressive investment policy that led to high inflation in 1963-64, U.S. officials reacted by practically forcing strong stabili- zation measures and a 50 percent depreciation to control inflation; the measures were taken rather reluctantly by the Korean government. Nevertheless, these measures brought important benefits to the Korean economy. Although the First Five-Year Economic Development Plan (1962-66) was closer to an import sub- stitution plan than to an export-oriented plan, follOwing the depreciation exports in simple manufactured products surged. The experience of an unexpected export surge in the mid-1960s played an important role in Korea's turn toward an aggres- sive export promotion strategy in the late 1960s and thereafter, and reminded Korean leaders of the need for independence from foreign (particularly U.S.) KOREA AND THE WORLD BA~K 31 influence. Thus the diversification of foreign financial sources was eagerly pro- moted. The interest rate reform of 1965 can be interpreted as another measure to reduce dependency on foreign sources of investment financing. 21 The Second Five-Year Economic Development Plan was made with the very extensive and practical help of the U.S. Agency for International Development (USAID). Several well-known American economists and USAID economists participated in a joint task force with Korean officials to set the basic targets, investment policies, and strategies for the plan. 22 It was the last major contribu- tion of the U.S. aid authorities in the development of Korean economic policy. The World Bank, whose relations with Korea were becoming Significant at that time, was skeptical about the ambitious targets of the plan, and the IMF expressed concern about the possibility of inflation, but the economy outper- formed the targets and later the Bank became supportive of Korean develop- ment policies in general. In the early 1960s USAID performed another important task for the future development of Korea; it financed research projects on such pending economic and social issues as financial systems and policies, grain market systems, land ownership systems, and tax systems. These were performed mainly by young Korean scholars returning from abroad. Some of the research results were immediately used in economic policy reforms and planning. The young economists became both healthy critics of economic policies and later able advisers and sometimes government technocrats. USAID also supported the establishment of the Korea Institute of Science and Technology (KIST) in 1966 and the Korea Development Institute (KDI) in 1971. The KDI has played a central role in economic policy analYSis since its opening and has served as a major Korean counterpart or contact point in relations between the Korean government and the World Bank. As noted earlier, however, toward the end of the 1960s the role of USAID in Korea was fading very rapidly. Although the Korean economy was performing impreSSively, Korean leaders were seriously lacking in experience with and knowledge of economic policymak- ing and were eager to find good sources of policy advice. In the early years of the military regime, senior economic professors in Korean universities, trained mostly in Japanese universities, were invited to advise the preSident. Several years later, however, the president began to realize that U.S.-educated mainstream economists were more appropriate for practical economic policy advice. \Vorld Bank economists were welcomed by Korean government leaders, including the preSident. 21. Offidal deposit rates were raised to apprOXimately 30 percent in the hope that domestic savings would be effectively mobilized through official financial institutions. 22. One by-product of the task force. Irma Adelman, ed., Practical Approaches to DevelopTMnt Planning: Korea's Second Five-Year Plan (Johns Hopkins University Press, 1969). 32 KOREA AND THE WORLD BANK The World Bank Role in Korean Economic Policymaking The Korean government's relations with the World Bank were quite different from those with the U.S. government. Relations with the United States were nation to nation--donor and receiver. In Korean perceptions, the United States attempted to assert some control over Korean affairs, whereas Koreans eagerly sought inde- pendence. In Korean-World Bank relations, the question of dependency was much less relevant. That the Bank provided Korea largely with loans, not grants, probably made Korean officials psychologically more comfortable with Bank personnel than with U.S. aid officials. Another important area of difference was that the Bank had relatively less interest in macroeconomic issues than in specific sectoral issues. The United States intervened heavily in Korean macroeconomic management, espeCially in the late 1950s and early 1960s. 23 Whereas proud Korean junior and middle-level officials could be hurt by the impression that foreigners were intervening in the major economic management of their country, criticism on specific sectoral issues could be accepted as friendly advice. Largely because of these factors, Korean relations with the Bank were much smoother than with the U.S. government, at least in regard to economic policy. However, the causal direction of mutual influence in Korean-World Bank relations is not obviously identifiable. Until the mid-1960s Korean-World Bank policy discussions and consultations were not very active. Although skeptical about the targets of the Second Five-Year Plan, the Bank was impressed by Korea's initial economic success in the mid-1960s. Nevertheless, Korea was still viewed as a newcomer to the scene. In the eyes of the Bank as well as of many Korean scholars, the ambitious Seoul-Pusan highway project was premature. Yet during the Second Five-Year Plan, the economy grew more than targeted, and the demand for inland surface transportation increased rapidly, more than justifYing the construction of the controversial highway project. In the late 1960s, as the Bank became more interested in the Korean economy, the issue of structural deepening was attracting attention domestically. Rapid structural transformations had already taken place during the first phase of economic development. The agrarian economy of the early 1960s had become conSiderably industrialized by the end of the decade. The growing manufacturing sector, however, was dominated by light industry and was labor intensive. Korea was exporting a lot of manufactured goods, but the balance of payments was chronically in deficit due to imports of materials and capital goods. Still, the government and the business sector were confident about the capability of the economy. 23. In the 1970s and 1980s, the Korean government was doing much better in macro- economic management than in the 1950s and early 1960s. In addition, the IMF, under the standby agreement, was specializing in macroeconomic issues in Seoul. KOREA AND THE WORLD BANK 33 President Park held a deep-rooted belief that both the economy and the nation should eventually become self-reliant. To Park, economic growth had a double role: it would enhance the material well-being of the Korean people and it would build up the power of the nation. A minimum level of income should be attained first; then the structure of the economy should be corrected, to become as self- sufficient as possible. A self-reliant defense capacity would be another important early step and would have structural implications. Self-reliance meant a "balanced," in contrast to a speciali7..ed, industrial structure. It also meant that some key items should be produced domestically. One of them was rice, the staple grain of the Korean people. Other key items could be produced by heavy industry and the chemical industry, which manufacture both the plow and the sword. Industrial Structural Deepening Discussions regarding the need for structural deepening were enriched and encouraged by supportive comments from the World Bank, although initially the Bank officials viewed Korea's interest in heavy industry and the chemical industry as premature. Korea did not have sufficient funds to invest in risky and capital- demanding projects and, in addition, its level of technology was negligible. How- ever, Bank officials were eventually persuaded by Koreans; the Bank saw Koreans as trustworthy and reliable and recognized the potential of a Korean economy that was outperforming its targets. World Bank country reports published in the late 1960s and early 1970s noted that the Korean economy, with its light manufacturing industries, was approaching maturation of import substitution and needed a mas- sive expansion of the capital goods sector in order to achieve structural balance.24 The Bank recommended protecting the intermediate and capital goods industries to achieve deepening in industrial structure. Because the easy import substitution stage was already over, the Bank commented that Korean growth could not be sustained by exporting only products oflight manufacturing industries. Encouraged by such comments from the Bank, the Korean government became even more confident about pursuing structural deepening. The term "industrial structural deepening" became a frequently used phrase in policy discussions until the end of the 1970s. The self-reliance argument of President Park was reinforced and justified by economists in Korea and at the Bank, who made at least five points in its favor. The fIrst justification was based on the Chenery-Syrquin normal pattern argument. 25 As Bank reports noted, Korea's capital goods sector was at that time underdeveloped, so it would be natural to direct more resources to boost the growth of the sector. 24. World Bank, Current Economic Positions and Prospects of the Republic of Korea (1969); The Economic Situation and Prospects of the RepubliC of Korea (1971). 25. See Hollis CheneI)' and Moises Syrquin, Patterns of Development, 19.50-1970 (Ox- ford University Press for the World Bank, 1975). 34 KOREA AND THE WORLD BANK The basic metal and petrochemical industries were also seen as underdeveloped. The second point concerned income elasticity. Light manufacturing products are largely necessities; therefore the growth rate of world demand for such items would be less than or at most equal to the growth rate of world income. To Korea, the world income gwwth rate was far too low to justifY tying the future export growth rate to it. Korea saw the income elasticities of heavy industry and chemical products as much higher than those of light manufacturing items. A third point focused on the latecomers' case. Light manufacturing products based on simple technologies could easily be emulated by other developing Asian countries, which would erode the competitive edge of Korean exports. To remain competitive in the world market relative to latecomers, Korea had to move to a higher stage of industrializa- tion. Structural deepening, according to this argument, should not only take place in import substitution for domestic demand but also be extended to export sub- stitution so that the export structure could be enhanced. The fourth point centered on the domestic content of exports. In spite of the rapid growth of exports, Korea's current account balance persistently recorded deficits-a result of importing inter- mediate materials and capital goods for export manufacturing. In other words, Korean exports in general had very little domestic content, which meant that the value-added ratio of export production was very low. Closely related was the fifth point, concerning technology intensity. Because Korea was not abundantly endowed with natural resources, the most promising way to increase domestic value-added production would be to raise the overall technological intensity of the economy Thus more investment was needed in industries that would adopt advanced technology. Many, including some Bank economists, argued that the Korean economy needed skill- or technology-intensive, rather than capital-intensive, structural deepening. Domestic economists, including government officials and World Bank econo- mists on the Korean country desk, agreed on most of the above arguments. Be- cause Koreans shared the same ideas with economists at the Bank, the confidence level of Korean policymakers in the direction of industrial structural policies was increased. With such theoretical and moral support, heavy industry and the chemi- cal industry were promoted and supported with the full strength of the Korean economy from the start of the 19708. Heavy Industry and the Chemical Industry From the early stage of industrialization President Park had been interested in heavy industry and the chemical industry. Although few key industries had been targeted for import substitution programs during the First Five-Year Plan, during the Second some major investments were made in heavy industry and the chemical industry. Under the Third Five-Year Plan, 50 percent of manufacturing invest- ments were allocated to heavy industry. In the late 1960s, when structural deepen- ing was actively discussed, several major projects in heavy industry and the chemical KOREA A~D THE WORLD BANK 35 industry were already in the planning or preparation stages; these included Pohang Steel, Changwon Heavy Machinery Complex, and Ulsan Petrochemicals. The formal declaration of the heavy industry and chemical industry strategy was made in 1973, when the economy was already moving in that direction. At that time World Bank reports conSistently expressed support for this industrialization strategy. The Bank emphaSized import substitution in capital goods and other intermediate goods via the needed protection and intervention. One Bank report warned of the probability of higher production costs during the transition period because of the use of more expensive domestically produced capital goods and other intermediate goods, which would probably be of lower quality than imported goods. The same report, however, stressed the inevitability of follOwing that strategy: "Korea has little choice but to brave the uncertainties of deepening the industrial structure if it is to stay on a fairly rapid course of development of which it seems capable."26 Around the mid-1970s, the Bank began to express concern about the drive for heavy industry and the chemical industry.27 It cautioned Korea about the overly ambitious scale and export targets of the drive and recommended scaling down and Simultaneously supporting the traditional light industries and small and medium- size firms. The Bank also emphasized the necessity of building institutions, secur- ing adequate technology, training manpower, and investing in infrastructure. But overall the Bank was supportive of the Korean strategy for heavy industry and the chemical industry. To efllciently achieve the intermediate goals of that strategy, the Bank recommended government intervention, exercise of leadership, and com- prehenSive planning. The agendas agreed on at the policy table were not always honestly imple- mented in the field, nor were government plans to deepen the industrial structure implemented exactly as intended. The plans were not perfect, but they were consbtent and relatively well organized. Those plans, however, could not fully incOlporate the unpredictable dynamiCS of various noneconomic factors. Even in terms of economic variables, long-term dynamiC repercussions could not be easily captured. Implementation of poliCies for heavy industry and the chemical industry af- fected large business conglomerates most directly, and their reactions in tum affected Critically the actual results of the policies. In particular, policies for these industries were promoted on the premise that the government would intervene in the private sector in a highly selective manner. The selection process resulted in many problems. Projects of heavy industry and the chemical industry were essentially high risk, given the inexperience of Korean firms. The government, however, bore most of the risk. Abundant funds, supplied by or through the government, were an important source of attraction. Under 26. World Bank, The Economic Situation and Prospects of the RepubliC of Korea (1971), para. ix. 27. World Bank, Growth and Prospects in the Korean Economy (1977). 36 KOREA AND THE WORLD BANK chronic inflation, the low-interest rate funds could produce large capital gains when invested in some types of real property. In the late 1960s and early 1970s, many large corporations enjoyed enormous capital gains from the inflation of land prices. 28 On the positive side, this prospect encouraged risk taking by guaranteeing substantial scrap value for factory sites or for office buildings even if the project totally failed. On the negative side, it provided some room to relax and enjoy inefficiency. In other words, a firm that was operating less effiCiently than its competitor could survive if it owned a piece of rapidly appreciating land as one of its business assets. Such inefficiency could be converted to excessive scale. The firm that had larger sites eventually won if the other conditions were equal. Thus every businessman wanted to have as much cheap money as possible, even if the money was earmarked for a project. A more important problem affecting the promotion of the heavy industry and the chemical industry was excessive competition among large business con- glomerates. The extreme rivalry among the large Korean business groups is not easily understood, but nevertheless it has been the reality. Excessive competition resulted in excessive and extensive expansion. Large-scale projects characterized firm-level plans. To justifY such large projects in a limited domestic market, huge export targets were projected. These projects were evaluated by the government and for some time by the Korea Development Institute, but the actual decisions on important projects were made at the political level. Among the strategic weak- nesses in promoting selective intervention policies were the morbid competition under a distorted incentive structure and the dominance of political factors in picking so-called winners. Toward the end of the 1970s, concerns over such excessive scales and overly ambitious export targets increased among domestic economists and government officials as well as at the World Bank. Other problems also began to be revealed. The costs of learning by dOing-a trial-and-error process-were much higher than expected. Much of the knowledge and skills accumulated through experience could not be learned from textbooks or manuals. Managerial ability at both the firm and government levels was seriously deficient. Institutional defiCiency, rigidity, and ineffiCiency created other problems. Moreover, the excessive competition among business groups intent on building their own self-sufficient empires resulted in investment overlaps and further inefficiency. The integrated facilities at the Chang- won machinery complex, for example, were not used as intenSively as intended. In spite of these problems, the aggregate targets set by the government for heavy industry and the chemical industry were successfully achieved. Investment resources were masSively directed to these industrial sectors, and their shares of production and exports increased dramatically. The growth rate of the whole 28. The introduction of a real estate speculation control tax in 1967 reflected the seriousness of the issue. KOREA AND THE WORLD BANK 37 economy, driven by the aggressive capital investments in heavy industry and chemi- cals, was maintained at a very high level throughout the 1970s. The economy nevertheless began to show symptoms of overheating around the end of the decade. To control mounting inflationary pressures, a comprehensive stabiliza- tion policy was implemented in 1979. However, other destabilizing events followed. President Park was assassinated in 1979, the Kwang-ju incident oreurred and the second international oil crisis shocked the economy. The sudden worsening of the economic environment revealed, and in some cases exaggerated, the problems of poliCies for heavy industry and the chemical industry. Even before these events took place, several large projects had to be delayed, scaled down, or canceled. In sum, both Korean policymakers and World Bank economists agreed on the deSirability of promoting heavy industry and the chemical industry through highly selective government intervention and import substitution under tariff protection. Even at the end of the 1970s, when the problems of the drive to promote these heavy industries began to be revealed, the Bank supported the basic direction of structural deepening througb selective government intervention. It even recom- mended further government intervention to remedy some of the revealed symp- toms. Moreover, neoclassical market economists at the Bank refrained from monitOring interventionist Korean officials. On the contrary, the Bank and the Korean government encouraged each other to pursue the industrialization strategy. But the Bank cannot be blamed for the strategy's excesses. The flexibility of the World Bank economists should be emphaSized. They were typical neoclassical market economists, and they contributed greatly to the indoctrination of Korean officials with the ideals of the market economic system. The Bank's economists in general were not dogmatic and knew how to harmonize text?ook prinCiples with real-world constraints. Structural Adjustment in the 1980s In many ways the 1980s were a period of structural adjustment for the Korean economy. The rapid growth and change of the two preceding decades had prevented Koreans from carefully investigating and coping with the economic problems that had arisen. Then in 1980 the galloping economy slowed to a halt, and the first negative rate of growth since 1953 was recorded. At the same time, mainly as a result of the oil crisis, inflation peaked at almost 40 percent, as measured by the wholesale price index-the second highest rate since the Korean War truce. The current account balaIK'C registered a huge deficit, and the external debt was rapidly accumulating. The heavy industry and chemical sectors, which had become leaders of the Korean economy, severely faltered. The dead weight of numerous troubled industries in these sectors was burden- some to the economy. Moreover, throughout the 1970s credit expansion had remained excessive to fmance not only projects in those sectors, but also projects 38 KOREA AND THE WORLD BANK for regional and agricultural development. The foreign exchange rate had been fIxed since the mid-1970s to keep down the cost of imported capital goods and other intermediate goods for heavy industry and the chemical industry. At the same time, chronic inflationary pressures made it diffIcult to depreCiate the won for fear that such an action might trigger a severe inflationary spiral. The adverse effects of the distorted foreign exchange rate pohcy on exports were largely offset by various export incentives. Such macroeconomic mismanagement began to be criticized openly by Korean and World Bank economists. Political turmoil also contributed to the macroeconomic diffIculties at the beginning of the 1980s. Not all the evils that appeared in the early 1980s could be attributed to domestic factors. The second oil price shock hit Korea's economy hard. The world economy was slowing down, and protectionism was beginning to prevail among the advanced countries, the principal markets for Korean exports. Extremely high interest rates in the international capital markets seriously burdened the heavy borrowers. Under such diffIcult conditions the sickness that had been dormant in many of Korea's heavy industries and chemical industries became apparent. Many industrial units in these sectors were seen to be underused. Some units were prodUCing items that nobody wanted to buy; and in general units in these sectors were prodUCing low-quality products at high production costs, mainly because oflack of experience. In addition, a rise in interest rates and depreCiation of the won severely hit the heavily indebted import-substituting industries. However, some of the diffIculties of heavy industry and the chemical industry exposed during that period were substantially exaggerated. If macroeconomic conditions had not been so severe, some of them eventually would have become mature competitive business units. As the problems of heavy industry and the chemical industry drive became more visible, open criticisms of the government's industrial poliCies of protection and inter- vention mounted and the arguments for hberalization and exposure to international competition gained wider support. It is ironic that at that time the government was practicing extreme intervention, even commanding private fIrms to manufacture only a specifIed hne of products. Government officials and economists in research institu- tions preached the virtues of market mechanisms and the positive effects of being exposed to international competition. The technocrats, particularly Kim Jae-Ik, who served as senior secretary to the president on economic matters, convinced President Chun Doo Hwan of the superiority of the market mechanism in achieving effIciency in resource allocation and of the importance of removing the entrenched inflationary expectation that prevailed in the early 1980s. World Bank economists, too, became skeptical about the effectiveness of the interventionist industrial pohcies. Industrial Restructuring Faced with these conditions, the new government led by President Chun ini- tiated drastic restructuring processes. Some restructuring programs had already KOREA AND THE WORLD BANK 39 been initiated, but in the early 1980s extensive and direct restructuring was en- forced in several problem industries. One of the most important restructuring cases was that of the automobile industry. The government selected two firms to specialize in producing passenger cars and one firm to specialize in commercial vehicles-a government fiat not easily conceivable in a market economy. However, the World Bank suggested that the government suspend its support of the automobile manufacturing firms and that the industry give up the manufacture of finished automobiles and specialize in prodUcing exportable automotive parts and components. The Korea Development Institute and the Korea Institute for Economics and Technology (KIET) also studied the issue. 29 A KIET report pOinted out the structural weakness of the Korean automobile industry. It noted that it would be very difficult to improve the product quality to the exportable level, and even the low-quality products would be produced at very high costs. 30 It also observed that the Korean automobile firms did not have marketing and service networks in major potential markets and that such networks were essential in exporting automobiles and extremely costly to set up. The report concluded that Korea would have a greater comparative advantage in manufactUring automotive parts and components and recommended that Korea forgo the national manufacture of finished automobiles. It also suggested that exposure to world competition should be increased, thus allOwing the market to select the appropriate areas of automotive specialization for Korea, a line of reason- ing that was widely aceepted at that time. As the Bank had suggested, government assistance was removed from the restructured automobile firms. Other suggestions were not followed. The restruc- tured automobile firms invested heavily in their own products. One result was that Hyundai, which was 100 percent domestically oVllned, succeeded in shipping fmished automobiles to North American markets in the mid-1980s. It is difficult to identifY the factors that enabled Korean automobile manufac- turers to succeed. For one thing, the government's restructuring of the industry and continued tariff protection reduced excessive competition in the domestic market. At the same time, the unexpected removal of government assistance, which was Originally intended to discourage the industry, contributed to activating the firms to live up to their potential. It was made clear that the firms must stand on their own feet in order to survive. This convinced them that the protection of the domestic market would not last permanently. Thus the success of the auto- mobile industry in Korea wa'i achieved by private initiative. That success cannot be attributed to market conditions alone; although improvements in economic condi- 29. Some of the studies were reported in Korea Institute for Economics and Technology (KIET), Problems and Policy Directions of the Autorrwbile Indust11j, Special Analysis 3 (Seoul, 1982); Y. B. Kim, Policy Direction for the Development of the Autorrwbile Indust11j (Seoul: KDI, 1981); and C. H. Lee, Autorrwbile Indust11j in Korea (Seoul: KDI, 1980). 30. KIET, Problems and Policy Directions. 40 KOREA AND THE WORLD BANK tions in both domestic and world markets contributed to the success of the private ventures. Korean automobiles nonetheless faced severe competition at the export frontiers. Yet it was not market competition that stimulated the industry to grow strong enough to venture into the world market. Rather, an environment was provided in which the creativity and responsibility of the private sector could be maximized. Neither World Bank economists nor Korean economists correctly evaluated the problem and the possibilities; thus they provided unrealistic policy recommendations. What if the government had taken their advice to an extreme and intervened further to prevent the "waste" of investment resources in the "hopeless" automobile assembly lines? Another example of restructuring can be found in the production of heavy equipment for thermal power generation--one of those industries cited for exces- sive scale and overly ambitious targets. Four companies were initially licensed, with each company's capacity far exceeding total domestic demand. One reason for the excessive capacity was that the government's energy policy unexpectedly switched emphasis from thermal to nuclear power generation. This change can be attributed to inconsistency in long-term planning and to the difficulties, in project evaluation, of forecasting demand and other relevant variables. At the time the World Bank was supplying a loan to one of the thermal projects; the major switch in energy policy was made right after the loan was approved. Restructuring merged the four companies into two. After several years of losses and difficulties, the break-even point was finally reached in 1986, mainly as a result of drastically improved domes- tic and international economic environments. The capacity utilization rate was as high as 90 percent, with a substantial portion of the products being sold in inter- national markets. The opportunity cost of that restructuring project, however, was enormous; precious capital was not used efficiently. One would be warranted in concluding that the heavy electrical machinery project was a success only because it eventually reached the break-even point or produced exportable products. Although both the automobile industry and the heavy machinery industry even- tually achieved success, it is clear that such outcomes do not justify the interven- tionist industrial policies that were followed. But neither do these outcomes refute the usefulness of government intervention in promoting industrial development. The science of economics always seeks to pursue the optimal path, but it is not easy to follow an unknown optimal path closely in designing economic development policies. To achieve a reasonably good performance, both intervention and market mechanisms must be used. World Bank economists, in concert with Korean tech- nocrats and economists working mostly at government research institutions, helped keep Korean government actions from going to extremes. During the drive for heavy industry and the chemical industry, however, the checking role appears to have been overdone; it was performed at a level that was too conservative. The restructuring process, on the other hand, showed a well-balanced harmony of KOREA AND THE WORLD BANK 41 intervention and free competition. During the restructuring period economists at Korean research institutions and at the Bank for the most part took a balanced position. Other Stmctural Policies and Macroeconomic Adjustment The effectiveness of interventionist industrial policies in a dynamic situation has been a controversial topic. In an uncertain world, it cannot be theoretically deter- mined; it is an empirical question. Most economists knew that not all the economic difficulties experienced in Korea in the late 19708 and the early 1980s were attributable to excessively interventionist policies, and when they looked at the many structural difficulties in heavy industry and the chemical industry, they tended to favor noninterventionist, market-determined resource allocation. As a result, the pendulum began to swing to tbe other side, and tbe government promoted liberalization in various fields. Within Korea, five government-owned commercial banks were privatized. Tbe government had used its bold on commercial banks to intervene deeply in the credit rationing of those banks in the 19708. Administrative price controls were reduced drastically. A new fair trade and antimonopoly law was enacted to prevent unfair business practices and collusion among firms. Korea's more important re- forms were enacted in the area of external transactions. Active liberalization of the domestic market under a preannounced schedule, including removal of tariff and nontariff protections, was promoted. At the same time, targeting of strategic in- dustries was discontinued. The industry-specific support system, which involved preferential interest rates, industry-oriented financial facilities, and industry- specific tax incentives, was phased out in the early 1980s. In other words, the government intentionally and voluntarily abandoned its cherished instruments for controlling the private sector. To cope with the current account deficit and the accumulating debt accom- panied by high inflation, the government formulated a drastic macroeconomic adjustment program. The strategy was straightforward and honest; it called for lower growth targets, depreciation, fiscal stringency, and a tight credit policy. ImpreSSively enough, the rate ofincrease in the money supply (M2) was reduced to about 15 percent in 1983, which was about 60 percent of the 1981-82 expansion?1 Taxes were raised and government expenditures were almost frozen, reducing the debt-to-GNP ratio drastically. The real exchange rate was raised substantially. As the most visible and important result of such adjustments, inflation as measured by the wholesale price index increase rate was abruptly reduced to 0.1 percent in 1983 and to -1.5 to 0.9 percent during the 1984-87 period. Balance of payments was rapidly stabilized. Thanks to the so-called three lows (low oil 3l. Bank of Korea, Economic Statistics Yearbook (1992), p. 3. 42 KOREA AND THE WORLD BANK prices, low interest rates, and a low yen-dollar rate) and the macroeconomic adjustment efforts in the early 1980s, the Korean economy recorded an extraordi- nary performance in the mid-1980s. These macroeconomic adjustments seemed more successful than the industrial restructuring of the early 1980s, although such comparison cannot be made on a scientific basis. But industrial restructuring and the well-conceived and superbly performed macroeconomic adjustment were mutually complementary and brought about the remarkable performance in the mid- and late 1980s. Regarding the macroeconomic adjustments of the 1980s, the World Bank was more or less an impressed onlooker rather than a contributing participant in policy discussions. Perhaps that was a result of the Bank's focus on microeconomic resource allocation issues. 32 Social Development Policy In the 1960s, the World Bank praised Korea for achieving equitable income distribution as well as high growth. It was not concerned about equity issues in Korea in the early stages of industrialization. The Bank was committed, however, to rural and agricultural development in Korea, and it provided substantial loans to be invested in projects in these sectors, especially during the 1970s. At the same time, the Korean government began to feel the need for rural development measures and launched the Saemaul campaign toward that end. Other social development policies also attracted the attention of policymakers; studies on major social de- velopment programs were pursued, and some programs were implemented in the 1970s. Although Significant resources were allocated to social development projects at that time, this fact was lost in the clamor over the drive for heavy industry and the chemical industry. On balance, the 1970s was a decade in which the drive for growth and efficiency resulted in rapidly worsening income distribu- tion, particularly during the second half of the decade. In the early 1980s the enhancement of equity and acceleration of social develop- ment were highly emphaSized policy goals. These goals were suggested as an antithesis to the previous regime's policy focus on high growth and effiCiency and paralleled the emphaSis on liberalization in the 1980s. As a gesture to emphaSize the social side of development, the official name of the five-year plans, beginning with the fifth plan (1982-86), was changed to "Economic and Social Development Plan" from "Economic Development Plan." Social development objectives were not pursued as effectively in the early 1980s as the government's rhetoric promised. The stabilization objective was more impor- tant, and the resultant stringent fiscal policy did not prOvide much room for the social development budget. During the second half of the 1980s the equity goals of 32. The World Bank and the Korea Development Institute carried out an ex-post research project on Korea's experience in structural adjustment. KOREA AND THE WORLD BANK 43 the government were emphasized more strongly, but again, largely because of financial constraints, they were not pursued aggressively. Income distribution, however, appeared to have improved in the 1980s mainly as a result of price stabilization.33 The World Bank also began to emphasize social development in Korea in the early 1980s. As shown in table 2-2, the Bank provided substantial loans for social' development projects, mostly during the 1980s. Other Dimensions of Cooperation Trained economists were scarce in Korea in the 19605. Government offIcials in charge of drafting economic policies did not have even the basic concepts of modern economics. Economists working at the u.s. Agency for International Development and on adviSOry missions in Korea were valuable sources of knowl- edge that was essential for economic policymaking and institutional reforms. In addition, the research department of the Bank of Korea was an important source of policy ideas and information, and the bank was heavily involved in formulating early long-term development plans. The establishment of the Korea Development Institute in 1971 was an impor- tant turning point in the number of economists in Korea. Numerous U.S.-trained economists, some of whom had been working at the World Bank, were brought to Korea. At a time when there was a shortage of economists, the various World Bank missions and Bank economists visiting Korea were valuable resources. KDI economists, having good connedions with the Bank, multiplied the usefulness of such Bank economists. At the same time, the training of domestic policy economists was sponsored by the Bank through its E<.-'Onomic Development Institute. Whereas USAID spon- sored rather formal training of Korean economists at American universities, the ED! program was oriented more toward development policy and short-term train- ing. Thanks to these programs and to the Korean government's programs to sup- port the training of offIcials abroad, the government had abundant foreign-trained economists in the late 1970s and the 19805. The number of economic professionals 33. See Hakchung Choo, "Income Distribution and Distributive Equity in Korea," paper presented at the USCDIKDI Joint Symposium on Micro-Social Issues in South Korea, La Jolla, Calif., June 26-27, 1992. There has been some controversy regarding the reliability of the official income distribution statistics, which show a clear trend of improving distribution in recent years. Soonwon Kwon, "Korea: Income and Wealth Distribution and Government Initiatives to Reduce Disparities," Korea Development Institute Working Paper 9008 (June 1990); and D. Kim and K. S. AIm, Korea's Income Distribution, Its Determinants and People's Consciousness about [the} Distribution Problem (Seoul: Jungang UniverSity Press, 1987), among others, using different data sets or different assumptions, show a worsening trend of income distribution. I chose to rely on the official statistics. 44 KOREA AND THE WORLD BANK outside the government also skyrocketed during the 1980s. In the early 1980s, the KDI even began providing training programs for policymakers in other developing countries; some of the programs have been presented in conjunction with the Bank's EDL It is not easy to identify the effects on Korean economic development of the Bank's training programs. However, the short-term, policy-oriented EDI program was especially appropriate for Korean officials in that it provided practical knowl- edge and opportunities to develop personal connections with the Bank staff and officials from other countries. Such opportunities enabled middle-level Korean government officials to gain international perspectives. Many of the middle-level officials trained by EDI were promoted to ministerial rank or hecame preSidential secretaries in various fields. Factors in Korea's Success Korea is one of the most successful among those countries that have benefited from World Bank support. Korea is widely considered a.<; a role model by many developing countries and was treated as such in development economics textbooks that were published in the 1970s or 1980s. Learning missions from eommunist and socialist countries seeking economic reform and development swarmed into Seoul. What has made Korea such an outstanding sllccess among so many member countries of the World Bank? To begin with, Korean government leaders in the 1960s and 1970s had a strong and, in a sense, Single-minded desire for national economic enhancement. They did not, however, have any idea how to achieve that goal, at least in the earlier stages of development. Korea's strong demand for advice on economic develop- ment policy created a close and smooth relationship between Korean officials and Bank economists; tbus the advice of Bank missions was highly regarded and well taken. At the same time, because of that intimate relationship, the real problems of the Korean government, which were not easily captured by analyses of published statistics or expressed in formal interviews, could easily be transmitted to the Bank's analysts. Yet it is important to note that Korean leaders did not take the advice of the Bank's economists blindly. They digested that advice and used it in modifYing and developing their own policies. A country must establish its own well-defined goals and a basic system to pursue and manage them, regardless of the availability of capable policy consultants. The Confucian culture and tradition of Korean society was the most critical factor in formulating and bringing about the success of the Korean approach to economic development. Centralization of power and decisionmaking in almost all organizations, from the national level to the household level, has been a natural phenomenon in that culture. Without the Confucian culture's respect for seniors KOREA AND THE WORLD BANK 45 and for authority, the two dictatorial regimes that governed Korea for almost three decades-decades during which the Korean economy witnessed its miracles- could have survived only at a much higher social cost and through cruel and systematic oppression. The Confucian culture also explains much of the Korean's drive for higher education. Moreover, the Confucian philosophy is relatively mundane in that it values worldly achievement in a way that religions more oriented to life after death do not, with a possible exception of Protestantism. Therefore hard work, accumula- tion of wealth, and pursuit of status are a natural and commendable pattern of Korean life. Yet Korea's Confucian tradition has elements that have been detrimental to economic development. It has valued empty formalities too much. It has respected scholars, government officials, and other professionals but despised those in manu- facturing and commerce.34 However, that part of the tradition was conSiderably weakened during the period of drastic social changes in the 1940s and the 1950s. With the traditional strncture of social status thus radically broken, wealth became the new standard of status, and the pursuit of it became more attractive. Personal factors were also important in determining the course of Korea's modem economic history. President Park's influence on Korea's industrialization was especially critical. Park was a humble man with outstanding leadership abilities; he was very smart and austere. His aspirations for economic development and the buildup of national power were exceptional. His stem personality and tight control of the information network kept the dictatorial regime relatively un- corrupted. With its extremely centralized power structure, the government had relatively few restrictions in chOOSing among various policy alternatives. It was rarely forced to adopt a populist policy that might conflict with goals of efficiency. In the early 1970s, however, Park had to take various pacifYing measures to gain support for the extension of his preSidency, which would have been impossible under normal Korean procedures. In particular, a substantial amount of public money was spent on the development of rural areas, the locus of the regime's main support. Such policies, however, were not totally out of line with the pursuit of the economic development of the nation. Thus the Korean economic policy wa~ not seriously distracted from its long-term development goals. This is not to say that the regime was indifferent to political popularity. With neither strong support from the people nor legal orthodoxy, it could not have remained in power for an e:Xi:ended time. Park's strategy to gain support was to achieve successful economic development; higb economic growth became his 34. For an interesting discussion of the relationship between religiOUS background and entrepreneurship in Korea, see Leroy P. Jones and I. Sakong, Government, Business, and Entrepreneurship in Economic Development: The Korean Case (Harvard University Press, 1980), pp. 221-23. 46 KOREA AND THE WORLD BANK trademark The World Bank played a critical role in this achievement, praising Korea's success. Such recognition from the Bank-the world's most authoritative international development organization-positively influenced Korea's international relations, but was even more important domestically. It provided a powerful and persuasive justification to the Korean public for the existence of a dictatorial government devoted to economic development. Park's exceptional aspiration for development and his humble personality, together with the domestic political advantage of World Bank recognition, contributed Critically to the development of a special relationship between the Korean government and the World Bank During his regime. Park was the source of all power in Korea, and high-ranking government officials and major business leaders were attentive to even minor movements in the Blue House, the official residence of the preSident. But it was not only the leadership that was effective in pursuing economic growth; the government's staff was able and efficient, and Korea's bureaucracy was orderly and powerful. In general, junior staff members were obedient to their superiors-as a result of the Confucian tradition. Reinforced by the military influence in govern- ment organizations, a submissive supervisor-subordinate relationship was almost absolute. In such a system, once a decision was made at the top, implementation could be accomplished efficiently. Both the Confucian tradition and the civil service examination system ensured that only persons of the best quality could get government jobs. Such officials were highly motivated, hard working, and fast learning. During the high-growth decades, government officials in the major policymaking ministries worked espe- cially hard. Ambitious young officials were eager to absorb advanced knowledge in their speCialized fields, to master English, and to acquire academic degrees, all of which not only improved the quality of their analytical work but also enabled them to communicate smoothly with foreigners, including the members of the World Bank staff. Contributing to such learning and communication were the profeSSional U.S. economists at the Korea Development Institute as well as various overseas training programs for government officials, including those conducted by the Bank's Economic Development Institute. At an early stage of modem Korea's development, the government created a powerful ministry, the Economic Planning Board, which would take the respon- sibihty for drafting eeonomic development plans and related poliCies, managing the macroeconomy, allocating the government's budget among various projects and programs, and resolving possible conflicts among ministries. With its concentrated power and infonnation, this ministry, headed by the deputy prime minister, managed the development of the Korean economy effectively. Generally the offi- cials working for the Board possessed the best intellectual ability, training, and motivation. The Board was directly supported by the research efforts of the KDI, whose staff included some thirty to forty full-time professional economists specializing in various policy fields. The Board was the counterpart of the World Bank in KOREA AND THE WORLD BANK 47 Kore,m-World Bank relations. The structure of the bureaucracy was thus oriented toward economic development and allowed the government to focus on economic policy issues. Another sourc-'e of the power of the administration was the high degree of com- pliance by the people with government policy. Such a behavioral pattern can be partly explained by the Confucian tradition. A public accustomed to oppressive regimes could account, in part, for the extended existence of the Park administration. A powerful and efficient administration that designed and implemented development policies effec- tively was an essential complement to a leader devoted to eo:mornic development. It should also be said that the Park regime was relatively little tainted by economic corruption. The regime was not particularly of very high moral standard, nor was everybody in the power circle honest and clean. Dictatorship itself can be regarded as immoral. And in general, to maintain a dictatorial regime for a pro- longed period, a ruling group often resorts to inappropriate actions. But in terms of material well-being, President Park was strict with himself and his family. More- over, a wide range of societal leaders was closely watched by well-organized and even threatening intelligence networks. Foreign exchange was especially tightly controlled. Investment funds, and in particular capital borrowed from abroad, rarely leaked out of the system. Money borrowed from the World Bank in conjunc- tion with specific projects was espeCially well managed and honestly invested, in part because the Korean officials were well aware that maintaining credible rela- tions with the Bank was essential to securing its continued support. During Korea's industrialization and rapid economic growth, the most Critically binding factor was the continuing flow of foreign capital. It was the World Bank that took care of the bottlenecks by directly lending to Korea and by endorSing the economy in international capital markets. At the same time, the Bank helped Korean officials to develop and implement sound and efficient development policies. Sometimes the Bank's economic policy advice was general, but in most cases it was specific and pertincnt. Valuable materials and advice provided by the Bank, such as foreign capital and policy ideas, were efficiently and honestly used by Korean political leaders, tech- nocrats, and civil servants. But most critical to the remarkably successful develop- ment of the Korean economy was the special and mutually trusting character of the relationship that developed between the Korean government and the World Bank. Korea now has started the process of transforming itself from being a taker into being a giver. The process cannot be rapid, but the direction cannot be rev'ersea. Korean public sentiment for repaying the benefit received from richer friends during the hard days, by helping other countries now in difficult situations, is rapidly spreading. Private campaigns to help starving people in Africa and South Asia are harvcsting great success. Although the amount is small, government aid money has been included in the budget. Currently Korea faces some balance-of- payment difficulties, but it will probably join the givers shortly. THREE Five Decades of Relations between the World Bank and Mexico Carlos M. Urzua FORTY-FOUR countries from Latin America and the Caribbean were represented at Bretton Woods in July 1944. Yet, while they constituted a near majority, these countries came away with less than .5 percent of total subSCriptions in the new International Bank for Reconstruction and Development (IBRD). Aside from the obvious fact that the rich donors wanted to have control, the meager quota can also be explained by the decision to link capital shares in the IBRD to members' quotas in the International Monetary Fund (1M F). This ruling, opposed by the Latin American countries, was an attempt to ensure that all countries accepted that their liabilities to the IBRD should be proportionate to their assets in the IMF. Of course, the Latin American representatives were fully aware that their economies were then marginal at best. They also knew that the IBRD was initially I am thankful to the many individuals who contributed to making this a better chapter: in Mexico City, former Mexican preSidents Luis Echeverria, Jose L6pez Portillo, and Miguel de la Madrid, together with FrancisL'O Suarez Davila, and several other persons who wish to remain anonymous; in Washington, Gal)' Gordon, Karin Lissakers, John Williamson, and eighteen World Bank staff members; and in Oxford, Ngaire Woods. I am also grateful to Gladstone Bonnick and coworkers at the Operations Evaluation Department of the World Bank for sharing with me their outstanding work on World Bank-Mexico relations. John Lewis's incisive criticism of an earlier version of this chapter was quite helpful. I also very much appreciate the help given to me by Richard Webb during the entire project, together with his sharp and extensive l'Omments on several versions of the chapter. Last but not least, I am most thankful to Devesh Kapur for quite valuable discussions on the Bank, for his extensive comments on this chapter, and for sharing ,vith me some of his work on the relations between Mexico and the World Bank during the mid-1980s. None of these in- dividuals is responsible for any errors, omissions, or misinterpretations made by me. 49 50 MEXICO AND THE WORLD BANK meant to aid the European economies ravaged by World War II. In any case, judging by the candid remembrances of some, the Latin Americans were simply exhilarated at the chance to participate at Bretton Woods, not to mention the opportunity of debating strategy with world-renowned economists such as Lionel Robbins, Joan Robinson, and John Maynard Keynes.! And debate they did. Mexico, for instance, submitted to the IBRD committee at Bretton Woods (led by Keynes) an amendment to the Articles of Agreement that explicitly put the IBRD's dual tasks of reconstruction and development on the same footing. 2 1t was one of the few amendments accepted by Keynes. The modification of Article III reads: "The resources and the facilities of the Bank shall be used exclusively for the benefit of members with equitable consideration to projects for development and projects for reconstruction alike."3 Mexico also succeeded in persuading the delegates to accept silver as a possible medium to store foreign reserves (a dear point for Mexico, an important silver producer).4 Such relative success at the conference creating the World Bank, as the IBRD and its younger affiliates came to be known, has been mostly but not always maintained in the five decades since. Indeed, as of 1994, Mexico became the largest borrower in the history of the IBRD.5 (If other World Bank institutions are included, the largest borrower continues to be India.) In addition, the economic reforms undertaken by Mexico in the late 1980s and early 1990s were used by the Bank as a model for the rest of the developing world. Of course, Mexico fell from its pedestal during the disastrous peso crisis of 1994. In fact, the Bank has often misread Mexico. For instance, in a lecture given in 1961, almost at the end of his term as preSident of the World Bank, Eugene Black noted that Russia, Mexico, and Japan (in that order!) "have yet to achieve high consump- tion economies, but could conceivably achieve them in the foreseeable future."6 l. See, for the case of Mexico, Daniel Cosio Villegas, Merrwrias (Mexico City: Joaquin Mortiz, 1976), pp. 216--21; Eduardo Suarez, Comentarios y recuerdos, 1926-1946 (Mexico City: Editorial Pomia, 1977), pp. 273-83; and Victor L. Urquidi, "Bretton Woods: Un recorrido por el primer cincuentenario," Comercio Exterior, vol. 44, no. 40 (October 1994), pp.83&-47. 2. Proceedings and Documents ofthe United Nations Monetary and Financial Conference (Bretton Woods, New Hampshire: 1944), vol. II, document 306. See also Urquidi, "Bretton Woods," for a detailed account of this amendment. 3. International Bank for Reconstruction and Development, Articles of Agreement (Washington: World Bank, 1991), p. 5. 4. Suarez, Comentarios y recuerdos, p. 28l. 5. See World Bank, Annual Report, 1994 (Washington: World Bank, 1994), appendix 6. Since the Bank calculates its cumulative lending without correcting for the loss in the value of the dollar over the years, and hence biases the ranking toward the most recent heavy borrowers, this claim is questionable. 6. Eugene R. Black, The Diplomacy of Economic Development (Cambridge: Harvard University Press, 1960), p. 2. MEXICO AND THE WORLD BANK 51 It is my purpose to review the more than five decades of relations between Mexico and the World Bank with a critical eye, paying close attention to the peaks and troughs in the relationship. I should note, in passing, that the interested reader may supplement the reading of this chapter with the excellent survey of this topic made by the Bank's own staff.1 The present work complements that survey by covering a wider period and providing a different perspective. The chapter does not cover each decade equally. In particular, since the heyday of the relationship can be traced back only to the late 1980s, almost half of the chapter is dedicated to a rcview of the post-1988 period, which begins with the Salinas administration. Furthermore, a long section is dedicated to the economic crisis that erupted in December 1994. Also, this chapter is ordered according to different Mexican presidential regimes, rather than World Bank presidential periods. Since Mexico still has what could be described as an autocratic political regime, the Mexican president in office at the time necessarily set the tone, overtly or not, for relations with the Bank. For readers unfamiliar with Mexico, it is worth remembering that embarrassing domestic facts are often better explained in the words of an outsider. The economist Angus Maddison correctly and succinctly described the Mexican politi- cal system as follows: Enormous power is conc'Cntrated in the preSidency. . . . The president can veto any legislation, and the veto cannot be overridden. This concentration of power is limited by a regular six-year alternation and ineligibility for reelection .... There are no overt checks and balances in this system, and the legislature has no control over budgetary policy. The party and the presidency also wield mnsiderable power of patronagc ....8 The First Two Decades When the World Bank and the International Monetary Fund effectively got under way in the summer of 1946, Mexico was set to start a new paradigm for development. Its import substitution strategy would prove to be quite successful over the next quarter-century in terms of both high rates of growth and intensive industrialization. Since that economic paradigm did not clash "vith the basic tenets then held by the Bank, the relationship was acceptably good for the first two decades. After all, 7. World Bank, OED Study of Bank/Mexico Relations, 1948-1992, Report No. 12923 (World Bank, April 1994). Readers in Spanish can also benefit from the work of Francisco Suarez Davila, "La politka financiera internacional de Mexim: Relaciones con el Banco Mundial y el FMI," Comercio Exterior, vol. 44, no. 40 (October 1994), pp. 853-64. 8. Angus Maddison and Associates, The Political Economy of Poverty, Equity and Growth: Brazil and Mexico (New York: Oxford University Press, 1992), p. 115. 52 MEXICO AND THE WORLD BANK it was in all respects a marriage of convenience. On the one hand, Mexico in 1946 fmally concluded a series of defaults and debt rescheduling agreements with foreign creditors---episodes that had been recurring since the Great Depression. 9 Consequently, Mexico was keenly aware of the fact that it would not have access to private capital markets for a while, and that all foreign credit would have to come from official sources (more than fifteen years had to pass before Mexico was able to sell bonds again to private foreign investors). On the other hand, during its first two decades of existence the World Bank directed most of its energies to lending for infrastructure, and Mexico, as a large country growing rapidly in the first phase of industrialization, was fertile ground for such aid. The Urgency for Industrialization Using the traditional taxonomy in Mexican economic history, the administration of Miguel Aleman (1946-52) constituted the last part of the so-called inflationary development period, characterized by high rates of growth and high Variability of the inflation rate.lO This era is typically traced back to the administration of Lazaro Cardenas (1934-40) and continued during that of Manuel Avila Camacho (1940- 46). Yet it seems slightly odd to lump together those three administrations on the basis of two indicators only, growth and inflation. For one, the conservative Aleman administration contrasted sharply from an ideological point of view with the Cardenas administration. While Cardenas nation- alized the oil industry in 1938, Aleman tried to attract foreign investment to the manufacturing sector; while Cardenas engaged in a massive land redistribution, the last economic reform truly descendant of the Mexican Revolution (1910-20), Aleman tacitly sided with the rich landowners who remained after the agrarian reform. The Aleman administration also contrasted, albeit more subtly, with the Avila Camacho administration. Although both came from the more conservative end of the political spectrum, Avila Camacho's economic policies were mostly a response to the turbulence of World War II. During his term, the increase in the domestic production of manufactured goods, accompanied hy a hefty increase in agricultural exports, mostly occurred because a world production gap had heen caused by the drop in the manufacturing of nonwar goods by the industrialized countries. Even the raising of tariffs during the period seems to have been adopted more for fiscal reasons, as an expeditious way to increase tax revenue, than for industry protection. 9. See Jan Bazant, lIistoria de la deuda exterior de Mexico, 1823-1946 (Mexim City: EI Colegio de Mexico, 19(8). 10. A general reference on this period is Enrique Cardenas, La hacienda pUblica y la politica economica, 1929-1958 (Mexico City: EI Colegio de Mexico and Fondo de Cultura Emnomica, 1994). For a mncise reference in English see Maddison, The Political Economy of Poverty, Equity and Growth. MEXICO AND THE WORLD BANK 53 Under Aleman, however, the new economic paradigm of inward development was fully assumed and forcefully pursued. In a way, it was natural to follow that strategy, given the abrupt changes the economy endured during the first years of his administration. After the war ended, the flow of foreign manufactured goods to Mexico increased sharply, not only because the industrialized countries switched out of war production but also because the Mexican economy was growing and the fixed exchange rate was becoming increasingly overvalued. As a consequence, from mid-1947 to mid-1948 the Aleman administration had to impose a series of quotas and tariffincreases. Furthermore, in 1947, the Mexican central bank, Banco de Mexico, had to request for the first time an exchange transaction of $22.5 million with the IMF to support the Mexican peso. Mexico also received some help from a stabili7.ation agreement with the U.S. Treasury. Nevertheless, all those measures were unable to stem the deterioration of the current account, and in July 1948 the peso had to be devalued. The devaluation in itself was not surprising; after all, Argentina, Colombia, France, Spain, and Uru- guay had to devalue their currencies in the same year. What surprised (and irked) the IMF was that Mexico let the peso freely fluctuate for almost a year, from July 1948, when the parity was at 4.85 pesos per dollar, to June 1949, when the parity was finally set at 8.65, a move in plain violation of the fixed exchange rate regime advocated worldwide in those years. As a response, the IMF rejected a petition in May 1948 for a second exchange transaction. II Another source of friction, with both the IMF and the U.S. Treasury, was that the new parity set by Banco de Mexico was substantially lower than the ten pesos per dollar that the two institutions were suggesting to Mexico. This devaluation episode, incidentally, marked the first time in which the U.S. Treasury-IMF duo (the Bad and the Ugly, as some Mexicans think) jointly participated (or colluded) in a Mexican crisis. The same behavior has been repeated since. In the short term, the devaluation had positive effects: In 1950, the rate of real GDP grov.1h reached 9.9 percent, the inflation rate was kept at 6.7 percent, and the current account deficit turned into a healthy surplus. GrO\vth continued to be healthy until the end of the Aleman administration, but the relatively high inflation that the country had to endure in 1951-52 had already consumed most of the comparative advantage of the peso when a new administration arrived at the end of 1952. Interestingly, the Mexican devaluation episode prompted Jacques Polak, at the IMF, to write the paper "Depreciation to Meet a Situation of Over-Investment" that would become the first in a series of IMF studies on the absorption approach to balance of payments adjustment. In that unpublished paper, dated September 1948, Polak wanted to show that "devaluation cannot be effective in correcting a large and persistent balance of payments deficit that is the result of overinvest- 11. J. K. Horsefield, The International Monetary FUM, 194.5-1965 (IMF, 1969), p. 228. 54 MEXICO AND THE WORLD BANK ment."12 Perhaps in response to that warning, the Mexican government not only devalued, but also turned a fiscal deficit in 1948 into a surplus over the next three years. THE FIRST IBRD LOAN TO MEXICO. It was in this economic environment that the first World Bank loan to Mexico was made in January 1949. The loan, for electric power development, was contracted by the Comisi6n Federal de Electrici- dad (CFE), a public utility founded by the state in 1937. It is noteworthy that electric power loans were to constitute the vast majority of the Bank's loans to Mexico for the next decade, with the exceptions of a loan for railway development, to be reviewed later, and a failed loan made in 1950 for the private industrial sector (of which only 5 percent was ever disbursed). Consequently, until 1972 electric power loans accounted for more than 50 percent of the Bank's total exposure in Mexico; at that point, disputes between the Bank and Mexico on electric tariffs made the Bank cease its lending to that sector for more than a decade. ECONOMIC ASSESSMENTS OF MEXICO BY THE BANK. Although the World Bank wrote an economic report on Mexico as early as August 1948, the first serious attempt by the Bank to evaluate the Mexican economy was made in February 1951 at the petition of Nacional Financiera (NAFIN), the main state development bank of Mexico. 13 As a result, a Combined Working Party of four economists from Mexico (Raul Ortiz Mena and Victor L. UrqUidi) and the World Bank (Albert Waterston and Jonas H. Haralz) was convened to report on the long-term prospects of the economy. The wording "Combined Working Party" was carefully chosen, since the Mexican government did not want to convey the impression that it was mostly a report by the Bank, even though Baralz and Waterston were indeed the main contributors. The report, published two years later, concluded both that Mexico was ready to absorb foreign loans and that there was a need for fiscal caution. Furthermore, the report was mildly enthusiastic about Mexico's import substitution strategy: "There is no doubt that tariffs have stimulated some branches of industry.... [Import restrictions] had important effects in promoting industrial development."14 This last point was in line with the import substitution strategy given academic credence by Raul Prebisch at the United Nations' Economic Commission for Latin America (ECLA). His work, which was fervently received across Latin America, justified import substitution and a drive for industrialization by claiming that developing countries faced deteriorating barter terms of trade-that is, the price of primary 12. See Margaret Garritsen de Vries, Balance of Payments Adjustment, 1945 to 1986: The IMF Experience (Washington: International Monetary Fund, 1987), p. 18. 13. Until the end of the 1980s the name of this development bank was lengthier: Nacional Financiera S. A. (NAFINSA). To avoid confusion, I always use the current, shorter name. 14. The Economic Development of Mexico: Report of the Combined Mexican Working Party (Baltimore: Johns Hopkins University Press, 1953), p. 80. MEXICO AND THE WORLD BAKK 55 products exported by developing countries was falling over time relative to the price of the manufactures produced in the industrialized world. l5 It is worth stressing that the report by the Combined Working Party was the best economic study ever made of a Latin American country until that point. In par- ticular, its detailed statistical analysis was so broad that it included estimates for capital-output ratios. At that time, the use of sucb indicators was uncommon in economic studies of developed countries. Toward a More Stable Path ofCrowth The Adolfo Ruiz Cortines administration (1952-58) brought a new stage of high growth coupled with abating inflation. This is apparent in table 3-1, which presents the main economic indicators of the past eight Mexican administra- tions, a period that overlaps with the Bank's own existence. Incidentally, as the table shows, annual World Bank commitments to Mexico during the Ruiz Cortines administration averaged a meager 0.2 percent of CDP, the lowest level of the postwar era. The economic successes of the era were not easily obtained, however. As noted earlier, the exchange rate adjustment of 1949 turned out to be inadequate by mid-1951, and by mid-1952 Mexico was suffering from a problem that would become endemic later: capital flight. The speculation against the peso continued intermittently until April 1954, when the central bank devalued the currency without warning and without consulting the 1MF. A chagrined IMF was left to note in its next Annual Report that: "On the proposal of the Government of Mexico, in which the Fund [sic] concurred, the par value of the Mexican peso was changed on April 19, 1954 from 8.65 pesos to 12.50 pesos per U.S. dollar."l6 After the devalua- tion, Mexico once again requested help from the "duo"; an IMF standby arrange- ment for $50 million (only $22.5 million was drawn) and a currency support agreement with the U.S. Treasury. The 1954 devaluation turned out to be highly controversial among Mexican economists. On one side, analysts believed it would "undennine confidence in the future stability of the peso."l7 On the other, which included the majority, the 15. See Raul Prebisch, The Economic Development of Latin America and Its Principal Problems (New York: United Nations ECLA, 1950). An independent study along the same lines was also undertaken by Hans W. Singer, 'The Distribution of Gains between Investing and Borrowing Countries," American Economic Review, vol. 40 (May 1950), pp. 473-85. A recent appraisal of the Prebisch-Singer hypothesis is given in John T. Cuddington and Carlos M. Urzua, "Trends and Cycles in the Net Barter Terms of Trade: A New Approach," Economic Journal, vol. 99 (June 1989), pp. 426-42. 16. International Monetary Fund, Annual Report, 1954 (Washington: International Monetary Fund, 1954), p. 84. 17. Dwight S. Brothers and Leopoldo Solis M., Mexican Financial Development (Austin: University of Texas Press, 1966), p. 86. Table 3-l. Performance of the Mexican Economy, 1946-94 Average annual percent changes, unless otheIWise noted Real Cross Current Public Percentage World Bank Real CDP Inflation wages national Public sector account foreign of po or commitments/ growth" rateb growth C savings/GDpd deficit/CDr deficit/CDpf debt/CDp6 peopl~ CDpi Aleman 5.8 9.6 6.0 11.8 -0.1 -1.6 8.5 n.a. 0.4 (1946--52) Ruiz Cortines 6.4 6.7 1.7 15.8 -0.7 -2.9 6.5 n.a. 0.2 (1952-58) L6pez Mateos 6.4 2.2 10.0 16.5 -0.8 -2.3 7.7 77.5 0.3 (1958-64) DiazOrdaz 6.2 3.6 5.2 19.0 -1.9 -2.6 11.5 72.6 0.3 (1964--70) Echeverria 6.0 15.2 4.1 18.9 -6.4 -3.7 15.7 58.0 0.4 (1970-76) L6pez Portillo 6.6 35.7 -3.8 21.7 -9.7 -5.1 34.2 48.5 0.5 (1976--82) De la Madrid 0.2 86.7 -8.6 21.5 -11.9 1.7 67.1 58.5 1.0 (1982-88) Salinas (1988-94) 3.0 15.9 -4.3 17.7 -2.8 -5.6 30.7 66.0 0.7 Sources: See notes below. a. Growth of real GDP is given in 1980 pesos. For 1947--59, the mte is estimated using data in Banco de Mexico, Indicadores ec6nomicos, various editions. For 196G-94, the source is INEGI, Banco de datos. b. For 1947-B9, the rate is based on a wholesale price index for Mexico City, and for 1970-94 on the national consumer price index. The source is Banco de Mexico, Indicadores econ6micos. c. Growth of the general minimum wage (national average) is deflated by the price index described in note b. The source for the minimum wage is Comision N acional de los Salarios Minimos. d. Gross domestic savings minus net transfers from abroad were estimated by the author. For 1947-79, the source is Banco de Mexico, Indicadores econ6micos, and for 198G-93 INEGI, Banco de datos. e. For 1947--52, the estimated proportion is based on INEGI, Estadisticas hist6ricas de Mexico (Aquascalientes, Mexico: INEGI, 1990). For 1953-85, the data are from Pedro Aspe, Economic Transformation: The Mexican Way (Cambridge, Mass.: MIT Press, 1993), table 2.3. For 1986--94 the source is Secretaria de Hacienda y Credito Publico, Estadisticas de Jinanzas publicas, several issues. The figures do not include the revenue from privatizations, and all include the deficit of financial intermediaries. f. Figures for 1947-49 are based on The Economic Development of Mexico: Report of the Combined Mexican Working Party (Baltimore: Johns Hopkins University Press, 1953), table 122. For 195G-94 the source is Banco de Mexico, Indicadores econ6micos. The conversion from dollars to pesos was made by the author using the end-of-the-period exchange rate. g. The first figure is based on the estimate for 1951 given in The Economic Developrrwnt of Mexico, table 151. For 1953-64 the source is Nacional Financiera, Informe anual. For 1965-94 the figures for total long-term public debt are from Secretaria de Hacienda y Credito Publico. The conversion from dollars to pesos was made using the end-of-the period exchange rate. h. Poor and extremely poor individuals are estimated for years 1963, 1968, 1977 (imputed due to lack of data for the Echeverria period), 1981, 1984, and 1992. The first five figures are taken from Enrique Hernandez Laos, Crecimento econ6mico y pobreza en Mexico (Mexico City: UNAM, 1992), table 3.2. The last estimate is due to julio Boltvinik (personal communication). i. Average of annual commitments as percentage of GDP is given (after converting the commitments to pesos using the end-of-the-period exchange rate). The source is World Bank, data bank. n.a. Not available. MEXICO AND THE WORLD BANK 57 devaluation was viewed as a success: after a typical J-curve effect that worsened the trade balance in 1954, the current account balance was restored the next year. Furthermore, GDP growth rates were very high during the first three years after the devaluation (10 percent, 8.5 percent, and 6.8 percent), and there was only a short-lived increase in inflation during 1955. As noted in later sections, the mechanics of this devaluation, engineered by the then director of Banco de Mexico, Rodrigo Gomez, differ sharply from how devaluations were orchestrated in the later decades. Part of its success was due to the care taken by the government in supplementing the devaluation with other measures: (i) the control of money aggregates, (ii) a comprehensive law for import licenSing and fiscal subsidies in the case of imported capital goods, and (iii) an increase in export taxcs to capture part of the exporters' windfall, which would bolster the government's fiscal position. A LOAN FOR RAILWAY TRANSPORTATION. Four months after the devalua- tion, the World Bank lent Mexico $61 million, the largest project investment loan ever made by the Bank to that point. (During the next three years, Mexico did not receive any new loans.) The money was loaned to Ferrocarril Sud- Pacffico for railway transportation development. Interestingly, the loan agree- ment stated that "the labor force should be reduced to and maintained at the minimum necessary for efficient operations."18 That clause notwithstanding, it actually took four decades before the government decided, in 1992, to substan- tially reduce the railway work force. And three years later, in 1995, when the government announced that the railways would be privatized, one of the most contentious points in the privatization process continued to be the size of the work force. MEXICO APPROACHES THE BANK FOR OIL FINANCING. After Cardenas nationalized the oil industry in 1938, oil exploration, production, and refining, together with the production of petrochemicals, were left to a Single state company: Petr61eos Mexicanos (PEMEX). PEMEX had lackluster production for several years after the nationalization: by the end of the Second World War, owing to a lack of foreign funds for much needed investment, as well as limited local knowledge, poor administration, and even boycotts by the major oil producers (the "seven sisters"), oil production dropped to less than one-fourth of the highest production level attained before nationalization. The Mexican government contributed to the difficulties by keeping domestic energy prices artificially low and imposing very high taxes on all PEMEX activities (not just oil exploration and production). These policies weakened PEMEX's finan- cial position to such a degree that, in most years, the state monopoly lacked money for new oil exploration. 18. Cited in World Bank, "Transport Sector," background paper in electronic form for the OED Study of Bank/Mexico Relations (Washington: World Bank, January 1993), pp. 21-22. 58 MEXICO AND THE WORLD BANK In 1943, when Mexico, like other Latin American countries, decided to support the Allies in the war (and a year after the indenmification process to U.S. oil companies for the 1938 expropriation), PEMEX was able to get from the U.S. Export-Import Bank (Eximbank) a $10 million credit for the construction of the Azcapotzalco oil refinery. In 1949, however, when the Mexican government re- quested a second oil credit from the Eximbank it got no response. Apparently, the U.S. State Department had vetoed the request on the grounds that the Mexican government could tap private U.S. capital for that purpose. 19 Whether the U.S. State Department's policy was concerned with a similar policy espoused by the World Bank is unclear. Wbat is known is that Mexican authorities approached the Bank in the mid-1950s looking for oil exploration loans. Months after the 1954 devaluation, President Black received a memo from J. Burke Knapp, who two years later became vice-president of the Bank, establishing that Antonio J. Bermudez, then the managing director of PEMEX, had inqUired about the pos- sibility of Bank financing for oil exploration in Mexico.20 Black replied that "he thought that the sector was more appropriate for development by the private sector and declined to hold out any hope for Bank support for Mexico's industry, it being in the public sector and a monopoly at that."21 At the time almost all Bank lending to Mexico had gone to a state electric utility, which was also a monopoly, the CFE. Until the mid-1970s, the Bank as a matter of policy did not lend for oil and gas exploration and development. In retrospect, that episode represented a missed opportunity not only for Mexi- co but also for the Bank and the United States. For the former, it would have opened a big new market for the Bank's loans worldwide and the Bank would have been able to monitor PEMEX finances, a sore point with the Mexican government for many years to come. The United States lost because it failed to support more oil production in the Americas, a shortSightedness that ended up being costly after the Organization of Petroleum Exporting COlmtries (OPEC) embargo in the 1970s. The First Half of the "Stabilizing Development" Period It may sound paradoxieal to some readers that, for the entire twentieth century, the best performance of the Mexican economy was attained under the decidedly interventionist government of Adolfo L6pez Mateos (1958-64). As can be ap- preciated from table 3-1, during his six-year term the average annual rate of real GDP growth was 6.4 percent, the average inflation rate was just 2.2 percent, and real wages rose at an annual average of 10 percent a yearl No wonder that the 19. Antonio J. Bermudez, Doce afios al servicio de In industrfu petrolera mexicana, 1947-1958 (Naucalpan de Juarez, Mexico: Comaval), pp. 254-60. 20. Carlos M. Urzua, interview with Gladstone Bonnick, November 11,1994. 21. World Bank OED Study of Bank/Mexico Relntions, p. 34. MEXICO AND THE WORLD BANK 59 period 1958-70 was christened, before a World Bank-IMF audience, as one of "stabilizing development" (desarrollo estabilizador) by one of its architects, Finance Minister Antonio Ortiz Mena. 22 The L6pez Mateos administration enacted several policies that go against cur- rent orthodoxy. The government intervened in most nonmanufacturing sectors; there were widespread price controls; real minimum wages kept increasing; a very high level of nontariff protection prevailed (four out of five imports required a license); and some key industries were nationalized. Although the United States was not particularly happy vvith L6pez Mateos's nationalization policies, Mexico in those years was hardly a major worry; in January 1959, Cuba saw a communist revolution. In response, the United States hurriedly announced in Augnst of that year its support for a pan-American regional bank-an idea that had been repeatedly urged throughout the Americas since the end of the nineteenth century. Mexico, for instance, had proposed a continental quasi--central bank in the 1930s. 23 As a result of the U.S. proposal, the Inter-American Develop- ment Bank (IDB) was offiCially created in October 1960. Kennedy'S Alliance for Progress came onto the scene thc next year. The creation of the IDB as well as the changed political context in Latin America and the Caribbean also spurred the World Bank to rethink its relationship with Mexico, as suggested by the sharp jump in annual lending commitments between 1955 and 1962: $0, $0, $0, $45 million, $0, $2.5 million, and $160.5 million (in successive fiscal years). Indeed, in the 1990s, competition from the IDB is of considerable concern to World Bank staff. A CLASH. At the end of the 1950s, the Bank started to pressure Mexico to realign public tariffs, especially electricity rates, which it blamed for the country's chronic (albeit small, see table 3-1) public deficits. The discussion reached its climax in Augnst 1959, in a meeting between Mexican President L6pez Mateos and World Bank President Black. The former resented a petition for electricity rate increases "which he saw as bringing undue pressure on Mexico for the purpose of advancing the interests of [a foreign] company since he understood that the Bank's policy would be to make no further loans to Mexico for any purpose until the rate issne was resolved:'24 An inerease in electricity tariffs was agreed only in 1961, a year after LOpez Mateos ordered the nationalization of the sector. NATIONALIZATION OF THE ELECTRICITY SECTOR. The Mexican govern- ment nationalized all privately owned electricity utilities (mostly U.S. and Canadian) in 22. Antonio Ortiz Mena, "Stabilizing Development: A Decade of Economic Stra.tegy in Mexico," paper presented at the 1969 annual meeting of the World Bank and the IMF. Published in Spanish as "Desarrollo estabilizador: Una decada de estrategia econ6mica en Mexico," Trimestre Econ6mico, vol. 37 (1970), pp. 417-50. 23. See Sidney Dell, The Inter-American Development Bank: A Study in Development Financing (New York: Pra.eger, 1972), p. 4. 24. World Bank, OED Study ofBanklMexico Relations, p. 93. 60 MEXICO AND THE WORLD BANK 1960. This nationalization lead to the CFE becoming the national power utility, except for a small public utility, Compania de Luz y Fuerza del Centro, which to the constant chagrin of the Bank, remains separate because the government has avoided a confrontation with its strong labor union. Interestingly, after the nationaliza- tion, not only was there no apparent effect on World Bank lending for electric power development but, as noted by an internal Bank document, the repeated request by the Bank for the integration of the power sector amounted, under the circumstances, "to a tacit support for the Government's nationalization policies."25 The Mexican incident, however, appears to be an exception to the Bank's implicit opposition in the case of other Latin American countries.26 THE FIRST LOAN FOR IRRIGATION. For many years, and for several reasons, the bulk of government spending on agriculture was allocated to irrigation. 27 Thus, it is no surprise that the first nonindustrial loan made by the Bank to Mexico, in 1961, was targeted to that end; fourteen others would follow over the next two decades. The majority of these irrigation investments were biased, however, toward the northern states and toward nonrepresentative farmers holding relatively large extensions of land. This selective lending behavior in the agricultural sector had dire consequences in the 19608. Irrigation, the draining of wetlands, and hydroelectriC dams were for many years three of the most preferred giant projects of the Mexican government. Since many of these ventures have adverse environmental impacts, one could then ask if the Bank blundered while collaborating with Mexico.28 The biggest blunder, however, actually came from the lOB when it financed, in the early 1960s, what would become an extreme example of bad planning: Plan Chontalpa. In 1961, the Mexican government, partially due to the ephemeral pan-American feelings of the times, proposed to the newly created lOB the financing of a project, in the southeastern state of Tabaseo, to make agriculturally productive several tens of thousand hectares of humid tropiealland. It took Mexico and the lOB five years to start the project, but when they did, they did so with zest: forty thousand hectares were deforested, with all the wood burned in situ, and five 25. World Bank, "Mexico, Power Sector," background paper in electronic form for the OED Study of Bank/Mexico Relations, p. 18. 26. As recounted by an influential Latin American historian, a few years after the Mexican nationalization the Bank appeared too protective regarding the interests of the U.S. company Electric Bond & Share in Guatemala (1966) and Colombia (1967), a company that, incidentally, had on its board of directors none other than Eugene Black (who had retired by then as the Bank's president). See Eduardo Galeano, Open Veins of Lntin America: Five Centuries ofthe Pillage ofa Continent, trans. Cedric Belfrage (New York: Monthly Review Press, 1973), pp. 256-57. 27. A general reference on this subject is Miguel Wiont'Zek, "The Roots of the Mexican Agricultural Crisis: Water Resources Development Policies (1920-1970),» Development and Change, vol. 13 (July 1982), pp. 365-99. 28. For a general reference on Mexican environmental poliCies, see Enrique Leff, Medio ambiente y desarrollo en Mexico (Mexico City: Unam and M. A. Porrua, 1990). MEXICO AND THE WORLD BANK 61 thousand families were relocated (with a little help from the army). All to no avail: the agricultural yields were so disappointing that two years later the land was used mostly for cattle raising. To be fair, there appears to be no blatant example of a similar lack of concern for the Mexican environment on the part of the World Bank; indeed there is evidence of a few cases where the Bank showed more respect for the environment than the Mexican government itself. In sum, the Bank's remark on the subject seems quite fair: Mexico and the Bank "were developing environmental awareness and exper- tise during the same period."29 To which one might add: "and at roughly the same pace." The End of the "Stabilizing DevelopTMnt" Period During the Diaz Ordaz administration (1964-70), the economy continued on its stabilizing development path (see table 3-1). As years passed, however, more and more Signals of the unsustainability of the strategy surfaced: a continuous deteri- oration of the current account; a decline of the agricultural sector; a slOwing down of labor productivity growth; and, finally, increasing political repreSSion by the government. An example of the latter was the killing of hundreds of students in October 1968, a crime known as the Matanza de Tlatelolco (Tlatelolco massacre). In retrospect, the most serious economic problem faced hy the Dfaz Ordaz government was the debacle in agriculture, which soon became a major, per- manent drag on tlle economy. During the L6pez Mateos administration, the gross product of the agricultural sector grew a healthy 33.5 percent in six years; during the Diaz Ordaz period, it only grew 6.1 percent. Many factors contributed to the decline-the increasing density of the rural population arising from a high popula- tion growth rate and an overvalued exchange rate that penalized agriculture and rewarded the urhan sector. But the lack of good planning in the sector should be singled out. By biasing lending and investment toward the rich, capital-intensive private lands in northern Mexico, leaving aside the majority of communal land (ejidos) where most of the rural population lived, the government (and implicitly the Bank) contributed to that decline. This pattern of investment should be con- trasted with the strategy so successful in countries like Japan and Taiwan, where "the pursuit of unimodal strategies for modernizing the small farm units progres- sively, by means of divisible, yield increasing innovations that are neutral to scale [achieved] widespread increases in rural incomes and well-being."30 Regarding World Bank financing to Mexico, the number and volume of the loans rose substantially during the Diaz Ordaz government. In 1970, the last year 29. World Bank, OED Study of BanklMexico &lations, p. 43. 30. Bruee F. Johnston, "The Design and Redesign of Strategies for AgriCultural Develop- ment: Mexico's Experienee Revisited," in Clark ,v. Reynolds and Carlos Tello, eds., U.S.-Mexico Relations: Economic and Social Aspeds (Palo Alto: Stanford University Press, 1983), p. 225. 62 MEXICO AND THE WORLD BANK of the administration, Mexico's share of total IBRD disbursements reached the staggering figure of 14.2 percent, a percentage surpassed only one other time (in 1990). Yet, most of the Bank projects simply perpetuated ones initiated by earlier Mexican administrations. The only outstanding difference was that the Bank was giving greater attention to the troubled agricultural sector. THE FIRST AGRICULTURAL CREDIT, Already in 1954, Banco de Mexico had created two agricultural trust funds, known jointly as Fideicomisos Instituidos en Relaci6n con la Agricultura (FIRA), with the purpose of promoting, under the aegis of the central bank, the agricultural sector. Until 1965, however, the funds managed by FIRA were relatively meager. In that year, the World Bank made its first loan for agricultural credit to Mexico. To manage this and subsequent loans by the Bank and the lOB, the central bank added a third trust fund, Fondo Especial de Financiamiento, to FIRA in 1965. Since then, FIRA has managed, with some success, the several billion dollars lent by the Bank and the lOB. In its agricultural credit lending, the Bank deliberately eschewed the channeling of funds through the government-mvned main rural bank, Banco Nacional de Credito Rural (BANRURAL), which was, and continues to be, quite inefficient in its operations. 31 By circumventing BANRURAL, however, the World Bank im- pliCitly contributed to the "bimodal" pattern of investment mentioned earlier: since FIRA loans were made through commercial banks, in contrast with BAN RURAL loans, which were lent directly, the World Bank loans were being distributed only among low-risk large private farmers. AN ICONOCLASTIC AGRICULTURAL SECTOR STUDY, Buried as an annex in the 1966 seven-volume Bank report on the Mexican economy is a remarkable study on the agricultural sector.32 The second part of it was made by Wolf Lade- jinsky, a noted expert on agrarian reforms (having worked on eountries as diverse as India, Japan, and Taiwan). Although the study was not publicly acknowledged by the Mexican government, it became an underground classic among government officials with an interest in the agricultural sector. Ladejinsky's work was full of recommendations to improve the productivity of the ejidatario (a member of an ejido). In one, he suggested that "the ejidatario should be given a status which, with freeing him completely to transfer the land as he wishes, would permit him to make various adjustments, including the transfer of his interest in a particular holding to other ejidatarios, thereby realizing the ac- crued value of his land.... "33 This recommendation coincides with one tenet of the land reform undertaken twenty-five years later. 31. World Bank, "Study of Relations behveen the World Bank and Mexico: The Agricul- tural Sector," background paper in electronic form for the OED Study of Bank/Mexico Relations, p. 8. 32. World Bank, Current Economic Position and Prospects of Mexico, vol. IV, annex VII (Washington: World Bank, 1966). 33. Ibid., pp. 94-95. MEXICO A:-iJD THE WORLD BANK 63 Relations between McNamara's Bank and Mexico As Robert McNamara was stepping into the World Bank presidency in 1968, Mexico was two years short of embarking on a new development paradigm that would stress the need for poverty alleviation and other social policies. This new paradigm roughly matched McNamara's own views. 34 Reading McNamara's famous 1973 Nairobi speech, when he asserted tbat at least half of the Bank's loans to agriculture should be targeted to rural poverty, one cannot help but notice its remarkable similarity to the views held by the Mexican government in the 1970s. Naturally, this ideolOgical concurrence helped to build up a better relationship between Mexico and the Bank The new, closer relationship also depended on the main actors during those years: Mc='Iamara and Mexican preSidents Luis Echeverria (1970-76) and Jose LOpez Portillo (1976-82). All of them had strong personalities, with a penchant for centralized decisionmaking, and personal relations between both sides were quite good. \-\Then I asked Echeverria about McNamara, he simply said "a first-rate person." LOpez Portillo described McN amara as "quite capable and objective, with an authentic social emotion," and then he added with a smile, "it was as if he were expiating some Vietnam sins."35 The relationship between the Bank and Mexico was also colored by economic conditions. A briefing paper to McNamara prepared for his 1969 visit to Mexico remarked: "there is little morc that we can expect to achieve in the way of institu- tion-building or influence over policy; ... the Mexicans naturally prefer the Bank's money to its advice; ... they can reasonably claim to have made a pretty good job of economic development." Consequently, the briefing paper noted, "Mexico is the last country in the world in which the overt exercise of leverage can be expected to pay Off."36 "Shared Development" Period "Shared development" was the name chosen by the Echeverria cabinet to distinguish their poliCies from those adopted during the "stabilizing development" period, since the high growth rates attained in the 1960s were thought to have had several adverse effects on poverty, income distribution, and the rural sector, as well as on political cohesion. Among all the policies it considered, the new administration made the need for increasing social expenditures a priority, paid for by a more progreSSive and effec- 34. See, for instance, Robert S. McNamara, Address to the University of Notre Dame (Washington, D.C.: IBRD, 1969). 35. Carlos M. Urzlia, interview with Luis Echeverria, February 16, 1995; and interview with Jose L6pez Portillo, February 28, 1995. 36. World Bank, OED Study afBank/Mexico Relations, pp. 48, 94. 64 MEXICO AND THE WORLD BANK tive tax system. Soon, however, the proposed tax reform ran into strong opposition from the private sector. 37 Consequently, in lieu of increases in government revenue, the administration ended up relying more heavily on foreign borrowing and budget deficits (see table 3-1). The key year in the Echeverria administration was 1973. In that year the conservative wing of the cabinet, represented by Finance Minister Hugo B. Mar- gain, lost the ideological battle over social expenditures and was considerably weakened. Furthermore, by 1973 it was evident that no sizable increases in tax revenues were forthcoming. As a result, in that year alone, the foreign public debt rose from $5 billion to $7 billion. Even that increase, however, was soon over- whelmed by the events of the remaining years of the Echeverria administration: from 1974 to 1976, foreign public debt almost tripled to $19.6 billion. In percent- age terms, the fivefold increase was much bigger than the increase to be registered during the L6pez Portillo administration (about threefold). World Bank financing to Mexico also greatly expanded during Echeverria's term: there were more Bank loans during those six years than during all past administrations put together. The average annual IBRD's share in Mexico's long- term debt reached almost 17 percent, while Mexico's average share in total IBRD loans was above 10 percent. This new, closer involvement by the Bank was already agreed upon when Echeverria met McNamara in 1972. In that meeting, Echeverria described a new rural development program, Programa de Caminos de Mano de Obra, just initiated by his administration. The highly labor-intensive program involved the construc- tion of local roads joining small towns (500-2,500 inhabitants) and became a great success among the participants (peasants from the same communities).38 According to Echeverria, McNamara was very enthusiastic about it, and, although the Bank never partiCipated in the project, both decided to focus a great deal of their future joint efforts on programs to address poverty and income inequality.39 As shown in the second to the last column of table 3-1, during the Echeverria administration, poverty, represented by the percentage of people unable to afford a given basket of goods, had its steepest decline. 40 How much of that was due to the Bank-Mexico effort would be difficult to assess; but the Bank projects over the 37. A review of tax reforms in Mexico, from 1970 to 1994, is given in Carlos M. Urzlia, "An Appraisal of Recent Tax Reforms in Mexico," forthcoming in Gary McMahon, Guillermo Peny, and John Whalley, eds., Tax Reform and Structural Change (London: Macmillan, 1995). 38. See the survey in Marielle P. L. Martinez, Los caminas de mana de ohra como facto res de cambia socioecon6mico, Cuademos del CES, No. 27 (Mexico City: El Colegio de Mexico, 1980). 39. Carlos M. Urzua, interview with Luis Echeverria, February 16,1995. 40. As is well known, the poverty statistics derived from income and expenditure surveys, as the ones in table 3-1, could be contaminated by potential measurement errors. See Nora Lustig and Ann Mitchell, "Poverty in Mexico: The Effects of Adjusting Survey Data for Under-Reporting," Estudios Econ6micos, vol. 10, no. 1 (January 1995), pp. 3-28. MEXICO AND THE WORLD BANK 65 period were interesting and diverse, as the next sections will show, and the most innovative relationship betwcen the Bank and Mexico was attaincd during those years. This was despite the fact that the financing consisted of old-fashioned sectoral loans, rather than the newer structural adjustment loans developed by the Bank. LOANS FOR RURAL DEVELOPMENT. To operationalize its new emphasis on rural poverty, the Mexican government launched a rural development program in 1973 known as Programa de Inversiones Pliblicas para el Desarrollo Rural, later known as Programa Integral para el Desarrollo RuralY The Bank jOined the program, which lasted a decade and cost more than $2 billion, contributing over $400 million in three loans (1975, 1977, and 1982). While all parties were initially satisfied with the program, the Bank later classified it as unsatisfactory because of cost overruns. The prinCipal goal of the program was to channel loans to poor rural areas for the financing of small investments at the community level ("microregions"), em- phasizing the decentralization of its administration. The government had already experimented with the direct participation of the beneficiaries in a program. The novelty this time was that Mexico joined forces with the World Bank, the ID B, and the International Fund for Agricultural Development (IFAD). This caused some problems in the implementation of the project, for the Mexican government had to face loan requirements from three different organizations. As told in a Bank's report: "[T]he Bank's requirements for public works bids went beyond Mexican law, and the Bank showed insuffident flexibility in regulations governing bidding, force aceount administration and poverty definition." But there is an added foot- note: "That the Bank was not the worst offender was illustrated by the remark.., that the IDB at one point (unsuccessfully) tried to require drastic reforms of the existing agrarian legislation ... while IFAD proposed such objectionable legal paragraphs that its own Board adopted the Mexican position."42 A TRY AT TOURISM. From 1972 to 1978, the World Bank made five loans to the tourism sector, to finance studies on Mexico's tourist potential and tourism projects themselves (including a resort that would become famous, Ixtapa-Zihuatenejo). Fol- lOwing the Bank's advice, the Mexican government created a tourism trust fund in 1974, managed by N acional Financiera, to coordinate development of the industry. Although the Bank has always pOinted to this fact \vith some pride, it is fair to note that Mexico had already created other tourism trust funds (the first in 1969), although on a smaller scale. 41. This program was preceded by a similar one initiated in the state of Durango by the Dfaz Ordaz administration in 1968. A general reference on rural development programs in Mexico is Eric J. Miller, Desarrollo integral del medio rural: Un experimento en Mexico (Mexico City: Fondo de Cultura Econ6mica, 1976). 42. "Study of Relations between the World Bank and Mexico: The Agricultural Sector," background paper for the OED Study of Bank/Mexico Relations, chapter 2, p. 7, and footnote 9. 66 MEXICO AND THE WORLD BANK NO MORE LOANS FOR POWER DEVELOPMENT. From 1972 to 1989, the Bank stopped its lending for electric power development. The issue of electric tariffs, which had been an irritant at the end of the 1950s, resurfaced in the early 1970s. Increasingly, electric tariffs were allowed to lag behind inflation, as the government attempted to check the price-inflationary spiral (a pattern that would be repeated several times over the next two decades). This led to the government transferring ever larger sums of money to the sector, a situation that proved unsustainable by the mid-1980s. The Bank resumed its lending to the electric power sector in 1989-90, when two loans, totaling over $900 million, were made to Mexico after the government adjusted its tariffs. THE FIRST LOAN TO THE STEEL SECTOR. The World Bank made its first loan to Mexico for investment in a state-owned industrial complex in September 1973, after three years of difficult negotiations, to the tune of $70 million (the ID B lent $54 million). The stories behind both the creation of the complex, named Siderurgica Lazaro Cardenas-Las Truchas S. A. (SICARTSA), and the Bank's own involvement deserve some attention. 43 Since 1957, the iron deposits found in Las Truchas, at the border of the southwestern states of Michoacan and Guerrero, were large enough for the Mexi- can government to plan a steel complex there. More than a decade passed before the project came to fruition. In 1968, Dfaz Ordaz officially announced the creation of Siderurgica Las Truchas, to be headed by former President Cardenas, whose home state was Michoacan and who had lobbied for the project for many years. COincidentally or not, the announcement was made two weeks after the Matanza de tlatelolco, and many interpreted the measure as Diaz Ordaz's way of appeasing the left wing of his party, represented by Cardenas. The project did not flourish, however, until the Echeverria administration and after Cardenas's death (hence the name change at Echeverria's suggestion). It then became the government's most ambitious industrial project, to the dismay of both the Mexican private sector and the U.S. steel industry. Given the controversial nature of the project, why did the Bank agree to finance it? First, as with rural poverty projects, there was a coincidental match in the needs of both Mexico and the Bank: the latter was looking to expand its financing from infrastructure to industry in the early 1970s. Second, once the Bank started talks with Mexico, it was unable to back away without appearing too protective of U.S. interests. As told by the Bank itself, "Early press accounts in the [United States] had warned of impending competition in the steel sector that U.S. firms faced from low wage based production by SICARTSA. The Mexicans were concerned that such fears would bias the Bank's evaluation of the project, on the assumption that the Bank was overly influenced by U.S. interests."44 43. What follows draws mostly on the work of Nelson Minello and Aristides Rivera, Siderurgica Lazaro Cardenas Las Truchas: Historia de una empresa (Mexico City: El Colegio de Mexico, 1982). 44. World Bank, "The Bank and the Mexican Industrial Sector," background paper in electronic form for the OED Study of Bank/Mexico Relations, p. 61. MEXICO AND THE WORLD BANK 67 So the project sailed on. The first stage (there were to be four) was completed in November 1976, days before Echeverria left office, at a fmal cost of about $1 bil- lion. The second stage was postponed for several years by President L6pez Portillo, even though the World Bank and the IDB had already committed money. It was fmished near the end of his term. To finish, SICARTSA experienced losses during the rest of the 19708 (partially as a result of a drop in the worldwide demand for steel rods), was moderately profitable in the early 1980s, and was privatized in 1991 at a price substantially below its original cost. TWO SOLID PLANS. Among other Mexico-World Bank projects during the period, two interesting studies are worth noting. The first, a resounding success according to all sides, represented a joint research venture among the United Nations Development Program, the World Bank, and the Mexican government on the devising of a national water plan. The venture, which started in 1972, resulted in the Plan Nacional Hidraulico of 1975, a landmark water plan that guided the next two decades of work in that sector. The second research project was a four-volume 1971 study on the transport sector made by the Bank, which had a lasting impact on the design of Mexican transport policy, and on future Bank loans for highway development. 45 That study correctly raised an issue that was to become a source of much friction: lack of an adequate system of road user charges to the detriment of both government finan- ces and the railways. The latter had to compete with trucks subsidized by low diesel prices and almost nonexistent road charges. This friction between the Bank and the Mexican government lasted two decades, until the Salinas government deregulated the transport sector. Oil Boom As the gap between government revenue and government expenditures in- creased, and as some of that difference was monetized, the problem of chronic government budget deficits coupled with relatively high inflation resurfaced in the final years of the Echeverria administration. The exchange rate, flxed since 1954 at 12.5 pesos per dollar, had become overvalued by the early 1970s, and a sizable trade deficit, as well as speculative capital flight, soon developed (see table 3-1). Three months before Echeverria left offlce, the peso was devalued. The event initiated a six-year cycle of devaluations, as well as an unwritten rule that was to prevail for almost two decades: an outgoing president had to clean house before the arrival of his successor. Together with the devaluation, a three-year Extended Fund Facility agreement for about $1 billion was signed with the IMF in October 1976, effective at the beginning of 1977, and, as usual, the U.S. Treasury provided a stabilization fund. 45. World Bank, The Transport Sector of Mexico (Washington: World Bank, 1971). 68 MEXICO AND THE WORLD BANK However, the macroeconomic adjustment in 1977, the first calendar year of the L6pez Portillo administration, was modest, partly because the government took a tough stance when it negotiated with the IMF. The government deficit declined from 9.1 percent to 6.3 percent of GOP, and because the contractive stance was mild, annual growth was still 3.4 percent. In any event, the IMF agreement soon became irrelevant a new actor jumped to center stage in 1978: oil exports. OIL VEINS ARE THE DEVIL'S GIFT. 46 For many years, the Mexican oil sec- tor was in a sorry state. By the mid-l000s, the country was unable to export oil, for the first time since the industry'S nationalization in 1938. Furthennore, the country became a net importer of oil by 1971, and the twenty-four million barrels of oil imported in 1973 easily exceeded any of the export figures ever attained by PEMEX. The government was alanned by the state of affairs and took steps to meet the problem. The Echeverria government had set up a commission to initiate more intensive oil exploration, emphasizing geographiC diversification. The search paid off in 1973: new oil reserves were discovered in the southern states of Chiapas and Tahasco. The discoveries were kept secret for a while, since Mexico did not want the United States to pressure it for fast oil exploitation (those were the years of the OPEC embargoes). But weeks after L6pez Portillo took office in late 1976, it was publicly announced that proven oil reserves had gone up from 6.3 billion barrels to over 11 billion. And that was just the beginning; by the end of 1978, reserves had risen to over forty billion oil barrels, and by 1982 to over seventy-two billion. 'We were the fIfteenth oil prodUCing country in the world," said L6pez Portillo in his September 1980 preSidential address, "today we are the fifth. We had the eigh- teenth largest oil reserves, today we have the sixth."47 Hand in hand with the oil boom came recklessness. Mexico was growing at more than 8 percent in real tenns by the end of the 1970s, and L6pez Portillo kept reminding the population that Mexico's problem was not to generate wealth but to administer it wisely. Unfortunately, neither Mexico nor he ever took that refrain seriously. Mexico's failure did not mimic the so-called Dutch disease, where the manufacturing sector in the Netherlands had suffered indirectly from the explOita- tion of a natural resource. Mexico's disease was less sophisticated: bad spending habits and overborrowing (compare the figures in table 3-1). Regarding the fonner, government economists adopted a grossly proeyclical policy of heavy government spending. 48 The overborrowing side of the story is even more interesting. 46. Free translation of a verse by the venerated Mexican poet Ramon LOpez Velarde (1888-1921). 47. Instituto Nacional de Estadfstica, Geografla e Infonnatica, Estadfsticas Hist6ricas de Mexico (Aguascalientes: INEGI, 1990), vol. 1, p. 465. Author's translation. 48. See Carlos M. Urzlia, EI Dejlcit del Sector Publico y la Politica Fiscal en Mexico (Santiago, Chile: Comision Economica para America Latina y el Caribe, 1991). .l/ORLD BANK 69 .NKS AS LOAN PUSHERS. 49 Soon after the oil discoveries, larling of foreign commercial banks. For bankers busy re- n the late 19705, Mexico was a tailor-made borrower. As a ition ensued: during the best years, 1979-80, Mexico got er the London interbank offer rate, LIBOR), which were ountty risk, that would have been the envy of prime multina- Kingdom of Sweden. 50 pect, not only public debt but also private debt increased Jit boom. In fact, the private sector's foreign debt grew at a : public sector's: from $6.5 billion at the end of 1976 to over nd of 1982 (including the debt of the banks nationalized in --I: 'his is an important fact because, at least in the Bretton Woods literature on the Mexican debt crisis, it is never pointed out that the oil disease infected not only the government but also the private sector. Actually, the most important industrial group in Mexico at the time, Alfa, went bust almost a year before the government did and had to be rescued with public funds. During the oil boom, Mexico could call the shots with the IMF, the United States, and the foreign commercial banks. But, because of a genuine appreciation for what it had done years earlier, the World Bank was treated more cordially during the boom period. As recounted by Lopez Portillo, the Mexican government appreciated the Bank's sectoral expertise and wanted to continue borrOwing from it. After McN amara complained personally to him about the lack of good individual projects in Mexico, as opposed to the global plans that the Mexican government kept (and keeps) churning out, LOpez Portillo created a special commission to propose projects to the Bank. 51 That acquiescence notwithstanding, the World Bank's lending to Mexico mir- rored commercial banking practices. The tenns on several Bank loans seem to have been substantially relaxed; a good instance of the latter was the way in which the Bank ended up agreeing, after so many years of refusing, to channel agricultural loans through BANR URAL, though doubts persisted about the agency's efficiency and transparency. 49. For the orthodox or incredulous reader alarmed by the possibility that a banker can become a loan pusher, see the lecture of William Darity, Jr., and Bobbie L. Hom, The Loan Pushers: The Role of Commercial Banks in the International Debt Crisis (Cambridge, Mass.: Ballinger Publishing Company, 1988). As noted by Karin Lissakers, Banks, Borrowers, and the Establishment: A Revisionist Account of the International Debt Crisis (New York: Basic Books, 1991), pp. 114-36, one reason for the overlending was that the banks were taking advantage of tax loopholes in the United States and other industrialized countries. 50. For a general review of the spreads charged to less developed countries before the debt crisis, and a theory that tries to account for their sudden changes, see Carlos M. Urzua, "Lending to Sovereign Borrowers: Snapshots of the Eurocurrency Market Using a Thomian Camera," International Economic Review, vol. 31, no. 2 (May 1990), pp. 469--89. 51. Carlos M. Urzlia, interview "\lith Jose Lopez Portillo, February 28,1995. 70 MEXICO AND THE WORLD BANK Furthermore, most of the projects were a continuation of programs initiated earlier. Aside from a loan at the end of the Lopez Portillo administration for pollution control (the first environmental loan to Mexico), and some overtures on the Mexican urban sector, the World Bank's projects simply continued fInanCing projects that had been jOintly pursued during the first half of the 1970s. ONE MISJUDGMENT AFTER ANOTHER. The World Bank began to monitor the new surge in Mexican oil production in its 1972 annual report on the Mexican economy. It concluded that "hydrocarbon imports were likely to represent an increasingly large share of merchandise imports in times to come and to account for a growing proportion of foreign exchange resources."52 This was a reasonable statement, since the Bank did not necessarily know about the new oil reserves discovered by PEMEX at roughly the same time. Similar underestimations per- vaded the economic reports of the next few years, however, after the dis(.'Overies had been confirmed. This is shown by the following extract from the World Bank's own evaluation report: The 1974 Economic Report ... c.'ontinued to forecast oil imports despite the confirmed Chiapas-Tabasco discoveries, assuming that an increase in oil production would take time to become effective. This proved quite unrealistic since Mexico's output rose rapidly and Mexico became a net oil exporter as early as 1975.... The 1976 Report was again too conservative regarding oil exports "given the lead time needed for capital investment to achieve full production." This proved wrong since exports of crude oil rose tenfold in 1975-80.... For the first time, the 1977 Bank Economic Mission included energy specialists.... The mission forecast proved again too pessimistic for eA'pDrts of crude.... Staff analySiS in the end proved only correct for total output of crude and domestic c.'onsumption in 1982.53 But just as the Bank conSistently underestimated PEMEX capacity for increas- ing oil production, it also conSistently underestimated, together with the Mexican government, the danger for Mexico of having an economy too dependent on oil. Again, to quote the Bank's own evaluation study, The 1979 Economic Report came out rather in support of the oil based strategy of accelerated growth arguing that vast oil reserves had COnsiderably increased Mexico's "flexibility of maneu- ver" particularly regarding acute social problems.... In 1981, another Economic Mission did not accept PEMEX's imposed ceiling in exports of crude oil (1.5 million barrels/day) for 1982 and snbsequent years although the ceiling eventually proved right ... It would thns appear that throughout the 1970s and the 1980s, Bank economic reports have conSistently and logically aimed at evaluating in macroeconomic terms the effects of oil resources on the Mexican economy. But such evaluations have generally been poorly perfurmed. 54 Two possible reasons for the Bank's failure to assess correctly the advantages and risks of the oil boom might be its lack of expertise in that sector and the secrecy 52. World Bank, "The Oil Sector," background paper in electronic form for the OED Study of Bank/Mexico Relations (Washington, March 1993), p. 44. 53. World Bank, "The Oil Sector," p. 44. 54. Ibid., "The Oil Sector," pp. 45-46. MEXICO AND THE WORLD BANK 71 with which the Mexican authorities treated all infonnation on PEMEX assets. What is certainly true is that the Bank missed two more opportunities to help Mexico in managing the oil boom: in mid-1977, Mexican authorities quietlyap- proached the Bank looking for oil financing, but to no avail. By coincidence, as in the 1954 request, Bank vice-president Knapp was the person to receive the request and return the denial. Furthennore, since by January 1979 the Bank had approved its new Accelerated Program for Petroleum Production, which sanctioned oil loans for the first time, two months later an economic advisor to L6pez Portillo let it be known to Ardito Barleta, the vice-president for Latin America, that Mexico wanted to participate in the program. Once again, the request was denied, but this time the reasons were that a full-fledged appraisal of the oil situation in Mexico was beyond the Bank's capabilities and that the Bank was going to give priority to poor oil- importing countries. Beginning of the Debt Crisis Just as McNamara was stepping down in July 1981 as president of the World Bank, Mexico was also stepping down, albeit more quietly, as the prime developing country in the Eurocredit market. Lending tenns for Mexico, and the rest of the developing world, were hardened in the early 1980s, when a financial crunch, caused mostly by a contractive U.S. monetary policy, spread around the world. To compound the problem, oil prices declined in 1981, and the Mexican current account deficit was becoming unsustainable with an overvalued exchange currency. In that ycar alone, Mexico's total external debt increased by $24 billion, of which more than one-third was short tenn (with a maturity ofless than a year). The new money was needed to cover the swelling trade deficit and to honor repayments of foreign debt, which were climbing with world interest rates. FUrthennore, an estimated $11.8 billion left Mexico as capital flight in that same year.5.5 The relation- ship between foreign debt and capital flight would aggravate the problem.56 By early 1982, the Mexican economy was heading to bankruptcy. In February of that year, the government attempted to regain control of the economy by twice devaluing the peso (with a cumulative devaluation of about 67 percent). But since the government did not follow up with a credible fiscal adjustment, the economy continued to head toward financial insolvency. Foreign debt repayments were becoming so high that the government at- tempted to arrange in the Eurocredit market for a trio of medium-term "jumbo" loans through PEMEX ($2 billion), Nacional Financiera ($1.2 billion), and the Mexican government ($2.5 billion), Mexico's perceived creditworthiness had 55. Figures taken from Jose Angel Gurrfa, La pol(tica de la deuda extema (Mexico City: Fondo de Cultura Economica, 1993), tables 3, 4. 56. For a paper on that relationship see Manuel Pastor, Jr., "Capital Flight from Latin America," World Development, vol. 18, no. 1 (January 1990), pp. 1-18. 72 MEXICO AND THE WORLD BANK deteriorated so badly by then, however, that few banks were willing to participate in the syndication of the last jumbo loan (July 1982), even though the terms were extremely favorable to the lenders. A month later, on August 6, foreign reserves fell to about $100 million, while the country's financial obligations in just the first half of that month were seven times higher. That day, the Mexican government decided that a debt moratorium was the only avenue left.57 On August 13, it announced, to the dismay of many foreign private investors, that the dollar-denominated deposits in the Mexican bank system would be only partially honored: investors would be paid back in pesos at an artificially low exchange rate, while the central bank retired from the foreign exchange market. The "mex-dollars" were suddenly converted to what could be called "U.S. pesos." This is a good example of what is known as "political risk" in the textbooks on international finance. That same day, a Friday, Finance Minister Jesus Silva-Herzog, who had been appointed barely five months earlier, started a series of meetings in Washington asking for financial help from official sources. He had interviews with the IMF managing director Jacques de Larosi(~re, the chairman of the Federal Reserve Board Paul Volcker, and the U.S. Treasury secretary Donald Regan. After a long weekend, he was able to return to Mexico with a fmancial rescue package. He then returned to 'Washington to meet, on August 20, with 115 representatives of Mexi- co's main foreign commercial creditors, from whom he asked for a ninety-day debt moratorium. Mexico had no other choice since its debt obligations for the rest of the year had climbed to over $11 billion, while reserves were almost nil. That date, August 20, 1982, has been Singled out as the beginning of the developing-country debt crisis, even though several African, Central American, and Eastern European countries had already begun a series of debt renegotiations. Furthermore, soon after Mexico declared a moratorium, many other countries followed suit. In 1983 alone, twenty developing countries, ranging from Argentina to Yugoslavia, held debt renegotiations with their commercial banks. The economic and political dealings that took place while Silva-Herzog was bargaining in Washington are fascinating, and have been told in a number of good books. 58 For the purposes of this chapter, it suffices to note three interesting outcomes of the bargaining game, which CUriously enough, would be played out again in the next Mexican financial crisis a dozen years later. First, as in all its economic emergencies since 1947, Mexico obtained some financial help from the United States. This time, however, one billion dollars were lent against future oil purchases (another billion came from the Commodity Credit Corporation), a contract that caused an uproar in Mexico where the nationalized oil 57. See Gurria, La polftica de la deud,a extema, p. 29. 58. A reference in English is the delightful book by Joseph Kraft, The Mexican Rescue (New York: Group of Thirty, 1984). For a reference in Spanish see Gunia, La politica de la dew:Uz extema. MEXICO AND THE WORLD BANK 73 industry was almost sacred. Furthermore, the loan had harsh terms: the oil price was set too low, and the U.S. Treasury wanted $100 million as a commission for the transaction. When LOpez Portillo heard about the latter, he ordered Silva-Herzog to return home to initiate a unilateral debt moratorium. Almost immediately, however, the U.S. Treasury officials changed their minds and offered to halve the commission. In the end, the U.S. loan had an implicit interest rate of about 38 percent!59 The U.S. officials also tried to impose, according to LOpez Portillo, political conditions, such as requiring Mexico "to act as a strikebreaker against OPEC by unilaterally lowering its oil prices, and to sever our diplomatic relations with Cuba."60 A second interesting outcome of the bargaining game was that, unlike previous crises, the financial obligations were so large, and the United States so adamant about their repayment, that Mexico had to look for help from other industrialized countries as well. By the end of August, Mexico had obtained a $1.85 billion loan from the other central banks that were members of the Bank for International Settlements. The last noteworthy outcome was that, in December 1982, an IMF three-year Extended Fund Facility agreement was Signed for about $4 billion. An interesting part of the agreement was that the loan was conditioned on the commercial banks lending $5 billion to Mexico. By early 1983, the banks did just that, and later in that year they also rescheduled Mexico's commercial debt, involving obligations from late 1982 to the end of 1984. The new period of repayment was extended to eight years. And the World Bank? The Mexican debt crisis took the World Bank by surprise, as it did most other observers. Already in 1981, the Bank was courting Mexico as a prospective donor to the International Development Association, since its growing affluence had led to preliminary negotiations on "graduating" Mexico, along with several other coun- tries. In that regard, McNamara personally approached Lopez Portillo to tell him that Mexico did not need World Bank financing anymore, since it was "taking off," to which the Mexican president answered that "if one were to use that aerodynami- cal simile, then Mexico needs the most fuel at this point:>61 \Vhen the new Bank's preSident, A. W (Tom) Clausen, visited Mexico in March 1982 his briefings and conversations dwelled only marginally on prospective li- quidity problems. In his meetings with Mexican officials, he had mainly endorsed the position that Mexico could continue to envisage very high growth rates in the near future. There was no sense of an impending crisis. Naturally, after Silva- 59. See Gurria, La politica de la MUda extema, p. 31. 60. Carlos M. U rzua, interview 'hith Jose Lopez Portillo, February 28, 1995. 61. Ibid. 74 MEXICO AND THE WORLD BANK Herzog's announcement of a moratorium just five months later, Clausen felt "rather caught with his pants down."62 Several reasons may be adduced for the Bank's failure to predict the impending crisis. First, the Bank had little influence on, and even scarce knowledge of, Mexico. This is illustrated by the limited nature of the Bank's contacts with Mexico, which were closely regulated by the government. The regulation extended not only to noneconomic ministries but to PEMEX and the private sector. Second, the Bank lacked in the early 1980s a data base that incorporated short-term debt, which, as noted earlier, had become substantial in the case of Mexico. Finally, the view that the Mexican economy was poised to implode was inconsistent with the volume of the Bank's lending to Mexico (1980-82), and this could have led to the suppression of any pessimistic assessment. The last point is illustrated by the follOwing episode. INTERNAL DISSENT. Not everybody at the World Bank had been so optimis- tic about Mexico's prospects. A junior staff member had been quite critical since early 1981 of the growth strategy being followed by Mexico. His dissent was even more remarkable given that not only inside the Bretton Woods institutions, but also inside Mexico, very few Cassandras were warning about an impending crisis at such an early point. 63 The staff member was part of a World Bank economic mission to Mexico in February 1980 and was responSible for the quantitative macroeconomic work. After having studied the data, he concluded that the Mexican economic strategy would almost inevitably lead to a Frisis. The rest of the mission members disagreed with his alarmist assessment, however, feeling that the debt problem could be managed. Drafts of the team's report were discussed with Mexican officials at the end of 1980 and in mid-1981, and the final report appeared in August 1981. 64 Despite the refusal from the rest of the team to consider his views seriously, he wrote a minority economic report in the form of a memorandum to files. Although the leaders of the mission were \villing to keep his main point in the final report, as a possible scenario if everything started to go wrong, it was relegated to an annex. Then, on July 14, 1981, a Mexican delegation went to Washington to review, among other things, the Bank's report. It was headed by Carlos Salinas de Cortari, then a brash young man in his early thirties who, as a director-general, was the right-hand man of Budget and Planning Minister Miguel de la Madrid. During the meeting, Salinas launched a sharp attack against the staff member's bleak assessment of the Mexican economy. In the Bank's own historical study of its relations with Mexico, 62. Devesh Kapur and Richard Webb, interview with a World Bank staff member, January 19, 1993. 63. Among the honorable exceptions on the Mexican side is the great poet and engineer, who in his spare time is also an excellent economist, Gabriel Zaid, EI progreso improductivo (Mexico City: Siglo XXI Editores, 1979). 64. World Bank, Mexico: Development Strategy-Prospects and Problems, Report No. 3605-ME (Washington: World Bank, 1981). MEXICO A::-.ID THE WORLD BANK 75 one finds this candid note: "Bank staff recall that [Salinas] had been critical of a Bank report that suggested that the public expenditure expansion financed by debt and money creation would lead to inflation."65 Another member of the Mexican delegation has confirmed this quote. What could be the explanation for Salinas's bitter criticism of the report? One reason could be ideological, since at that time Salinas was, at least on the surface, a leftist economist. But a more likely explanation has to do with politics: the report happened to come out in the middle of a battle between his boss Miguel de la Madrid and Finance Minister David Ibarra. Both wanted to become the next presidential candidate of the official party, and Ibarra had endorsed the Bank's document from the beginning. This conjecture is reinforced by the fact that Salinas's explOSive behavior at the World Bank prompted a letter from Ibarra to Clausen, on September 11, 1981, in which Iharra praised the entire report. Two weeks later, on September 25, Miguel de la Madrid was chosen by LOpez Portillo as the party's next presidential candidate. By March 1982, Ibarra had left the Finance Ministry. The sad end of the story is that the staff member's career in the World Bank subsequently stagnated. After Salinas's criticism, his supervisors in the Mexico division had wanted to sack him, but he fought back, with the aid of a lawyer, and was reluctantly retained by the Bank. He was nonetheless treated as an outcast for several years after the incident. Toward Closer Relations On December 1, 1982, fifteen weeks after the eruption of the debt crisis, Miguel de la Madrid became Mexico's president for the next six years. He inherited an economy in shambles and under an IMF Extended Fund Facility agreement that required deep cuts in government spending. It is not surprising that in 1983 the economy suffered its worst recession in half a century (a drop in real G D P of 4.2 percent). De la Madrid's administration is very difficult to evaluate. Not only did most of the main developments of the debt crisis take place during his term, but there were natural disasters as well, and a substantial deterioration of Mexim's terms of trade. As a result of all these factors, and some bad economic policies, the performance of the economy was extremely poor during these years (see table 3-1). For the purposes of this chapter, the de la Madrid years are the key to under- standing why the relationship between the World Bank and Mexico evolved as it did during the 1980s. To start, it should be noted that most of the breakthroughs in the relationship, to be recounted shortly, were made with de la Madrid and not his 65. World Bank, OED Study of Bank/Mexico Relations, p. 75. 76 MEXICO AND THE WORLD BANK successor Carlos Salinas. Although the Mexican refonns of the past decade are almost solely associated with Salinas, it was de la Madrid who, for good or for bad, unlocked the key doors. He made the initial decisions on all major fronts. De la Madrid had been very interested in the World Bank since the mid-1960s, when he was a young middle-level government officiaVl6 As a subdirector of credit in the Finance Ministry from 1965 to 1970, he had the opportunity to appreciate the quality of the Bank's sector work. A few years later, he met McNamara and came to respect his intelligence and leadership-qualities that he did not find in President Clausen, whom he met twice in Washington, or Barber Conable, who succeeded Clausen in 1986. In sum, de la Madrid was the first of a new breed of Mexican politicians: he did postgraduate work at Harvard, and neither he nor his circle was afraid of, or even suspicious about, a close relationship with the Bank. World Bank Starts to Move In After the debt moratorium in August 1982, major management changes oc- curred in the Bank's Latin American division. 67 Since the new officers were to play an important role in the relationship that developed between 1983 and 1987, it is convenient to record their names: Rainer B. Steckhan, director for the region that included Mexico; Pieter P. Bottelier, the division chief for Mexico; and Frederick E. Berger, lead economist for Mexico. (The latter, a Danish-Uruguayan economist, died of a brain tumor in 1988.) Bottelier made the first attempt to forge a new relationship between the Bank and Mexico. In a memorandum written in late 1983, he proposed to the Mexican government that the World Bank could have a high-quality macroeconomic dialogue with Mexico and might even construct a few policy loans around that dialogue. These loans were called, in the jargon of the Mexico division of the Bank, "development policy loans," although since 1980 they have been officially known as "structural adjustment loans." The memorandum became the subject of enonnous debate \\ithin the de la Madrid cabinet. Many resisted a prominent policy dialogue with the Bank, includ- ing the Bank's most important borrower, Nacional Financiera. Gustavo Petricioli, its then director, submitted a response to Finance Minister Silva-Herzog explaining that the World Bank wanted inadmissible prerogatives. This note was then con- fidentially shown to Bottelier by officials in the Finance Ministry as an explanation for why the Bank's proposal had to be rejected. Meanwhile the debt crisis in Mexico had spilled over to other countries, and the banking community began to push the international agencies to assume a more prominent role to protect their own backs and to get out of further lending. Thus, 66. Carlos M. Urzua, interview with Miguel de la Madrid, March 3, 1995. 67. This section has benefited greatly from the unpublished article by Devesh Kapur, 'The World Bank and the Mexican Reforms after 1982" (Washington: Brookings, 1994). MEXICO AND THE WORLD BANK 77 the World Bank and the IMF were slowly becoming the escorts, so to speak, of the banking community. Silva-Herzog saw that very well and overruled Petricioli, deciding to accept the Bank's proposal at the end of 1983. This marked the beginning of what gradually evolved into a closer relationship. A WATERSHED AGREEMENT. The Bank first attempted to foclls its new policy dialogue with Mexico on interest rates. At that time, the Bank's lending portfolio to Mexico consisted principally of credit operations. The portfolio had fifteen lines of credit to many different on-lending institutions, each of which had different loan covenants, reflecting the somewhat ad hoc manner in which these project loans had been negotiated. Most of the loans went through Naeional Financiera, which on-lent directly to firms and served as the lead agency for on-lending to banks. Nominal interest rates charged by Nacional Financiera on its loans had fallen below the inflation rate in Mexico, becoming negative in real tenus. That often violated loan covenants that prohibited negative real interest rates. Thus, as its first major project, the Bank proposed to the Mexican government that they negotiate an umbrella interest rate agreement that would substitute for the covenants of the fifteen individual loan agreements. The proposal was a novelty at that time, and within the Bank there was considerable skepticism that the Mexican government would accept the idea. Nonetheless, the proposal was sent in early 1984, and, much to the Bank's surprise, it had a negotiated legal document hy May. This agreement became known as the General Interest Rate Agreement (GlRA), which substituted for the preceding covenants, and set out a three-year timetable, sector by sector, on how the rates would be adjusted every three months to an inflation proxy (with an exemption for most loans in the rural sector). The GIRA was a watershed in the relations between the Bank and Mexico. Tbe agreement covered not only Bank loans but also loans from external donors, including, to its chagrin, the IDB. It was the first time that the Bank had succeeded in initiating a policy dialogue on a broader front. The Mexican Finance Ministry was also quite bold in accepting the agreement, for the harmonization ofloan rates across so many governmental agencies implied an enormous amount of work, including political lobbying. Partially because of the political difficulties, the Mexican government had failed to eomplywith the GIRA agreement by the end of 1984. A decision had been taken internally by the Bank that the agreement was a make-or-break point, and the Bank decided to suspend disbursements. The Mexican government was orally advised that they should not submit any disbursement applications under any of the fifteen loans. Since these loans amounted to more than half of the total ongoing Bank loans, the Bank's hard line was no minor thing for the Mexican government. However, to everybody'S relief, the adjustments were made within a few weeks, and the agreement sailed through. 78 MEXICO AND THE WORLD BANK Cartagena Meeting In June 1984, there was a meeting in Cartagena, Colombia, where most of the foreign and finance ministers in Latin America openly discussed possible avenues to cope with the debt overhang (a first meeting had been held in Quito months earlier). The international press covered the event heavily, and for the first time the specter of a Latin American debtors cartel started to haunt bankers around the world. The coalition never prospered, however, since a debtor's cartel poses many incentive problems; each country is tempted to distinguish itself from the rest. Yet, it is puzzling that so few countries dared to declare a moratorium on their own, since, as noted by Kaletsky in his classical work, the costs of a conciliatory default "may not be as daunting as is often supposed. On the contrary, these penalties could be surprisingly moderate. . . . A bank attempting to invoke the modest legal sanctions available might do more harm to itself than to the defaulter."6B Furthermore, from a legal point of view, the principle that a country could be entitled to a partial default, ifit were able to prove an unforeseen change of circumstances, is quite persuasive. TIlls was precisely the case during the debt crisis, given that the sharp increases in the world real interest rates at the beginning of the 1980s were certainly unanticipated by the developing countries when they contracted the debt.59 In reality, however, few Latin American countries dared to challenge the banks in the1980s. One was Costa Rica, which perfectly showed how a small country could benefit from simply (and quietly) stopping debt payments. Several larger countries, like Peru (since 1984) and Brazil (1987), also staged temporary face- downs with creditors. Why not Mexico? After all, it is so close to the United States, and their economies are so intertwined, that any U.S. retaliation against Mexico would seem self-destructive. Wby not Mexico? I asked former president de la Madrid. He answered that since the country had suffered so much by being shut out of the international credit markets for decades after the defaults in the 1930s, it would have been an "histori- cal irresponsibility" to have made the same mistake again. 70 Yet, those were other times, and the investors were individuals, not banks. Furthermore, although Mexico behaved in the 19808 more "correctly" than, say, Brazil, few people would dare to claim now that such a distinctive behavior made any difference at all once intemationallending was resumed in the 19905. Clearly, there are other explanations for Mexico not having chosen to default, two of which have the advantage of being quite Simple. The first is the human factor. Fortunately for the bankers, the Mexican officials with decisionmaking 68. Anatole Kaletsky, The Costs of Default C~ew York: Twentieth Century Fund, 1985), p.65. 69. For a cogent defense of that point, see George T. Kanaginis, "Default on Developing Country Debt: Is It Justified by International Law?" Economics and Politics, vol. 3, no. 3 (November 1991), pp. 239-63. iO. Carlos M. Urzua, interview with Miguel de la Madrid, March 3, 1995. MEXICO AND THE WORLD BANK 79 power during the debt crisis were uncharacteristically cautious. President de la Madrid was a conseIVative at heart, both ideologically and temperamentally, and Finance Minister Silva-Herzog was never known as a politician willing to take risks. Finally, the chief foreign debt negotiator for several years, Jose Angel Gurria, was an economist who became known for his nonconfrontational style, and, perhaps because of that, as the archetypical Latin pal of the New York bankers. They were so comfortable with him that the Mexican government had to renew his appointment for a dozen years, until the end of 1994, when he was promoted to foreign minister. The second is a systemic factor. The semi-authoritarian regime in Mexico has always had enormous control over the population, and the country is extremely unbalanced in terms of income distribution and political power. Those two charac- teristics of the Mexican political system played a role in the debt crisis as well: few members of the elite would back a Mexican default because they knew that the lower classes would bear most of the debt burden and that as individuals they did run the risk of being the subject of retaliation in case of a Mexican default. After all, they had more than $50 billion deposited in the United States and other foreign countries. Beginning of Full-Blown Relations As noted earlier, a procedure that was helpful in strengthening the relationship between the World Bank and Mexico was the "country strategy implementation" meetings begun in late 1983. These meetings, held alternately in Washington and Mexico every six months, provided a forum for consultation. During the meetings, the Bank would produce, first, a ten-page paper on the macroeconomic situation; second, a paper that reviewed the project implementation of the existing portfolio; and, finally, a "forward-looking" paper. The consultation based on this routine became an established pattern that continued until the early 1990s. Trade Liberalization Saga Based on the themes developed in those short papers, and emboldened by the success of G IRA, the World Bank began in early 1984 to propose a trade policy loan that would Significantly liberalize the Mexican economy.71 This was the heyday of Anne Krueger, then the Bank's vice-president for economic research and well known in academic circles as a forceful proponent, some would say "a zealot," of free trade. As such, there was ready acceptance \vithin the Bank of this approach to Mexico. It took more than a year, however, before this momentum translated into a loan, as the negotiations proved very difficult. The biggest handicap was the weight of history: in Mexico, the World Bank was (and still is) identified with Washington. 71. See also Kapur, "The World Bank and the Mexican Refonns after 1982." 80 MEXICO AND THE WORLD BANK Of course, some compensating factors worked in favor of the trade policy loan. An obvious one was that some Mexican government officials had begun to look at liberalizing the economy as a way to lower inflationary pressures, which were steep by late 1984. Another factor could have been, according to some World Bank officials, Silva-Herzog's awareness that without the trade loan he would have even greater difficulties rescheduling Mexico's debt with its commercial bank creditors. In 1985, Mexico was negotiating what was then the largest financial deal in world history, a deal that involved its entire commercial bank debt. And Silva-Herzog knew that to get the roughly five hundred participating banks to underwrite this new program, Mexico needed the participation of the multilateral institutions. But Mexico's decision to proceed with a radical trade reform was too complex to be explained by these two factors alone. The following incident exemplifies neatly the delicacies involved. 72 In April 1985, a Bank manager gave a copy of a so-called policy matrix for the proposed loan to Finance Undersecretary Francisco Suarez Davila. The matrix set out what Mexico would have to do regarding trade liberaliza- tion, and how much of the $500 million loan Mexico would receive in each tranch. A few days later, he was called into the office of the Bank's vice-president for Latin America, David Knox, who had just received a complaint from Senior Vice- President Ernest Stem, who apparently had been summoned by Clausen, who had been called by Donald Regan, who in turn had heen called by Volcker! The policy matrix caused such a furor, since it appeared to dictate tenns to Mexico, that the Mexican government angrily decided to pull out all stops. When I asked former president de la Madrid about the political maneuvering that swirled around the trade refonn, he asserted immediately that the economic cabinet members largely agreed regarding the issue. In fact, he said, the trade minister at the time, Hector Hernandez, supposedly the most vocal opponent of the trade policy loan, had been de la Madrid's main collaborator in 1979-80 when de la Madrid as budget and planning minister had pushed for Mexico's entrance to the General Agreement on Tariffs and Trade (GATT), a suggestion eventually rejected by LOpez Portillo. During 1984-85, differences among the economic cabinet members were more "a matter of rhythm rather than of substance," said de la Madrid. 73 Some cabinet members were afraid that, after liberalizing the economy, the current account would deteriorate rapidly, at a time when there was an acute shortage of fresh foreign credit. This explained, he said, the piecemeal approach to liberalization that took place in 1983 and 1984. But how did the group dynamicS within the cabinet evolve to the point where President de la Madrid ended up accepting the trade refonn in mid-1985? He did 72. Devesh Kapur and Richard Webb, interview with a World Bank staff member, January 19,1993. 73. Carlos M. Urz6a, interview with Miguel de la Madrid, March 3,1995. MEXICO AND THE WORLD BANK 81 not say, but perhaps there was a shift in the balance. One guess is that the most powerful cabinet member, Budget and Planning Minister Carlos Salinas de Gortari, President de la Madrid's right-hand man, became more involved and tilted the balance. For a while, Salinas had kept his distance from the trade debate, partly because he was not yet a neoliberal. But if so, why did he change his mind? The influence of two new players, who suddenly gained prominence in the Mexican government, may be responsible. The main one was Pedro Aspe, who Salinas promoted in 1985 to his undersecretary; the other was Aspe's former professor Francisco Gil Dfaz, a conservative economist who was head of economic research at the central bank. Whatever the political impetus, the fact is that on July 23, 1985, the Mexican government ended the import-substitution strategy that had guided its economy for decades. The trade reform, which was downplayed as another component of a general stabilization plan, was impliCitly justified as an anti-inflation measure. The reform was, however, quite dramatic: it called for over 60 percent of the controlled- good categories to be removed from import licenSing and Simultaneously increased tariffs to provide roughly equivalent protection. The trade measures took place after the government devalued the currency by 20 percent. As a bonus, the Mexican government started to dismantle other parts of the import substitution framework: fiscal incentives and implicit subsidies to domestic firms. The dismantling was done mostly in the manufacturing sector, where, ac- cording to a World Bank study, in 1980 total government subsidies "were worth more than 10 percent of value added in the sector, of which 1.8 percent were fiscal incentives, 0.9 percent were credit subsidies, 1.6 percent were straight subsidies, and 5.8 percent were the implicit subsidy due to underpricing of inputs supplied from public corporations."74 The last step in this trade liberalization saga was concluded when Mexico acceded to GATT in August 1986. An Earthquake and a Debt Plan The economic adjustment initiated at the end of 1982 was able to stabilize the economy by 1984. It was, however, a Pyrrhic victory, gained at a considerable cost in terms of output and employment. Thus, the government was rather distressed when it saw that by early 1985 the macroeconomic indicators had again worsened. When the economy picked up in 1984, imports grew as well, and soon the government faced a foreign credit constraint, made more critical by the hemor- rhage of debt repayments and a drop in oil prices. Furthermore, domestic prices grew with the economy, and tbe surge of inflation led to a corresponding surge of capital flight induced by an overvalued exchange rate. It is no surprise that, by mid-1985, the Mexican government was unable to meet IMF fiscal targets, and hence the Fund agreement was canceled. 74. Maddison, The Political Economy of Poverty, Equity and Growth, p. 180. 82 MEXICO AI\D THE WORLD BAI\K Then, on September 19, 1985, came the proverbial straw that broke the camel's back: an earthquake (with another one following the next day). It was a shock of enormous dimensions: roughly 10,000 people perished, and 85,000 families lost their homes. But Mexico was also shocked by what the earthquake exposed about Mexico's inner-city shantytowns, and the Mexico City inhabitants, while on the streets, released, for the first time in many years, all their contained grievances against a corrupt and incompetent government. After the tragedy, the World Bank intervened in a felicitous way (as opposed to the IMF that initially showed very little empathy). More than $90 million from other Bank projects were immediately shifted to earthquake reconstruction. Six months later, the Mexican government also received a Bank loan for $400 million to help with rehabilitation and reconstruction. The Bank's opportune intervention was helped by the fact that, months before the earthquake, Mexic'O and the Bank had Signed the first of a series of low-income hOUSing loans to be managed by the Fondo Nacional de Habitaciones Populares, a fund that on-lent to local developers (with a remarkable success, since the production of housing units increased twenty times from 1982 to 1986). THE BAKER PLAN. On October 8, 1985, barely two weeks after the earth- quake, U.S. Treasury Secretary James A. Baker unveiled a new plan to cope with the debt crisis. The Baker Plan called for the provision of fresh money to the fifteen most indebted countries, with twenty billion dollars coming from commercial banks and roughly another nine billion from multilateral institutions. The new loans were conditioned on deep structural reforms in the recipient countries, such as trade liberalization and privatization of public enterprises. The announcement of the plan was widely celebrated in Washington circles. But, even from the beginning, it failed to address the issue of how the commercial banks were going to be forced to participate. Less than a year later, it was con- sidered a failure by most debtor countries. That has led many countries to ask whether the Baker Plan was simply a response to a possible Latin American radicalization on the debt issue. In Washington, the typical answer is a resounding no! And predictably in Latin America, one gets preCisely the opposite response. Several academics who have studied the case side with the latter view. 75 In mid-1985, the new Peruvian president Alan Garcia had imposed a 10 percent ceiling on the proportion of export earnings that would be used to repay the debt. By early August, Fidel Castro had held a well-attended meeting on the Latin American debt problem in Havana, Cuba. In that meeting, Castro, with his sense of political opportunity and baroque rhetoric that are still his mark, VOciferously 75. See, for instance, Lissakers, Banks, Borrowers, and the Establishment; and Diana Tussie, "The Coordination of the Latin American Debtors: Is There a LogiC behind the Story?" in Stephany Griffith-Jones, ed., Managing World Debt (New York: St. Martin's Press, 1988), pp. 282-307. MEXICO AND THE WORLD BANK 83 76 called for a Latin American debt moratorium. Certainly, those two factors were more than enough to crisp the nerves of more than one U.S. official. Indeed, the author of a highly respected book on the debt crisis quotes a U.S. Treasury Department official as saying that the Baker Plan had been "pasted together qUickly in breakfast meetings" as a response to the new radical proposals. 77 ANew Slump In 1986, the average annual price of oil dropped more than 50 percent eom- pared with a year earlier. That external shock sent the Mexican tenns of trade reeling to its lowest level ever registered. Furthennore, the consolidated govern- ment deficit reached 20 percent of GDP in that year, partly because of the drop in oil revenues, but two other factors also contributed. First, the domestic debt burden had become by 1986 a problem even more pressing than the foreign debt overhang. Because of its laek of external financing, the government ran up its domestic debt after 1982, so much so that by 1986 interest payments on the domestic debt had climbed up to over 12 percent of GDp, about 40 percent of total public revenues from tax and sales. The second factor was political. The government not only refused to adjust other speuding items to cope >'\lith the fall in revenue, but it even increased slightly current and capital expenditures before the national elections in mid-1986. That policy was engineered mostly by Budget and Planning Minister Salinas. He had become by then the most powerful member of the de la Madrid cabinet, and his main rival, Silva-Herzog, soon was to leave his post as finance minister, apparently because of economic and political differences with de la Madrid and Salinas. Silva-Herzog was sueeeeded by Gustavo Petricioli, who a~ a director ofN adonal Financiera had had some frictions with the World Bank but in his new post would become quite friendly'h1th the Bank. Meanwhile, a new multiyear debt reschedul- ing package was being structured. Mexico was meant to be a principal "beneficiary" of the Baker Plan, and soon after that initiative was announced, Mexico started a round of negotiations with the multilateral institutions and the commercial banks to resehedule its existing debt and to renew the flow of credit. After difficult negotiations, the first aecord was reaehed with the IMF in July 1986, when Mexico Signed a standby agreement for $1.7 billion. The main bone of contention was how to measure the fiscal deficit for the purposes of setting the fiseal targets in the agreement. Mexieo contended, follmving an argument put 76. Fidel Castro, La impagable deuda extema de America Lati1UJ y del Tercer Mundo: C6nw puede y debe ser cancelada y la urgente necesidad del nuevo orden econ6mico internacional (Havana: Editora Polltica, 1985). 77. Lissakers, Banks, Borrowers, and the Establishment, p. 229. At the time, Karin Lissakers was a professor at Columbia University; she is currently serving as the U.S. Executive Director of'the IMF. 84 MEXICO AND THE WORLD BANK forward by Brazil, that the targets should be set in tenns of the so-called operation- al deficit, or the inflation-adjusted government deficit (about 7 percent of GDP in that year), as opposed to the nominal deficit (about 20 percent). After initially opposing it strenuously, the IMF finally went along with Mexico's proposal. Shortly thereafter, the World Bank announced a $2.3 billion lending program in 1986-87. The Bank arui the Mexican Debt Issue The Federal Reserve, the U.S. Treasury, and the IMF were the main official interlocutors with Mexico during the first part of the debt erisis. 78 That the IMF played a role and the Bank did not was natural given that, in the initial stages, most people saw the problem as a temporary liquidity issue. AN OPPORTUNITY FOR THE BANK. As noted, the Baker Plan gave an ex- plicit role to the multilateral institutions. Until the plan, the Bank had been left in the cold while the debt crisis unfolded, criticized externally for its seeming passivity and internally for wasting an opportunity to use its expertise. Since Mexico was the first major country where a new role for the World Bank was to be tested, Senior Vice-President Ernest Stem used all his influence to make it a success. Stern was heavily involved in the negotiations between Mexico and the commercial banks, as well as in the Bank's guarantee negotiations with Mexico. A process was initiated whereby Stem would inform Finance Minister Petricioli of the status of each project and the steps required to expedite the flow of funds. To move the funds, the Mexico division at the Bank was allowed to cut through the nonnal bureaucratic processes at the Bank. By the end of September 1986, after a series of nasty clashes between Mexico and the commercial banks, a new debt package was completed. 79 It involved the rescheduling of around $52 billion of public debt, of which almost $44 billion was given a lengthier maturity (twenty years) and a lower spread over LIBOR (1¥l6 percent). Furthennore, the banks agreed to provide $6 billion in new money and to lend another $1.7 billion in case of adverse external developments. LACK OF DEBT INITIATIVES FROM THE WORLD BANK. In a quite detailed study on the Bank's intellectual contribution to the understanding and solution of the debt crisis sponsored by the London School of Economics, the authors concluded that "the Bank was overoptimistic before 1982, sometimes disseminating assessment~ and advice which they would directly contradict later, with the benefit of hindsight. And it also seems that during the crisis, it was a slow follower in the debate on possible remedies."80 78. See also Kapur, "The World Bank and the Mexican Reforms after 1982." 79. A detailed account of the negotiations with the commercial banks is given in Gunia, La poUtica de la deuda extema, pp. 75-79. 80. Beatriz Armendariz de Aghion and Francisco Ferreira, "The World Bank and the Analysis of the International Debt Crisis," Discussion Paper No. 51 (Development Economics Research Programme, London School of Economics, November 1993), p. 3. MEXICO AND THE WORLD BANK 85 Most observers outside the World Bank would agree with this sober statement. But the Bank itself has been more self-congmtulatory about its role in the debt crisis. A pamphlet circulated by the Bank purports to show that "the World Bank played an important role in the way Latin America dealt with the debt crisiS."81 And, in fact, the Bank has a point. As opposed to the IM}<~ the Bank is a more open organization, made of members with a wide mnge of economic and political beliefs. This was illustrated quite neatly in the case of the debt crisis. That problem was viewed very differently by different members of the Bank staff, even at the top level. Among the ones that opposed, and discoumged, any nonofficial view on the debt problem were Clausen, Stern, and Krueger. Stem, for instance, once chastised Guy Pfeffermann, then chief economist for Latin America, for publishing in 1986 a well-regarded book on the impact of the debt crisis on poverty in Latin America.82 Krueger, after leaving the Bank to return to academia, and when almost all ob- servers were pushing for some kind of debt relief, still opposed it with such statements as: "It can even be argued that, in countries where fiscal diScipline is lax, relaxation of the debt-service burden would simply result in increases in other expenditures or a retardation in the rate of reforms."83 The claim, by the way, is at odds with what actually happened. A different view was held by another group in the Bank, which included the Vice-president for operations policy Shahid Husain, the vice-president for Latin America David Knox (the former replaced the latter in 1987), and some of the staff in the Mexico division at the Bank. By 1985, this group became convinced that mere debt rescheduling was not enough, and that debt reduction had to become part of the solution. Noone at the Bank dared to put those words on paper, however. There was a belief that the World Bank could not be an active agent on debt reduction and Simultaneously remain a preferred creditor in the capital markets. Initial work on debt reduction came from the Mexico division, which contacted Donald Lessard, a finance professor, to explore ways in which the World Bank could contribute to effective debt reduction through some form of fmancial en- gineering. The working papers and strategic sketches that resulted actually pre- ceded the Baker speech in 1985. But since the Mexico division was afraid the papers might leak, they had little effect in the rest of the Bank. Other papers were also produced internally, such as Fred Jasperson's, who worked for Pfeffermann. Furthermore, by the end of 1986, there was a change in the official attitude of the Bank itself, albeit in an unassuming and quiet way: in December the Bank appears to have put the words "debt relief' in print for the first 81. Sebastian Edwards, The EvolVing Role of the World Bank: The Latin American Debt Crisis (Washington: World Bank, undated), p. 2. 82. Guy Pfeffermann, Poverty in Latin America: The Impact of Depression (Washington: World Bank, 1986). 83. Anne O. Krueger, "Resolving the Debt Crisis and Restoring Developiug Countries' Creditworthiuess," Carnegie-Rochester Conference Series on Public Policy, vol. 30 (Spring 1989), p. 105. 86 MEXICO AND THE WORLD BANK time. It was on the last page of an economic report on Bolivia.84 By that time, the idea that debt reduction could be optimal, if the debt overhang was too taxing, had been given academic credence by Harvard Professor Jeffrey Sachs and others. 85 GURRIA BORROWS AN IDEA. Lessard's pieces were shown confidentially to Mexican officials, who grew exasperated by the schizophrenic attitude of an institu- tion that was officially ignoring any possibility of debt reduction, but was clearly taking the issue seriously. The exasperation did not last long. One day the Mexico division staff learned that Mexico's chief debt negotiator, Gurria, who had access to all the debt reduction papers, had taken them to New York and shopped around for an agent willing to do a debt reduction scheme for Mexico. He found none other than J. P. Morgan & Co., which during the entire century had been ready to do all kinds of fmancial deals with Mexico, even in the revolutionary times. 86 The new debt reduction strategy replaced the one preferred by the government up to that point: it featured debt- for-equity swaps. The conversion scheme was initiated and had its largest success (swaps actually represented half of the foreign investment in 1986), but soon afterwards enthusiasm for it abated, owing to fears of the effects of the monetary redemption that accompanied the swaps. The J. P. Morgan deal proved unsuccessfuL Mexico tried to implement it through a bond auction to be held in February 1988, expecting to redeem about $20 billion of commercial bank debt at an average discount of 50 percent, by offering, in exchange, zero coupon bonds with a maturity of twenty years and a spread of 1.625 percent over LIBOR, fully guaranteed (by zero coupon bonds that Mexico bought from the U.S. Treasury). However, the accepted bids only amounted to $3.7 billion, at an average discount of only 30.2 percent. A Heterodox Stabilization Plan By December 1987, faced with the traumatic experiencc of an annual inflation rate exceeding 150 percent (never experienced in Mexico before), the government launched a new stabilization program known as the Pacto de Solidaridad Econo- mica, the Economic Solidarity Pact. It involved heterodox policies, wage and price controls, and (as opposed to other stabilization plans tried earlier in Argentina and Brazil) some orthodox policies, such as stringent fiscal and monetary stances. In the middle was the exchange rate, which was pegged to the dollar in March 1988 as a 84. World Bank, Updating Economic Memorandum on Bolivia, Report No. 6455-BO (Washington: World Bank, Decemher 1986), p. 44. 85. See Jeffrey Sachs, "Managing the LDC Debt Crisis," Brookings Papers on Economic Activity, 2:1986, pp. 397-431. 86. See Emilio Zebadua, Banqueros y revolucionarios: La soberanfa financiera de Mexico, 1914-1929 (Mexico City: EI Colegio de Mexico and Fondo de Cultura Economica, 1994). MEXICO AND THE WORLD BANK 87 nominal anchor. Given the semi-authoritarian cum corporatist character of the Mexican political system, the package won ready acceptance from the private sector, the workers, and the peasants. The pact also involved a practice that was becoming increasingly orthodox: further trade liberalization to gain more control over domestic prices. By the end of 1987 the average tariff was lowered to just 10 percent (from 22 percent in 1986) and the weighted average to about 6 percent (from 13 percent). At that pOint, Mexico became more open than almost any industrialized country. It should be noted that the pact was similar to the Argentinian and Brazilian pacts tried a few years back. The pact brought down inflation to 52 percent in 1988 and 20 percent in 1989, without a drop in output (the economy actually grew 1.2 percent in 1988). Given its success, the government has since renewed the pact. In November 1991, a new Pacto de Estabilidad y Credmiento Econ6mico, the Pact for Stability and Emnomic Growth, allowed for readjustments in energy prices, increased minimum wages, slowed down the peso crawling peg, and decreased the value-added tax rates. The World Bank played no role in devising the 1987 pact. As noted by its own staff, "the Bank was essentially caught unprepared for the comprehensive Mexican homemade heterodox approach by dint of having focused too narrowly on trade liberalization. .. At first, Bank reaction to the novelty of the Mexican approach was slightly skeptical due mainly to unfamiliarity with aspects like inmmes policy."87 The Heyday of the Relations During Carlos Salinas de Gortari's mandate (1988-94), the government made the most drastic economic reforms in recent Mexican history. They ranged from a large-scale privatization program, to a plan to attack extreme poverty; from a free trade agreement with the United States and Canada, to a land counterreform. A masterly politician, Salinas so impressed his foreign peers that he was repor- tedly filmed by World Bank staff during a speech, for it was thought that he could be of great help in spreading the gospel of neoliberalism in other countries. His influence even reached the United States, where he received many awards and, after leaving office, was for a while the U.S. candidate to head the new World Trade Organization in 1995. Readers unfamiliar with Mexico might be puzzled about how Salinas managed to effect so many reforms and command so much recognition. It seems less surprising, however, after allOwing for the sui generis Mexican political system. For more than six decades, the dominant party, Partido Revolucionario Institucional (PRI), had delivered a model autocracy. But in July 1988, the PRI hegemony wa~ 87. World Bank, OED Study of Bank/Mexico Relations, p. 98. 88 MEXICO AND THE WORLD BANK suddenly in danger during a presidential election. Its candidate, Salinas, hand- icapped by the dismal performance of the economy during the de la Madrid administration (see again table 3-1), and his own poor public image, had to com- pete for the presidency against a popular Cuauhtemoc Cardenas, the son of re- vered former president Lazaro Cardenas. In an election marred by dubious electoral practices by the PRI, Salinas was proclaimed the winner after the computerized voting system suffered a convenient "breakdown" for several hours. When Salinas took office on December 1, 1988, many Mexicans questioned his legitimacy. To the credit of Salinas's political skills, he gained more and more recognition from some of the skeptics as his administra- tion went on. Brady Plan On March 10, 1989, Treasury Secretary Nicholas Brady disclosed a new U.S. debt plan that expliCitly incorporated, for the first time, the goal of debt and debt service relief. How much relief he had in mind is unclear, but it was certainly much lower than what Mexico and other debtor countries ended up requesting. There has been much speculation about the reasons for that change in the U.S. debt strategy, but the new initiative was, almost certainly, a response to a constellation of events happening in Latin America. First, since the 1988 electoral results in Mexico pointed to a resurgence of a nationalistic left, an event probably not welcome in the United States, the election results could have prompted the U.S. government to help Salinas to gain more legitimacy. Second, in February 1989, one month before the Brady Plan was announced, a team of Mexican government officials, headed by the new finance minister, Aspe, let the U.S. Treasury know that Mexico was going to demand a Significant debt reduction in the next round of debt rescheduling. Third, also in February, a series of riots in Venezuela left about three hundred dead after that government, follOwing typical IMF advice, took a series of unpopular adjustment measures. Fourth, in 1988, the Japanese government appeared ready to underwrite a new initiative, the Miyazawa Plan, which proposed the securitization of the debt, with the IMF as a guarantor; hence it was somewhat the predecessor of the Brady Plan. And fifth, the commercial banks' health had substantially improved by then, and they were able to write down part of their debt. Whatever the rationale for the Brady Plan, Mexico was its first benefiCiary. Tentative negotiations with the com- mercial banks and the multilateral institutions started in April 1989 and were formally on track after Mexico Signed in May 1989 an IMF three-year EFF agreement for $4.1 billion, part of whieh was expliCitly targeted for debt reduction. The core of the Brady Plan was the use of financial mechanisms to support debt and debt service reduction by exchanging old commercial debt for new securities, the so-called Brady bonds, using loans from multilateral and official creditors as MEXICO AND THE WORLD BANK 89 guarantees. Since there were supposed to be several financial alternatives to allow for some flexibility, the procedure was labeled the "menu approach to debt reduction." Negotiations between the banks and the Mexican government lasted longer than anyone thought and were colored by sharp remarks among the negotiators. B8 Just the design of the menu took from April 19 to July 23, with the low point of the negotiations coming on July 20, when President Salinas ordered the Mexican negotiators to return to Mexico for good. However, the U.S. Treasury immediately backed off (Similarly to what happened in 1982 with L6pez Portillo) and called for another round of negotiations on July 22; it turned out to be the final session. It was mediated by Brady himself, Treasury Undersecretary David Mulford (the intellectual author of the Brady Plan), and the chairman of the Federal Reserve Bank of New York, Gerald Corrigan. Despite their stated neutrality, it was obvious that they were occasionally unhappy with the Mexican negotiating stance, something that Mulford suddenly let be known with an expletive against the "number-people" on the Mexican team. 89 The menu contained three options for the banks: exchange their existing Mexi- can debt for thirty-year bonds with a 35 percent lower face value, yielding l:}l16 per- cent over LIBOR; accept thirty-year bonds with the same face value as the existing debt but \\'ith a fixed interest rate of 6.25 percent; or prOvide, over the next four years, fresh loans to Mexico equivalent to 25 percent of the existing exposure. The debt relief dishes were spiced ,'lith an oil recapture clause that gave the banks, beginning July 1996, extra income if the price of oil were to rise above $14 (real terms) per barrel. 90 It took another six months, from September 1989 to February 1990, to get all the banks to submit their choices. The deal was closed on March 28, 1990. The first option was chosen by banks holding 42 percent of the $48.5 billion of eligible commercial bank debt; the second, by banks holding 47 percent of the debt; and the third, by those banks holding the balance. After Mexico, more than a dozen other highly indebted countries used the Brady agreement. According to a careful study sponsored by the Organization for Economic Cooperation and Development (DECD), the effects of the plan differed considerably from country to country: Costa Rica benefited greatly, Mexico also gained from the deal; the Philippines and Uruguay benefited very little. 91 The agreement did help to reduce the commercial banks' exposure in the developing world, mainly at the expense of the multilateral institutions. ROLE OF THE WORLD BANK. The Bank's main financial contribution to the Mexican component of the Brady deal was made through a $1.26 billion loan for 88. See Gunia, La politica de la deuda externa, pp. 105-66, for a very detailed account. 89. Ibid., p. 147. 90. See Stijn Claessens and Sweder van Wijnbergen, "The 1990 Mexico and Venezuela Recapture Clauses: An Application of Average Price Options," Journal of Banking and Finance, vol. 17 (June 1993), pp. 733-45. 91. See Jean-Claude Berthelemy and Anne Vourc'h, Debt Reli4 and Growth (Paris: OECD, 1994), pp. 58-,'59. 90 MEXICO AND THE WORLD BANK interest support. The Bank also provided $750 million of set-asides from existing loans. Together with the IMF and World Bank loans, Japan also lent about two billion dollars, bringing the total guarantees for the new Mexican bonds to $7.1 billion. The Bank also played an important adviSOry role to the Mexican government on the design of the different options to be presented to the commercial banks. One has only to look at the memoranda in the Bank files for the year 1989, especially the ones relating to the vice-presidency for development economics (then headed by former MIT professor Stanley Fischer), to realize the enormous effort the Bank made to advise the Mexican government. It is worth reproducing some of those comments: Bank staff helped Mexican authorities to evaluate debt-seIVice reliefimplied by the different options in the menu offered to commercial banks including the pricing of the oil recapture clause. . . . The Bank also advised Mexico during negotiations with the commercial Bank AdvisoI)' Committee, initially faVOring a more demanding posture vis a vis commercial banks than the one Mexico finally took. Particularly, Bank projections of Mexico's external financing needs played an important role in validating Mexico's request for debt-seIVice relief.92 Another Bank claim, made repeatedly by its staff, is quite doubtful, however. Several published documents assert that the debt relief obtained through the Brady Plan was the main reason for the (mild) recovery of the Mexican economy during the next few years.!!.1 It is difficult to sustain this claim in view of other positive factors that were Simultaneously present during the rest of the Salinas administration (1990-94). First, world interest rates, as represented by LIBOR, dropped from an average of 9.1 percent in 1990 to 3.9 percent in 1994. Second, the income accruing from the Mexican privatization process was extremely large, reaching 4.1 percent of CDP in 1991 and 4.2 percent in 1992. And, finally, by 1992 the Mexican economy had started reaping benefits, in the form of a sharp increase in foreigu investment, from a possible North American Free Trade Agreement (see below). Of course, the Bank is entitled to advertise its work, but selective self- congratulation is less acceptable. The large number of staff papers on the Brady deal contrasts with the lack of published work on the trade reform of 1985 and the social and environmental programs in which the Bank actively participated during the Salinas administration. Privatization Process At the end of the L6pez Portillo administration, the Mexican federal govern- ment owned 1,155 enterprises. When de la Madrid left office, that number had 92. World Bank, "Review of Mexican External Debt," background paper in electronic form for the OED Study of Bank/Mexico Relations, p. 11. 93. See, for instance, Banco Mundial, America Latina y el Caribe: Diez afios despues de la crisis de la droda (Washington: World Bank, 1993), p. 48; and Sweder van Wijnbergen, ''The Mexican Debt Deal," Economic Policy, vol. 6, no. 12 (April 1991), pp. 13-56. MEXICO AND THE WORLD BANK 91 declined to 618, though most of the enterprises sold (or liquidated) were small. By the end of the Salinas administration, the number had further declined to 252, and the enterprises sold included all the commercial banks, the phone monopoly, and the two main airlines. For a while, the Mexican privatization process, among the largest in the world both in number and value of the public enterprises sold, received resounding applause from the multilateral institutions, especially the World Bank, and the industrialized world. More recently, however, a bacldash has set in, so that one can now find even in the U.S. press opinions like the follOwing: "The privatization of state-owned companies-supposedly Salinas's crowning achievement-degenerated into a piiiata for the cronies of powerful officials, beginning with the friends of the President."94 The truth, as usual, lies between the extremes. It may be too early to take full stock of Mexico's privatization process. The sheer number of enterprises sold, together with the lack of information for hundreds of them, makes the accounting a daunting job. Accordingly, the follOwing remarks are somewhat limited and general: (1) Generally speaking, the sale process was accomplished Swiftly and with limited instances of corruption. Whether the same good marks can be given to the privatization outcomes is an issue that needs some qualification, as noted below. (2) The privatization drive obeyed fiscal considerations more than effiCiency goals. Using the privatization revenue, the government was able to decrease domestic debt from 20 percent of GDP in 1988 to barely 8.5 percent in 1993. This was a good use of the sales receipts, because the economy was burdened by a huge domestic debt in the second half of the 1980s, a debt run up to pay for its foreign debt. Thus, efficiency, although given lip service by the Mexican bureaucrats, was never the main issue. Budgetary pressures account for both the speed of privatization and the government's frequent disregard for efficiency considerations. 95 (3) Just as in many other Mexican government ventures, the selling process was sometimes marred by irregularities. They ranged from selling to the nonhighest bidder (for example, the Cananea copper mine) to dubious financial engineering (such as illegally declaring dozens of enterprises bankrupt right before their privati- zation).96 The latter hoax was particularly expedient: with a single stroke, the government could make the enterprises more palatable to private buyers, not only 94. Andrew A. Reding, "It Isn't the Peso. It's the PreSidency," New York Times Magazine, April 9, 1995, p. 55. 95. Some of the many efficiency issues involved in a privatization process are reviewed by RaUl E. Saez and Carlos M. Urzlia, "Privatisation and Fiscal Reform in Eastern Europe: Some Lessons from Latin America," forthcoming in Gary McMahon, ed., Economic Lessons for Eastern Europe from Latin America (London: Macmillan, 1995). 96. Francisco Valdes Ugalde, "From Bank Nationalization to State Reform: Business and the New Mexican Order," in Maria Lorena Cook, Kevin J. Middlebrook, and Juan Molinar Horcasitas, cds., The Politics of Economic Restructuring: State-Society Relations and Regime Change in Mexico (University of California-San Diego, 1994), pp. 219-42. 92 MEXICO AND THE WORLD BANK by boosting the deals' financials but also by disposing of such nuisances as syndi- cates and possible past misconduct by the bureaucrats fonnerly in charge. (4) It is common to point to the commercial banks as successful examples of privatized companies. From mid-1991 to mid-1992, the government sold all eighteen commercial banks to the Mexican private sector in a deal that, judging solely by the revenue obtained by the government, was a resounding success; the receipts exceeded the initial value expected by the government by more than 50 percent. Yet, it is unclear that bank consumers benefited from the sale: by September 1994, still three months away from the financial collapse (reviewed below), past- due loans, as a percentage of total loans, were at an historical high of almost 10 percent. This was partly due to the high interest margins charged by what became a protected oligopolistic banking sector. After privatization, the difference between the lending and borrowing rates grew dramatically. As a consequence, net earnings grew as well. To give an idea of the magnitude of the profit margins, in 1992 the average pretax profits of the three largest Mexican banks were larger than those of the three largest French banks ($752 million versus $738 million), while the average return on assets was almost eight times as large (2.2 percent versus 0.3 percent).97 The problems of oligopolistic practices and poor asset quality were compounded by negligent regulation by the government. Examples include inadequate reserve re- quirements on the banks and a bank president who lent $700 million to his own enterprises prior to the collapse of the institution. These lapses occurred despite the fact that a $500 million World Bank loan disbursed to Mexico in 1989 was meant to be partially used to improve prudential regulation and supervision in the financial sector. It is true that the absence of these problems during the period of government ownership could be attributed partly to the banks being forced to fmance the government, rather than the private sector. Yet, deregulation of the sector, which relaxed the requirement of forced lending as well as lending rates, started in 1988-three years before the banking sector was privatized, a period during which the nationalized banks continued to be managed reasonably well. An antistatist reader might ask, but what about the quality of the banking services? Surprisingly, the privatized banks have perfonned better, at least regard- ing the provision of innovative services, than when they were government owned. After the nationalization, the banks developed several new products, ranging from NOW-type accounts to such services as factOring. As an extensive study on the subject concludes, the government "used nationalization to strengthen the banks, in order to perform a market oriented role in the economy.... The banks became profitable and introduced many new products and services."98 97. Figures calculated by the author using data from The Banker, July (vol. 143, no. 809, p. 99) and August 1993 (vol. 143, no. 810, p. 43). 98. Dianne Stewart, "Changes in the Pattern of Ownership, Structure and Operations of the Mexican Banks: 1982-1991," Working Paper No. 26 (London: Department of Economics, SOAS, University of London, 1992), p. 34. MEXICO AND THE WORLD BANK 93 (5) But the bad ex post performance of the privatized banking sector pales in comparison with the performance of other privatized enterprises. Three cases taken from a cross-country privatization study sponsored by the World Bank and conducted from 1990 to 1992 are illustrative. The study included two airlines, Aeromexico and Mexicana, as well as the phone monopoly, TeIefonos de Mexico (TELMEX).oo Very Simply, the first two firms were technically bankrupt by mid- 1995, even though they were financially healthy when sold by the government in 1989. A more subtle case is the monopoly TELMEX. In the study sponsored by the Bank, a key question is raised: who won and who lost from the sale? The author of the study answered candidly: The government gained ... other winners were employees, domestic shareholders, and buyers .... Foreign buyers have gained 27 percent of 1991 sales, so there has been substantial leakage of benefits abroad .... Consumers were the only losers. They lost mainly because of the pricc increases. It is important to emphasize, however, that this welfare loss to consumers is not net of any gain from improved quality, which could be substantial. 1oo Moreover, foreign buyers not only gained 27 percent (of 1991 sales) but also won most among the groups of winners. Furthermore, Mexican consumers lost more than 60 percent (of 1991 sales)! Finally, regarding the issue of higher quality, it is interesting to note that from 1990 (the year of its privatization) to 1994 TELMEX led the number of complaints received by the Mexican consumer protection agency: 70 percent of all complaints. (6) A final troubling aspect of the privatizations was their effect on equity. In reviewing the privatizations covered in the above mentioned study. then chief economist of the World Bank Lawrence H. Summers argued, "there will probably still be some privatizations that will make some people very rich, and the ethical defense of that wealth will be difficult to achieve ... [b Jut if, as I believe, issues of income distribution are best approached through concern for the poor rather than envy of the wealthy, tllese results will not prove to be such a serious problem."lol To place Summers's argument in perspective, consider the follOwing: according to the magazine Forbes, the number of billionaires in Mexico rose from two in 1991, to seven in 1992, to thirteen in 1993, to twenty-four in 1994. 102 By then Mexico had more billionaires than the United Kingdom and Italy. Admittedly, part 99. Pankaj Tandon, "Mexico," in Ahmed Galal and Mary Shirley, eds., Does Privatization Deliver? Highlights from a World Bank Conference (Washington: World Bank, 1994), pp.59-69. 100. Tandon, "Mexico," p. 68. 101. Lawrence H. Summers, "A Changing Course toward Privatization," in Galal and Shirley, eds., Does Privatization Deliver?, p. 17. 102. Forbes, "The Billionaircs," July 18, 1994, pp. 134-219. 94 MEXICO AND THE WORLD BANK of the reason was that the peso was grossly overvalued in 1994; a year later, "only" ten of the twenty-four remained on Forbes's list. Still, how did Mexico create a net increase of eleven billionaires during 1993, a year in which the economy was virtually stagnant? One simple reason is that most of those "entrepreneurs" were earning rents from oligopolistic privatized industries and unregulated privatized monopolies. 103 PRONASOL: A Program against Extreme Poverty Salinas's doctoral dissertation in political economy written in the late 1970s was entitled "Public Investment, Political Participation, and System SUpport."104 Clearly, he had a long-standing interest in how economic patronage could build political support. Not surprisingly, this interest would be reflected in his programs, especially that against extreme poverty, Programa Nacional de Solidaridad (PRONASOL), the National Solidarity Program, which was initiated soon after he took office and lasted until mid-1995 (when a new program with a less centralist overtone was launched). From the beginning, PRONASOL was supposed to be a grassroots poverty alleviation program. Among its key elements were (i) the direct targeting of poor communities by the federal government, bypassing state and local governments; (ii) the use of a corps of local leaders; (iii) an emphasiS on beneficiary participation; and (iv) the provision of soft loans to small enterprises. In one way or another, the first three of those elements were present in Salinas's doctoral thesis on how to build system support. The World Bank publicly embraced PRONASOL. In private, however, Bank staff were more cautious: "The co-existence of the hefty subsidies and grants-in-aid under Solidarity with policies to liberalize and deregulate urban development and housing markets may prove contradictory at the local level. It is, however, consis- tent with the Mexican tradition of identifYing each president with a particular social interest program which generally operates apart from the long-term development policy."105 In any event, by early 1991 the Bank had already made an important contribution to PRONASOL, when it approved a loan for $350 million as part of a $1.4 billion program to attack extreme poverty in the four poorest Mexican states: Chiapas, Guerrero, Hidalgo, and Oaxaca. lO3. For instance, Carlos Slim, the sixth richest man in the world in 1994, is the largest stockholder ofTELMEX. lO4. Carlos Salinas de Gortari, Political Participation, Public Investment, and System Support: Study of Three Rural Communities in Central Mexico, Ph.D. dissertation, Harvard University, 1978. The Spanish version appeared as Producci6n y participaci6n politica en el campo (Mexico City: Fondo de Cultura Econ6mica, 1982). 105. World Bank, "Overview of the Urban Sector Story," background paper in electronic form for the OED Study ofBanklMexico Relations, p. 4. MEXICO AND THE WORLD BANK 95 Empirically, the obvious question is whether PRONASOL succeeded in poverty alleviation. Interestingly, there has been almost no study of this question, though there is a considerable literature on the electoral effect of the program in 1994. From the few available studies of poverty, three discouraging findings emerge: first, political and administrative criteria were more important than extreme pover- ty in explaining the state,vide allocation of funds; second, in Chiapas many of the poor viewed the program as a government imposition that forced them to provide unpaid labor for projects that would not directly benefit them; and third, regional distribution was not responsive to comparative need as indicated by World Bank guidelines. 106 Clearly, more evidence on the impact of the program is needed, especially given the sharp increase in the percentage of poor people during the Salinas administra- tion (see table 3-1). In particular, it can be argued that the World Bank, as a main endorser of PRONASOL, should fully appraise its success, or lack of it. Further- more, whatever the Bank ultimately finds, the research should be made public by the Mexican government to quell suspicions (most likely erroneous) that PRONASO L was solely a pork barrel program devised by Salinas to get votes for his party. North American Free Trade Agreement At the beginning of his administration, President Salina,> was reluctant to con- sider the possibility of a free trade agreement with the United States and Canada, even though members of his cabinet, especially tlle new trade minister, Jaime Serra Puche, urged him to do so. It is said that the Mexican government started to consider an agreement seriously only in 1989 when it looked very possible that Eastern Europe could draw an increasingly larger share of foreign investment from the West (a possibility that did not materialize). Once it decided to go for an agreement, tlle Mexican government allocated a lot of effort, as well as money, lobbying during the fonnulation of the trade agreement and getting it passed. After some strong opposition in the United States and Canada, and almost none in Mexico, the final text of the North American Free Trade Agreement (NAFTA) was Signed at the end of 1992 and took effect the first day of January 1994. There is no evidence to indicate that the World Bank ever sponsored the agreement or participated in its deSign. Perhaps regional trade is not the Bank's cup 106, See, respectively, Adalberto Garcia Rocha and Alejandro Guevara, "Impacto SOclO- economico del Programa Nacional de Solidaridad en el estado de Zacatecas» (Mexico City: EI Colegio de Mexico, 1992); Carlos Marin, "Estudio del propio Consejo Consultivo del Pronasol: Solidaridad hundi6 mas en la desesperanza a los ocho municipios del estallido zapatista," Proceso, January 9, 1995, pp. 28--33; and Sara Lovera, "Efecto relativo del Pronasol en el combate ala pobreza extrema," Jomada, October 3D, 1994, p. 25. 96 MEXICO AND THE WORLD BANK of tea, or it would have heen awkward for the Bank staff to help Mexico, or any other participant, in the trade negotiations. Nevertheless, the Bank made sixteen sectoral studies on how NAFTA would affect the Mexican economy. Most remain unpublished and are not particularly enlightening. The only one published was on the agricultural sector; it attempts to show that the impact of NAFTA on poor, com-producing rural workers would be relatively mild. 107 Land Counterreform At the end of 1991, Salinas called for an amendment to the Mexican constitution that would modifY the land tenure system inherited from the Mexican Revolution. The system had rested, since the Agrarian Reform Act of 1915, on the prinCiple of communal lands (ejidos and comunidades agrarias) owned by the state and lent to the peasants. The core of Salinas's counterreform was to change property rights and make it possible for the peasants to trade the communal land, which accounted for about 60 percent of total arable land in central and southern Mexico. Before, the gidatarios were able only to bequeath to their descendants their rights in an ejida; they could not (in principle) rent the land. By transferring the property rights to the peasants, the government hoped to induce the more productive ejidatarios to hold more land and benefit from increasing returns to scale. The reform also attempted to send a message to the private agricultural and cattle-raising sectors that the expropriation risk with which they had had to cope for many decades was gone. As noted earlier, the Bank has had a long-standing interest in the Mexican land tenure system, going back to Ladejinsky's work in 1966. Yet, Mexican officials deny that the Bank played an important role in the counterreform, and only a few Bank documents refer to it even tangentially. Consider, for instance, the follOwing state- ment: 'Whether [the land counterreform] will ease or exacerbate the problem of rural poverty remains to be seen. The Bank has only recently begun to show an interest in this subject that goes beyond micro-economic effiCiency. However, in deference to Mexican political sensitivities, the Bank (as well as the IDB) are keeping a low profile with respect to reforms in this field, while furnishing advice and technical collaboration when so requested."lOB It should be noted in passing that the skepticism of the Bank regarding the land reform was warranted: the impact of the reform has not been Significant. 107. Santiago Levy and Sweder van Wijnbergen, "EI mafz y el Acuerdo de Libre Comercio entre Mexico y Estados Unidos," Trimestre Econ6mico, voL 58, no. 232 (October 1991), pp. 823--62. 108. World Bank, "Study of Relations between the World Bank and Mexico: The Agricul- tural Sector," background paper in electronic form for the OED Study of Bank/Mexico Relations, pp. 23-24. MEXICO AND THE WORLD BANK 97 OTHER WORLD BANK INVOLVEMENT. During the Salinas administration, the Bank had up to fifty-five people in Mexico at one point plOwing through the government's list of reforms with Mexican officials. The Bank's main contribution was to give other perspectives by providing the officials with intellectual partners for discussions. There is no space to go over the list of sectoral reforms undertaken jOintly by the Mexican government and the Bank during the Salinas government, but very briefly one reform that the Bank tenaciously pursued for almost a quarter of a century was the deregulation of the transport sector. Starting with its 1971 report on the transport sector in Mexico, the Bank had always been quite critical of the way in which the Mexican government had regulated entry into the trueking industry and controlled freight rates. The Bank won the argument in 1989, when the Mexican government relaxed entry conditions into the trucking industry, and a year later abolished the regulation of freight rates. A Lackluster Perfonnance Despite Mexico's much lauded stabilization efforts from 1987 onward, plus the financial relief that was to have resulted from the Brady Plan, the resources that accrued from privatization, and the many structural reforms touted by the World Bank, a tantalizing puzzle remained: the Mexican economy continued to grow anemically. This is illustrated quite dramatically in table 3-2, which presents a ranking of the last eight administrations in terms of key economic indicators. Comparatively speaking, the Salinas administration did very poorly. The performance of the economy during that period was the worst, except for that during the de la Madrid administration (which can be partially explained by the poor policies followed during the last two years of the LOpez Portillo administration). Furthermore, it is precisely during those two periods that the Bank had some influence on the macroeconomic policies followed by the Mexican government. Given such a dismal performance, by early 1994 the Bank was already distanCing itself from the economic reforms adopted in Mexico. In a 1992 article entitled "Mexico's Growing Intimacy with the World Bank," the Financial Times was quot- ing the Mexican debt negotiator Gurria as saying that World Bank economists "and Mexican officials often spend weekends together brainstorming on policy issues. Many are the graduates of the same U.S. universities, and friends."l09 But two years later, the same newspaper was reporting that the Bank "is worried about Mexico's slow economic growth and low sa\ings rate, which it believes makes its economy over-dependent on foreign capital."IlO 109. Damian Fraser, "Mexico's Growing Intimacy with the World Bank," Financial Times, March 3,1992, p. 7. 110. Damian Fraser, "Trying Hard but Could Do Better, Says World Bank," Financial Times, February 22, 1994, p. 6. Table 3-2. Rankings of Economic Performance, 1946-94 World Bank Real Growth Gross Current Percentage of influence in GDP Inflation of real national Public sector account Public foreign poor macro policy growth rate wages savingslGDP deficitlGDP deficitlGDP debtlGDP households Aleman Minimal 6 4 2 8 1 2 3 n.a. Ruiz Cortines Minimal 2 3 5 7 2 5 1 n.a. Lopez Mateos Minimal 2 1 1 6 3 3 2 6 DfazOrdaz Minimal 4 2 3 3 4 4 4 5 Echeverria Minimal 5 5 4 4 6 6 5 2 Lopez Portillo Minimal 1 7 6 1 7 7 7 1 Dela Madrid High 8 8 8 2 8 1 8 3 Salinas High 7 6 7 5 5 8 6 4 Sources: See table 3-1. MEXICO AND THE WORLD BANK 99 A New Financial Crisis On December 1, 1994, Ernesto Zedillo took office as the new president of Mexico. Twenty days later the Mexican financial markets were in trouble. Three months after that, the Mexican eeonomy was heading toward its largest recession since 1932. The factors behind this collapse were so many and sometimes so bizarre that the following brief synopsis can seem occasionally like the script of an operetta. Promise of Foreign Investment To understand what happened next to the Mexican economy, it is necessary to pause over a key worldwide development that started in the late 1980s: the renais- sance of private, nonhank foreign investment. From Mexico to India, from China to even Cuba, the phrase "foreign investment" began flOWing from the lips of policy makers with a fervor of alchemists close to a major discovery. Equally remarkable is that, unlike what bappened in the 1970s, the developing world welcomed foreign capital in all forms, from foreign direct investment to portfoliO investment in stock markets. Furthermore, the sharp increase in demand for capital was partially fulfllied by the suppliers: about three-fourths of the long-term investment to the developing world is now private, although the growth in private capital flows to less developed countries has recently subsided (from 55 percent of annual growth in 1993 to 9 percent in 1994). However, as optimism about Latin American economic prospects rapidly trans- formed into euphOria, Mexico came to depend too heavily on sales of short-term government bonds to foreigners. By the end of 1993, this type of debt to foreigners accounted for over $21 billion. with 70 percent of it coming from sales of peso- denominated treasury bills, Cetes. During 1994, though, foreign (and domestic) investors started to change the composition of their bond portfolio toward the so-called Tesobonos, bonds denominated in Mexican pesos but pegged to the preVailing peso-dollar exchange rate as a way to protect against exchange risk. When Salinas left office at the end of Kovember 1994, Tesobonos accounted for about 70 percent of the roughly $24 billion owed to foreign short-term bond holders. These highly speculative and volatile forms of investment can represent a high risk for an economy that grows too dependent on them. This rather obvious fact was painfully evident during the 1994-95 Mexican financial crisis. A Rebellion and Two Assassinations On January 1, 1994, the precise day when NAFTA went into effect and eleven months from the end of the Salinas administration, a peasant uprising began in the southern highlands of the state of Chiapas. That day, hundreds of masked natives of Maya descent, the poorest of the poor, boldly occupied several cities to demand 100 MEXICO AND THE WORLD BANK better economic and social conditions. The Chiapas uprising was a public relations debacle for the Salinas administration. The charismatic leadership of the Ejercito Zapatista de Liberaci6n Nacional (EZLN), under Subcomandante Marcos, fired the imagination of a segment of the Mexican population. l l l But the shocks to the Mexican political system did not stop there. Almost three months after the uprising, on March 23, Luis Donaldo Colosio, the PRI presiden- tial candidate in the upcoming elections, was assassinated. The murder was alleged to have been committed by a lonely and deranged man, although other hypotheses point to a conspiracy. After Colosio's death, Salinas hurriedly handpicked Emesto Zedillo, a Ph.D. in economics from Yale with no charisma and little political background, as the new PRI candidate. Helped by a still growing economy, Zedillo won the presidential election on August 21 with 50.2 percent of the valid votes. That magnitude was large enough to appease most of the opposition, and the renewed stability was only slightly shaken when a month later, on September 28, Jose Francisco Ruiz Massieu, the new PRI secretary and a self-described political reformer, was assassinated. But the worst was to come, and the next and decisive blow to the system would be financial. Beginning of the Financial Crisis As political events unfolded, foreign reserves, which had attained a respectable peak of about $29 billion by the end of February 1994 (the EZLN uprising in January notwithstanding), started a toboggan ride down. After the killing ofColosio in March, the reserves suffered a fast and continuous depletion of more than $10 billion in less than a month, forcing Mexico to ask for help from the u.S. Treasury, which opened a six billion dollar line of credit to prop up the peso. To compound the problem, an unexpected rise in U.S. interest rates took place over 1994: the average of the three-month T-bill rate went from 3.02 percent to 5.64 percent between January and December. Given those factors, the central bank had lost $13 billion by July. That figure included several billion dollars used in active interventions when the number of pesos per dollar in the foreign exchange market exceeded a certain threshold. (The peso had been allowed to float inside an exchange rate band whose ceiling and floor were daily adjusted by a preannounced depreciation rate.) The situation appeared to improve after the presidential elections in August, and the reserves did not change much immediately after the killing of Ruiz Massieu at the end of September. However, after the prosecutor of the case reSigned in November 23, alleging the complicity of PRI bosses in the killing, a new drop of several billion dollars ensued in the next few days. Thus, when Zedillo came to 111. A good reference in English to the armed movement is Alma Guillermoprieto, "The Shadow War," New York Review of Books, March 2, 1995, pp. 34-43. MEXICO AND THE WORLD BANK 101 office at the beginning of December, foreign reserves were at about $10 billion, almost one-third of its peak nine months earlier. The stage wa~ ready for a final run on the peso. And the new government did not wait long to provide a reason for it. Immediately after taking office, President Zedillo sent signals that he was considering a military option in the case of the EZLN rebellion. As a response, the rebels started a swift advance that allowed them by December 18 to take posses- sion of dozens of villages. Predictably, the next day Zedillo got the news from the new finance minister Jaime Serra Puche that the prospect of further trouble in Chiapas had prompted investors to move about one billion dollars out of Mexico in a Single day, that the peso had reached the exchange rate band ceiling, and that the stock market had gone down more than 4 percent. That same night, at 10:00 p.m., a meeting was convened for the signing of an "addendum" to the Pacto para el Bienestar, la Estabilidad y el Crecimiento, the Pact for Welfare, Stability and Growth, the last of the series of economic pacts that, as noted earlier, had been renewed from time to time since the late 19805. In that meeting, Serra told the private sector representatives that the government was considering stopping central bank intervention in the exchange market, allowing the peso to fall an estimated 15 percent. But, after an arduous debate that lasted hours, it was agreed instead on widening the exchange rate band by increasing its ceiling by 15 percent. The next day, foreign reserves fell by about $3 billion. As a consequence, a new pact meeting had to be held a day later to announce that the central bank would let the pcso freely float. Another Pact and a Rescue Plan A new pact, Acuerdo de Unidad para Superar la Emergencia Economica, the Unity Agreement to Overcome the Economic Emergency, was unveiled on January 3, 1995. This pact involved the free flotation of the peso and a cut in government spending. It also contemplated the future privatization of railroads and ports and the opening of the banking system to complete foreign ownership. Weeks later, the privatization ofPEMEX's secondary petrochemical production and gas distribution was also announced. The plan also included thc provision of a line of credit of $18 billion extended by the U.S. Treasury (1$9 billion), the Canadian government (about 81 billion), other members of the Bank for International Settlements ($5 billion), and some foreign commercial banks ($3 billion). Most of the credit was to be used to finance the repayments ofTesobonos, of which the amount outstanding was then about $29 billion. On the next Monday, January 9, after the Banco de Mexico increased short-term interest rates on domestic bonds to 50 percent, the Mexican stock market suffered a 6.7 percent loss, and the central bank had to ask the intervention of the central banks in United States and Canada to support the peso. But the consequent gain of 7.7 percent in the peso value was qUickly lost a day later when there was a decline 102 MEXICO AND THE WORLD BANK of 8.1 percent. During that same day, the exchanges in Argentina and Brazil had losses of more than 9 percent. This was the most dramatic example of what was becoming known as the "tequila effect." This picturesque term was first coined in South America, after the Argentinean and Brazilian financial markets started to suffer the indirect consequences of the devaluation in Mexico. Since both of these countries had been using the dollar exchange rate as a nominal anchor to control inflation, private investors in the industrialized world saw them as the next trouble spotsY2 It only took a week after Zedillo's announcement of the new pact for everybody to realize that the Mexican economy was not going to survive without either a moratorium or a larger injection of dollars. Thus, U.S. President Bill Clinton was forced on January 12 to announce the possibility of a new package of U.S. loan guarantees for as much as $40 billion. But in less than a week, Clinton faced a revolt from both Republicans and Democrats against the package. On January 30, the Mexican stock market then plunged again to its lowest level in more than a year, and the peso dropped to 6.35 pesos to the dollar, a devaluation of about 85 percent from before the crisis. On the same day, several U.S. senators made known that the aid package would not pass the Senate, despite the announcement that it had the bipartisan backing of three former presidents, six former secretaries of state, five former secretaries of the Treasury, and six former secretaries of commerce. At 11:30 that night, President Clinton changed plans. A New Package, and Some New Mistakes On January 31, Clinton, bypassing the U.S. Congress, announced a new $51 bil- lion rescue plan for Mexico. The plan extended the U.S. Treasury line of credit to $20 billion, by means of the Exchange Rate Stabilization Fund. It also included a $10 billion increase in the IMF standby agreement announced a week earlier, for a new total of $17.8 billion. Also, the pledge made on January 3 by the Bank for International Settlements was doubled to $10 billion, and the $3 billion promised by the commercial banks was reaffirmed. The $20 billion pledge was controversial in the U.S. Congress. After all, it committed four-fifths of the entire U.S. Exchange Rate Stabilization Fund. But the $10 billion increase in the IMF standby agreement was even more contentious 112. It is also interesting to record that the "tequila effect" not only affected financial markets in the Americas but also the market for neoliberal economists: "Shame of the Technocrats," read the January 16 cover of Newsweek (international ed.). That phrase probably sounded quite strange to the many academics who just a few years earlier had been celebrating the arrival of economics Ph.D.s to Latin American cabinets. See, for instance, the witty paper by John Williamson, "In Search of a Manual for Technopols," in John Williamson, ed., The Political Economy ofPolicy Reform (Washington: Institute for International Economics, 1994), pp.11-28. MEXICO AND THE WORLD BANK 103 among IMF members, given that the initial proposal of $7.8 billion was already a record. Although the IMF board accepted the increase the day after Clinton's announcement, some European nations abstained from approving the increase, as a silent protest against not being consulted. Since the IMF credit could not, in principle, be larger than $7.2 billion, roughly the dollar equivalent of 300 percent of the Mexican quota in special drawing rights, the European representatives expressed concern that the United States was dangerously bending the institutional rules. In the end, the IMF directors pulled out of the hat an "exceptional clause" that allowed the extra amount. A few days later, the Group of Seven industrialized countries publicly endorsed the plan. Predictably enough, the day after Clinton's announcement, the Mexican stock market bounced back by more than 10 percent, although foreign reserves were just about $3.5 billion, and the amount of Tesobonos still circulating was nearly $24 bil- lion (roughly $14 billion in the hands of foreigners). With the bailout, everything suddenly seemed to go right: the World Bank announced it would lend $2 billion to Mexico during 1995 to strengthen its financial system, advise on the new rally of privatizations, and support poverty alleviation programs, and the IMF disbursed $7.8 billion from its line of credit. A Chain of Mishaps Soon after negotiations with the United States over the terms of the financial rescue plan, President Zedillo went on national television to announce that he had ordered the arrest of the EZLN leaders, after disclOSing their presumed identities. The move did not succeed: the rebels hid in the jungle, and more than one hundred thousand Mexicans immediately took to the streets in repudiation of the govern- ment while chanting «All of us are Marcos." By mid-February, Zedillo was backing away from his verbal attacks on the EZLN, and the initial euphoria in the Mexican markets was abating. At last, on February 21, the three-week-long bargaining session between Mexican and U.S. officials on the terms of the bailout plan was concluded. The foremost condition, in Mexican eyes, was that which required foreign buyers of Mexican oil to send payments to a special account in the Federal Reserve Bank of New York in case Mexico were to stop repayments of the loan. Although the use of Mexican oil as collateral went back to 1982, the novelty in 1995 was that all the oil revenue had to be deposited in the United States, regardless of whether or not there was a breach of contract. Other loan conditions called for Mexico to follow a stringent monetary poli<-y, to realize a fiscal budgetary sUlplus in 1995, and to publish some key economic indicators, including the main items of the central banks balance sheet, weekly; before, the central bank revealed only the amount of foreign reserves and only thrice a year. ON HOW NOT TO PLAY POKER. The financial bailout was regarded in the United States as a defense of the neoliberal economic policies that Mexico and 104 MEXICO AND THE WORLD BANK other Latin American countries had cspoused in the 1990s. According to the director of the Washington-based Institute for International Economics, a Mexican financial collapse would have tempted other countries to revert "to the discredited managed-economy policies of the pa~t ... [which] would of course be extremely adverse to the interest of the U.S."m Yet, the terms of the agreement were greeted with great resentment and skepticism in Mexico: on the day of the announcement, the peso fell 4 percent against the dollar, the interest rate on domestic bonds rose 2.5 percent, and the stock market lost 4.9 percent of its value. Why did the Mexican government show so much docility while negotiating the loan terms? As in other instances, the answer seems to lie in the poker players. Responding to several economists (inside and outside Mexico) who wanted the government unilaterally to extend the maturity of the Tesobonos so that they could be repaid over a much longer period, Zedillo publicly declared that a debt mora- torium would only hurt Mexico. At one point he claimed, based on unknown arguments, that a moratorium could cause a drop in CDP of up to 30 percent. Two New Pacts Paralleling the rapid decline of Mexico's economic fortunes was that of the principal architect of these poliCies, Carlos Salinas. FollOwing the arrest of his brother Raul on February 28, who was accused of mastenrunding the murder of PRI Secretary Ruiz Mas!>ieu, Salinas launched a hunger strike and soon had to go into an exile. Naturally, the turbulence of the Salinas family saga seized the economy as well. By March 9, the peso had fallen to 7.5 pesos per dollar, a devaluation of 120 percent since Zedillo came to office. That night, the Mexican government finally disclosed the long-awaited adjustment plan negotiated with the U.S. Treasury and the IMF. Perhaps the only true novelty of the pact was its Orwellian doublespeak: Program a de Accion para Reforzar el Acuerdo de Unidad para Superar la Emergencia Econ6mica-the Action Program to Reinforcc the Unity Agreement to Overcome thc Economic Emergency. Its content was very much as expected, since the agreement with the U.S. Treasury already had as conditions some new measures, while the rest were typical of most IMF stabilization programs. As the U.S. Treasury and IMF credits were religiously used to pay back the debt in Tesobonos, the financial markets settled down for the next six months. Better than expected export perfornlance, coupled with substantial import compression, also helped; they allowed Mexico to effect a trade surplus by the first quarter of 1995. Finally, the initiation of a peace dialogue between the government and the EZLN in April calmed nerves. By October, however, the markets suffered a new upset, although by then practically all the Tesobonos had been paid. Thus, the government was forced to 113. C. Fred Bergsten, quoted in Time (intemationai ed.), March 6, 1995, p. 14. MEXICO AND THE WORLD BANK 105 announce a new pact at the end of that month in the hope of reviving the economy through tax deductions and fiscal incentives to enterprises hiring more workers. At the root of the new turmoil was the cold fact that the economy had in 1995 its largest recession in memory, with an annual drop in real GOP of 6.9 percent. The adjustment, it was now clear, had been too severe. ll4 To end with the saddest note of the drama, around one and a half million workers lost their jobs in the formal sector during 1995. AND THE WORLD BANK? The main contribution of the World Bank during the crisis was to help, with the lOB, to capitalize the Fondo Bancario de Protecci6n al Ahorro (FOBAPROA), an insurance banking fund created in 1990, which served as the conduit for an emergency capitalization program for the banking sector, called Programa de Capitalizaci6n Temporal. The FOBAPROA was urgently needed since the commercial banks faced a sharp increase in nonperforming assets, due to both bad lending practices and sharp hikes in interest rates; as such, the govern- ment had to rescue the entire financial sector. The Bank contributed not only by extending a loan of more than $1 billion but also by helping to diagnose the health of the financial system and to reform the accounting standards and prudential regulations for banks. As noted earlier, the Bank had already provided to the Mexican government a financial sector adjust- ment loan in June 1989 that lasted until June 1993, \vith obviously inadequate results. AND THE CASSANDRAS? Contrary to the crisis ofl982 recounted earlier, the new crisis did not take all people by surprise. As far back as 1992, several academics were warning about the current account defiCit, which that year had reached an historic high of 7 percent of GOP. In fact, by the end of 1992 the deficit was very likely unsustainable without a change in macroeconomic po!iciesYs The political opposition also supplied a few Cassandras. For instance, the two main opponents to Zedillo in the presidential race, Cuauhtemoc Cardenas and Diego Fernandez de Cevallos, both warned about the risk of an overvalued ex- change rate. In Cardenas's first economic speech as a candidate, he was so close to forecasting what happened fifteen months later that, as one observer noted, he failed only to give the precise day and hour of the crisisY6 Similarly, Fernandez de Cevallos's economic plan hung on the premise that a peso correction would be unavoidable after Salinas left office. On the other hand, both the IMF and the U.S. government failed to acknow- ledge the gravity of the situation. The IMF's review of the Mexican economy in 114. See Carlos M. Urzua, "Monetary Policy and the Exchange Rate," paper presented at the conference "Mexico: Assessing Neo-liberal Refonn," held at the University of London, London, December 1, 1995. 115. See Urziia, "Monetary Policy and the Exchange Rate." 116. Adolfo Aguilar Zinser, iVarrws a ganar! La pugna de Cllallhterrwc Cardenas par el poder (Mexico City: Oceano, 1995), pp. 360-64. 106 MEXICO AND THE WORLD BANK February 1994 does not contain any hint of a possible financial crisis, or even of the eventual need to adjust the exchange rate. This failure, from an organization designed to anticipate problems in countries' external accounts, is quite worrisome. The U.S. government failed, according to a critic of the Clinton administration, to recognize the seriousness of the problem even after receiving a series of signals and warnings. Already by March 1994, the U.S. Treasury had had to open a line of credit for Mexico. Furthermore, the Central Intelligence Agency was sending warnings about the Mexican economic situation by the spring of 1994. There were even internal U.S. Treasury documents on the subject being circulated a bit laterY7 Interestingly, the World Bank did have some misgivings about the Mexican economie situation as early as the beginning of 1993. This is shO\vn in an aide memoire written after a mission that took place in January 1993: The high [Mexican) current ac'Count deficit would be less of a concern if it could be traced primarily to a rise in domestic investment, rather than to a fall in domestic savings. . . . The economy is now dependent on high levels of foreign capital inflows, which are subject to often rapid shifts in expectations .... Whether it will be possible to work out of this situation with little cost is not clear.... All this suggests that the Government should consider allOwing further exchange rate flexibility, which could be best achieved through a widening of the band. 1l8 Given the varied perceptions that individuals and institutions held about the Mexican economy from 1992 to 1994, were there factors that misled observers? One factor could have been Salinas's undeniable political skills, which caused such euphoria in some foreign circles. Another could have been the way in which the Mexican government hid information, even from its own citizens, a dramatic example being the concealment of the deficit of financial internlediaries (with Nacional Financiera the prime example) in 1993 and 1994. By that means, the government was able to overspend on the back of its citizens, especially during the election year (1994). Finally, foreign observers may have overestimated the inde- pendence of the central bank, perhaps taking too seriously the fact that the Banco de Mexico bccamc nominally autonomous in April 1994. Concluding Remarks As interesting as the most recent economic events in Mexico are, relations between the World Bank and Mexico have evolved over the last five decades and gone through several stages. As is apparent from the chapter, the fIrst stage took place during the twenty-fIve-year period from 1946 to the end of the 1960s. 117. A. M. Rosenthal, "Cover-Up Chronology," New York Times, April 4, 1995, p. A25. 118. World Bank, "Aide Memoire: Mexico Private Sector Assessment Study," unpublished paper (Washington: World Bank, 1993), pp. 3-4. MEXICO AND THE WORLD BANK 107 Regarding that period, Mason and Asher claim, in their classic book on the Bank written in the early 1970s: "In a country like Mexico, which has made excellent economic progress and has received substantial assistanee from the Bank, some believe that the progress was due almost exclusively to Mexico's firm adherence to policies it considered appropriate rather than to the regular flow of loans and advice."1l9 This is true, except for the assertion that Mexico received "substantial assistance from the Bank." As noted earlier, almost all of the Bank's sectoral loans were used for just two purposes: electrical power development and irrigation projects. And although the World Bank did produce several high-quality reports on the Mexican economy, the fact is that the Bank had little influence on the economic policies undertaken during the period. The second stage in the relationship developed during the nrst part of the 1970s. The similarity of views on economic issues, such as the need to attack rural poverty, between McNamara's Bank and the Echeverria government led to a series of interesting and diverse joint projects. Those fruitful relations could have continued under the L6pez Portillo administration had oil not come onto the scene. Once the Mexican government started to borrow from private commercial banks in the Eurodollar market, a new phase in the relationship developed-one in which the government, out of a genuine regard for the Bank, (,'ontinued to pursue several sectoral projects jOintly, but also one in which the role of the Bank as a policy interlocutor became almost negligible. After the debt crisis of 1982, a new, much closer association developed. During the de la Madrid administration, particularly from 1984 to 1988, the World Bank continuously widened its policy dialogue with Mexico. This was a consequence of the introduction of structural adjustment loans and Mexico's need for fresh loans. During this period, the Bank was a key factor in several reforms made by the Mexican government, including the important trade liberalization of 1985. Fur- thermore, in the second half of the 1980s, the World Bank shed its passive role regarding the developing-country debt crisis and became an active player in devis- ing debt reduction mechanisms later used by the government. The apogee of the relationship occurred during the Salinas administration. During those years, the Mexican government and the World Bank engaged in an open policy dialogue on almost all major economic issues, with dozens of Bank staff working in Mexieo at various points. The level of the Bank's involvement in several reforms of the period was quite high, although the outcomes were varied. Ex- amples range from a successful collaboration during the negotiations to secure debt and debt service reductions from private banks, to an association in the controver- sial PRONASOL, to a joint effort to improve the prudential regulation of the fmancial sector. 119. Edward S. Mason and Robert E. Asher, The World Bank since Bretton Woods (Brookings, 1973), p. 648. 108 MEXICO AND THE WORLD BANK The final phase of the relationship between the World Bank and Mexico came with the financial crisis at the end of 1994. The resources needed to overcome that crisis pushed the IMF and the U.S. Treasury to the fore and in 1995 the role of the World Bank was reduced to the channeling of funds to save the Mexican financial system. Given the amount of funds required to do so (more than 5 percent ofGDP was spent in 1995), it is likely that a good part of the Bank's loans will be allocated to that end in the next few years. Finally, what will the next century bring to the relationship between the World Bank and Mexico? It is difficult to say, given that Mexico will be an entirely different country. Not only will the economic crisis have brought signifieant policy changes by then, but the authoritarianism that has ruled Mexico for so many decades will likely disappear. The nature of the new political system will be the most important determinant in future Bank-Mexico relations. This probably means that the days of fast, sweeping economic reforms is gone and that the Bank will be dealing with a more diverse set of political and social groups. Despite the challen- ges such pluralism will pose, there is strong evidence that the new political reality in Mexico represents a step forward: as the Mexican history has repeatedly shown, it is risky to leave all important decisions in the hands of just a few. FOUR The World Bank and Cote d'Ivoire Jacques Pegatienan and Bakary Ouayogode WHEN the World Bank began its intervention in independent Cote d'Ivoire, in June 1968, most international opinion subscribed to the view that Black Africa, politically independent since the early 1960s, was off to a bad start on its journey toward economic development. Only one country, Cote d'Ivoire, appeared to escape this gloomy verdict, to such an extent that its achievement, which long remained unparalleled, was termed the "Ivorian miracle." In the mid-1970s, at the time ofIvorian economic prosperity and ten years after it first criticized the poliCies of the young Black African independent nations, the World Bank made an in-depth study of Cote d'Ivoire and concluded that the nation's success, far from being attributable to good luck, as some had suggested, was actually the result of the prndent policies of a government that stubbornly and consistently was able to extract the greatest benefits from market opportunities. 1 The Bank was unrestrained in its optimism about this exemplary economy's future, which was expected to show great promise once certain strnctural problems created by past successes had been attended to. But to everyone's surprise, the crisis that began in Sub-Saharan Africa in the early 1980s did not spare the showcase country. Indeed, Cote d'Ivoire has been so affected by this prolonged crisis that it can be wondered if there is hope for recovery. Given the Bank's reputation, it is somewhat surprising that it should have been so mistaken about the 1. Bastiaan A. den Tuinder and World Bank, Ivo"J Coast, the Challenge of Success: Report of a Mission Sent to the Ivo"J Coast by the World Bank (Johns Hopkins University Press, 1978). 109 no COTE D'IVOIRE AND THE WORLD BANK strength of the Ivorian economy. This chapter traces the stages of Ivorian economic dccline and evaluates the impact that relations between the World Bank and the government of Cote d'Ivoire have had on these developments. Overview and Characteristics of the Ivorian Economy The Ivorian economy is dominated by agriculture; coffee and cocoa are its principal exports. For almost two decades after independence Cote d'!voire en- joyed vigorous and sustained economic growth, until 1978. 2 From 1969 to 1973 annual real economic grO\\th was strong (7.2 percent), inflation weak (4.0 percent); the balance of payments showed a slight excess, which represented 0.3 percent of the gross domestic product (CDP), and the state budget (minus public enterprises) had a surplus equaling 6.1 percent of CDP. The economy's savings rate was higher than its investment rate, with most of the excess accruing to the private sector. In 1974-75 real economic growth (6.5 percent) was barely affected by the first oil price shock resulting from a ban on oil exports imposed by Arab producers. Subsequent domestic inflation occurred because of a simultaneous increase in coffee and cocoa quotations. However, the balance of payments deteriorated, posting a deficit of 0.07 percent of CDp, compared with the previous period's surplus. The state budget showed a deficit equal to 4.7 percent of CDP. Total investment exceeded savings, but the savings shortfall was all in the public sector: the public deficit equaled 10.2 percent of CDP, whereas the excess of private savings over investment represented 9.1 percent of CDP. In 1976--77 the economy revived with an unparalleled real growth rate (16 per- cent) and inflation rate (16 percent), caused by a surge of coffee and cocoa on the world market. The excess in the balance of payments amounted to 1.3 percent of CDP, and the government budget surplus stood at 0.4 percent. The most striking characteristic of this spurt was that the investment rate went from 6.0 percent in 1974-75 to n.O percent in 1976--77, financed in part by the exceptional revenues of the Stabilization Fund, but especially by external public borrOwing, which went from 5.2 percent of CDP in 1974-75 to 11.0 percent in 1976--77. In effect, the financial surplus of the Stabilization Fund served as security for the debt expansion. The private sedor again saved more than it invested, the surplus representing 10.22 percent of CDP. The ability of the country to attract sufficient capital to fmance its current account deficit would decline after 1977. The 1976--77 boom in raw materials was brief. Export markets began to deteriorate in 1978, and in 1979 the inflationary effects of the second oil price shock aggravated the decline in the terms of trade. By 1980 servicing the debt that 2, Data here and in the two follo\\9 After the Bank granted its first loan to Cote d'Ivoire in 1968, to finance a road in the east of the country linking Abengourou to Agnibilekrou, relations became more relaxed, especially with a visit by McNamara. But this did not prevent the Bank from continuing to criticize the government for the size of its development pro- gram and the mechanisms employed to allocate public resources. For the first time, on September 15, 1970, the Bank formally addressed its comments to President Houphouet-Boigny, who interpreted them as strong criticism of his bold economic policies. It was noted that although "formulated in moderate terms, the World Bank's letter constitutes a firm warning before the implementation of our plan."l0 Tbe next year, when the Bank cited problems of financial disequilibria and over- leveraging, these criticisms received so little attention from the government that the Bank wondered about its own readiness and capacity to penalize future dis- regard of its advice; the question was raised of "whether the Bank would be ready to employ sanctions of whatever kind should the government persist in a policy of overextending itself."11 At the same time, the Bank recognized that it was difficult to apply sanctions against a winning country, too often vindicated by events: "It was not easy to take a finn line with a country whose performance hitherto had been good."12 6. Minutes of a staff Economic Committee meeting on the economy of the Ivory Coast, February 25, 1963, in World Bank, COte d'Ivoire country files. 7. Mr. El Emary, note to files, February 20, 1967, in World Bank, Cote d'Ivoire country files. 8. Note to files, June 1966, in World Bank, Cote d'Ivoire country files. 9. Felix Houphouet-Boigny to Robert S. McNamara, November 21, 1968, in World Bank, Cote d'Ivoire country files. 10. Xavier de la Renauruere to Roger Chaufournier, October 15, 1975, in World Bank, Cote d'Ivoire country files. 11. Minutes of an Economic Committee review of an Ivory Coast Country Program Paper, June 28, 1971, in World Bank, Cote d'Ivoire country files. 12. Ibid. 116 COTE D'IVOIRE AND THE WORLD BANK In 1972 the Bank perceived what it regarded as greater realism on the part of the government in its approach to the country's economic problems. 13 After the fIrst oil price shock in 1974, however, the government seemed to renounce budge- tary discipline, realistic investment programs, and a prudent use of public resour- ces. During this period the Bank's recommendations concerned the problems and dangers that could be created by the speed of investment growth in relation to the aVailability of local taxes and savings, on the one hand, and to the need for drastic reductions in public spending on the other.14 But the Bank noted its general inability to influence President Houphouet-Boigny's decisions on the nature, dimensions, and programming of any project. It also observed that there existed within the heart of the Ivorian administration a combination of great assurance and stubborn optimism that was attributable both to past successes and to the many previous gloomy and erroneous predictions by foreign observers.15 Caught be- tween the obstinate Ivorian administration and the economic problems Cote d'- Ivoire was exposed to, the Bank did not give up. But the tone of the alarm bells it continued to sound seemed slightly less confident and categorical than in the past: Total external debt has already increased from $424 million in 1970 to $1,529 million at the end of 1975, and with an annual growth rate of 30 percent per year, public debt is probably the fastest growing economic indicator in the country. This development pre- sents serious dangers, and debt service already plays a major role in the deterioration of the balance of payments .... We are not exceSSively worried about these facts and trends. Ivory Coast has on many occasions proved to be capable of solving its problems and adapting to (.'Omplex and difficult situations. We believe, nevertheless, that public invest- ments envisaged for the next five year period (1976-80) have to be carefully selected and rationed to give priority to those that are most profitable. 16 The Bank also noted that the ministers it was obliged to go through were not able to influence the preSident, who was the sale decision maker. It was observed that "the Minister [of Planning] is well aware of the overall problems and the need for determining the real priorities, but has not been able to convince the President, who seems to have a low regard for so-called experts and a fIrm belief that oil hidden under Ivorian territory will be found in the not-tao-distant future."17 13. Cornelius Jansen to Roger Chaufournier, April 20, 1972, in World Bank, Cote d'Ivoire country files. 14. Luc de Wulf, IMF, to B. den Tuinder, International Bank for Reconstruction and Development (IBRD), April 15, 1975, in World Bank, Cote d'Ivoire country files; Burke Knapp to Robert McNamara, July 2, 1975, in World Bank, Cote d'lvoire country files. 15. Luis de Azcarate to Roger Chaufournier, July 30,1975, in World Bank, Cote d'Ivoire country files. 16. Burke Knapp to Felix Houphouet-Boigny, November 3,1976, in World Bank, Cote d'Ivoire country files, 17. Bastiaan den Tuinder to Peter Eigen, December 9, 1976, in World Bank, Cote cl'Ivoire country files. COTE D'IVOIRE AND THE WORLD BANK 117 In 1976 what had become the Bank's predictable macroeconomic diagnoses and recommendations were dismissed by the Ivorian economic administration as lack- ing technical rigor. Objecting to a Bank report, Minister of Finance Konan Bedie wrote that "finally, this document, extremely rich in information and analyses, does not to our eyes represent, in its composition as in certain details of its form, the rigor that would seem useful for it to have, given the authority that is given to the Bank's work."18 As though to verify the validity of its criticisms, the Bank began a systematic study of the Ivorian economy that reflected the embarrassment it felt at advising change to a country whose policies recent events seemed to have vindi- cated. This 1978 study for the first time gathered in one place the analyses and recommendations the Bank had made sinG'e the beginning of its dialogue with the government of Cote d'Ivoire. 19 Convinced of the correctness of its past policy choices as well as of its future prospects, the government did not at the time grant the attention that the criticisms and reG'Ommendations of the Bank warranted. The government was offended by the criticisms because the macroeconomic disequilibria were not worrisome in the short term; the country at the time disposed of sufficient means to enable it to mask obvious imbalances. Moreover, the financial weight of the Bank in the country's economy wa~ not great enough to influence the course of events. In any case, the Bank's mode of intervention at the time~that is, support for individual projects and specific sectors~gave it little power to demand macroeconomic policy chan- ges. Cote d'Ivoire and its government already had performed exceptionally well within a Black Africa that was arguably on the wrong path. Despite the cold welcome its criticisms received, the Bank was convinced of the validity of its role as an independent economic adviser~the more so because in the Bank's opinion the large French technical assistance program, while competent, was biased by its own profeSSional interests against pinpointing in a timely way problems created by the policies of its employer, the government. In the face of the government's obstinacy, the Bank seemed resigued to letting Cote d'Ivoire incur the costs implicit in a bold and imprudent public investment policy. No other course seemed feasible in view of the surge in the coffee and cocoa market in 1976-77, which conSiderably improved the country's balance of pay- ments, and of the discovery of oil in Cote d'lvoire. These developments gave new hope to the country and new ambitions to President Houphouet-Boigny. In the euphoria of the new financial rewards, COte d'Ivoire did indeed become bolder; it initiated major public investment programs that had not been screened against rigorous economic criteria. This new laxness wa~ aggravated by the govern- 18. Letter from Minister of Finance Konan Bedie to Robert S. McNamara objecting to the publication of the Basic E~'Onomic Report, December 16, 1976, in World Bank, Cote d'Ivoire country files. 19. See den Tuinder and World Bank, Ivory Coast. 118 COTE D'IVOIRE AND THE WORLD BANK ment's easy access to short-term supplier credits. The Bank contented itself with drawing the government's attention to the need to curb its expansive budgeting, which could only augment the country's debt burden.20 The Bank also noted that despite the lack of economic rigor in the investment planning by public enterprises, the government was approving their external borrOwings, even when the bor- rowers' projects promised to generate few financial resources. 21 The unprecedented atmosphere of prosperity in the late 1970s made the ad- ministration slack, especially in industrial and commercial policy. The government was conSiderably weakened after 1975 by institutional changes associated with a ministerial reshuffling in 1976, and by corruption linked in part to the granting of import and export quotas for coffee, cocoa, and rice. 22 At the end of 1979 and through 1980 the country began to feel the adverse effects of a drop in coffee and cocoa prices, as well as the effects of a second oil price shock, as it was more a consumer than a producer of oll. The Bank and the government differed over both the causes of this crisis and the necessary remedies. For a long time the Ivorian government chose to emphasize the external origins of the troubles, blaming speculation in raw materials on international markets. Yet the government did finally recognize the role played by poor internal management in public enterprises, among others. For its part, the Bank was consistent in its emphasiS on Cote d'Ivoire's internal structural problems, and on the need for improved financial balance, external as well as internal. Among sectoral matters, the dialogue on agricultural policy was particularly difficult, with the government arguing that there was no need to change its policy course, and viewing the sectoral problems as mainly external. The role and reform of the Stabilization Fund was a particular bone of conten- tion between the Bank and the government. The Fund fixed the prices of principal export products-among them coffee and cocoa-for producers, and for a long time producer prices stayed below the international price received by the Stabiliza- tion Fund, which also acted as the vendor of Ivorian products on the international market. The difference between the international and producer prices was public revenue, transferred in part to the state budget and in part used to finance public investments. The management of the Stabilization Fund was under the exclusive authOrity of the president. The Bank realized that the structural and institutional reforms it advocated- particularly those that would reduce the role of the state and alter the process of resource allocation-were neither eaSily accepted nor effectively implemented. 23 For its part, the government was neither convinced of the benefit of radical reforms 20. World Bank, "Country Program Paper: Ivory Coast," November 16, 1977. 21. World Bank, Ivory Coast economic memorandum, May 30,1979. 22. World Bank, "Ivory Coast Industrial Sector: Back to Office Report," December 27, 1979. 23. World Bank, "Steering the Ivorian Economy toward Sustained Recovery," July 15, 1989. COTE D'IVOIRE AND THE WORLD BANK 119 nor prepared to cope with the social and political problems they might generate, (As will be seen, an example would arise in 1984 when the country's second structural adjustment loan would seek to simulate a devaluation of the CFA franc by Simultaneously increasing import customs duties and export subsidies, Neither the administration nor the private sector could be persuaded of the efficacy of such a de facto devaluation,) From 1980 onward, the Bank made changes in the development model whose virtues it had previously extolled and whose implementation it had supported fmancially. It now advocated state divestiture, privatization, and the liberalization of a commerce already considered open-all of which represented for the Ivorian administration new fads that might pass with the change of seasons. The new doctrines were seen as applicable everywhere, regardless of a given country's specific needs. In short, Ivorian government lenders saw the Bank as being driven by an ideolOgical agenda,24 The Bank's change in tone preCisely at the time when it became an indispen- sable source on the international financial market upset the lvorian administration. Needing new money, the administration found itself obliged to accept policies in whose purpose it did not fully believe. Until 1983 the government could escape the Bank's requirements, and its remaining financial means still allowed for a margin of negotiation; but by 1987 this option had practically disappeared,25 Vigorous economic growth over a period of twenty years had fashioned the mentality and behavior of the lvorians; for a long time they believed that their relatively eaSily acquired prosperity would be without limit or end. The thought of abruptly abandoning a model that seemed to foster growth caused fear and distress. The government's misgivings about the importance of the Bank-advocated reforms were all the more understandable in that the reforms were proposed toward the end of the long reign of President Houphouet-Boigny, whose tenure represented prosperity and stability to both Ivorians and the outside world, At the end of 1986 there was still hope that Cote d'Ivoire would come out of its crisis, but shifts in the international market forced the government to suspend servicing of its external debt in May 1987. The political uncertainties of a central- ized Ivorian administration, completely dependent on a leader with a glOriOUS past, compounded the difficulty of understanding and accepting the radical changes that were needed in economic policies. Although President Houphouet-Boigny was not as strong as he once had been, it was difficult to imagine repladng him. Within the administration there was disillusionment about the Bank-a dis- illusionment all the greater because despite its criticisms, the Bank had always shown optimism in its analyses and recommendations. Although such confidence had been warranted in regard to individual and sectoral projects, it appeared that 24. Opinion of a director of public investments, COte d'Ivoire. 25. Opinion of a fonner minister of state, Cote d'Ivoire. 120 COTE D'IVOIRE AND THE WORLD BANK more prudence in ascertaining the impact of structural and institutional reforms would have been advisable. A crisis of mutual confidence set in: Cote d'Ivoire found it hard to accept measures it considered too austere; the Bank found itself battling the technical ministries' indecision and a lack of will for radical change at the top of the government. For the Bank the realization that its advice was going unheeded was bitter. The Bank's position was that the government understood the measures that needed to be taken, but that it refused to enforce them. 26 During this particularly difficult time, COte d'Ivoire's dialogue with the Bank was further complicated by the actions of the Direction et Controle des Grands Travaux (DCGTX), a parallel administration dominated and directed by French expatriates. HistOrically, the DCGTX was not always as powerful as it became after 1987. At the beginning, under the protection of the Minisby of Public Works, it was charged strictly with control over the technical aspects (such as architecture and execution) of state infrastructure works. It acquired importance through a weakening of the technical ministries after the cabinet reshuffling in 1976, which saw the departure of four important lninisters-those for economy and finance, planning, agriculture, and foreign affairs. Subsequently there was a merging of ministries. Plruming, for example, disappeared as an autonomous ministry, merging with the Ministry of Economy and Finance. This merger led to heavy centralization of the country's economic administra- tion. Through this redistribution of roles and powers in the regular bureaucracy the DCGTX gained its importance, allegedly to limit the poor financial management that had become commonplace. Henceforth placed under the direct stewardship of the president, the DCGTX attained the height of its power when in March 1987 the technical ministries were entirely removed from the making of project studies. The DCGTX had the reputation of being fiercely opposed to many viewpoints of the Bank,27 In the Bank as in the regular administration, it was generally agreed that the parallel administration played a negative role in the dialogue between the Bank and the government until 1991, when new agreements with the Bretton Woods institutions were signed. 28 At that time the DCGTX was officially removed from negotiations with the Bank; it had been quite unqualified to handle the cOlmtry's macroeconomic problems, especially without the help of the technical ministries. In summary, the paralysis in Bank-Ivorian relations reflected the weakening of the technical ministries to the advantage of the DCGTX, frequent institutional changes after 1986, and excessive centralization of the decision making power in the hands of a leader who could not eaSily see new internal and external developments with a fresh eye. 29 26. World Bank, "Steering the Ivorian Economy." 27. Ibid.; World Bank, "Country Strategy Paper, Ivory Coast: Comments and Sugges- tions," September 19, 1988. 28. Opinion of a former minister of state, Cote d'Ivoire. 29. World Bank, "Steering the Ivorian Economy." C6TE D'IVOIRE AND THE WORLD BANK 121 Throughout this period the Bank noted that Ivorian economic leaders gave no importance to the links among the budget deficit, inflation, and the current ac- count deficit 30 On this matter there was disagreement The government was not convinced of the compulsory link between the budget deficit and inflation.31 Nor was it convinced of the supposed negative link between public investment and private investment.32 On the contrary, it held that even when not cost effective, public investment created opportunities for profitable private investment.33 There was also Bank-Ivorian disagreement on the availability of fmancing for public investment. Objectively, Cote d'Ivoire no longer had the means to fmance its investments, and foreign backers who were approached to provide fmancing were skeptical of the viability of the government's current economic policy. The Bank- government dialogue also labored over the allegedly excessive volume of public spending (chiefly the wage bill for the public stam, and the weak competitiveness of Ivorian products resulting from the overvaluation of the CFA franc and the absence of a credible macroeconomic framework. 34 The absence of any new Bank financing in Cote d'Ivoire in 1988 is attributable to the failure to resolve these problems. On the government side, an attempt to break the stagnation was made at the end of 1989 through the creation of an Interministerial Coordination Committee charged with stabilization and economic recovery. The committee was preSided over by the Ivorian governor of the Banque Centrale des Etats de l'Afrique de l'Ouest (BCEAO), Allassane Dramane Ouattara, who on November 30,1990, was to become prime minister of Cote d'Ivoire. The Bretton Woods institutions were certainly not without a role in this unprecedented institutional and political change. Both the creation of the post itself and the prime minister's technical credentials spoke to the gravity of the economic and political problems that had developed. With the creation of the Interministerial Committee, the tone of the Bank's dialogue with Cote d'Ivoire took a remarkably warm tum, although the country's economic and financial sibmtion remained basically unchanged. 35 This shift was associated with the signing, in September 1991, of three new sectoral adjustment loans. The reforms 30. World Bank, "Cote d'Ivoire Industrial Sector Work and Bank Support for the Inter- ministerial Commission on Factor Cost," September 6, 1988. 31. Opinion of a former minister of state, Cote d'Ivoire. 32. The way that public investment can "crowd in" private investment is a reality ror Cote d'Ivoire, as well as for many other countries. Pegatienan, in an ongoing sIDdy on the impact of devaluation on the Ivorian economy, estimates that a 10 percent increase in the volume of total public investment induces a 4.3 percent rise in the volume of private investment. At the present time it is not possible to show that public investment has a financial "crowding out" effect, or to determine whether the "crowding in" dominates over financial "crowding out." 33. Opinion of a former minister of state, Cote d'Ivoire. 34. Bank documents, 1988. 35. Opinion of a director of public investments, Cl)te d'Ivoire. 122 COTE D'IVOIRE AND THE WORLD BANK contained in these loans were the spearhead of a medium-term economic program that was supposed to lead to the recovery of economic growth by 1995. As late as December 1993, however, the Ivorian economy did not show any signs of revival. By then the prime minister had exhausted his capabilities and faced enormous political difficulties. Furthermore, President Houphouet-Boigny fell ill and died on December 7, 1993. In accordance with article 11 of the constitution, Henri Konan Bedie, president of the National Assembly, succeeded Houphouet-Boigny. The prime minister resigned and was replaced by Daniel Kablan Duncan. Completing these rapid changes was the devaluation of the CFA franc by 50 percent on January 11, 1994. The Institutional Actors It will illuminate this analysis to establish more fully the roles of the two principal institutional actors, the World Bank and the government of Cote d'Ivoire, as well as the role of the government of France, the other main official intervener in !vorian affairs. In doing so, attention is given to how each of the principal actors has been seen by the other. The World Bank It is important to note that the Bank is a moneylender whose role in Cote d'Ivoire long remained secondary. Its financial input has generally been less promi- nent than that of bilateral lenders and donors. However, in the context of structural adjustment, agreement with the Bank and the International Monetary Fund be- came a precondition for all financial contributions from other moneylenders be- longing to the Paris and the London clubs (except at times for contributions from France itself, which has tended to act on its own counsel). Thus the Bank's credentialing role has remained as important as its role as lender in its own right. The projects in which the Bank has participated have been judged by the outside world to be healthy and viable. Such judgments would inerease the country's financial credibility and ease the future mobilization of external funding-although in the past in many instances Cote d'Ivoire could have done without the Bank's assistance (as in cases involving palm oil and rubber). Nevertheless, when relations between President Houphouet-Boigny and his ministers soured and decisions were concentrated more tightly in the president's hands, the Bank's approval was an instrument ministers used to convince the president of the value of a project. The Bank generally has been perceived as a flexible institution, disposed to resolve the problems it encounters.36 This has helped it to free administrative and financial deadlock. The government's directors of public investment have ap- 36. An opinion expressed to us by all those spoken to in the current and former Cote d'Ivoire administrations. COTE D'IVOIRE AND THE WORLD BANK 123 preciated the Bank's contributions to the programming process for choosing public investments and deciding their geographic locations and designs.37 Furthermore, the intense dialogue with the Bank since the early 1980s has allowed administration executives to improve their analytical competence. 38 But there have also been numerous complaints about the Bank's role from the government side. The most widespread is that Bank staff members give the impres- sion of always knOwing more about technical matters than those out in the field. Occasionally such lack of modesty causes setback., that hamper the proper execu- tion of projects. 39 Moreover, Ivorian agents in the field live with the cultural and political constraints of the country; they perceive that the Bank is unaware of these constraints, whether because of the youth of its staff or the latter's ignorance of the Ivorian terrain. Even when it has recognized the constraints, the Bank has not been particularly sensitive to them, in part because noneconomic variables are not addressed by orthodox neoclassical economic tools.40 In many cases, especially since the advent of the economic crisis in the 19805, the Bank has been seen to bypass the technical echelons of the administration to deal directly with the presi- dent or the prime minister. 41 The Bank has argued that with the weakening of the economic administration since the disappearance of the Ministry of Planning it has been necessary to go straight to the preSident or the prime minister when urgent decisions have been needed. Although pOSSibly justified, the Bank's behavior has emphasized a weakness in the administration that the latter itself had denounced. The lvorian Regime That public investment ha., played a decisive role in the growth of Cote d'Ivoire has already been emphasized. The effects of such investment have rested as much on the chok>e of investments as on their overall quantity. Thus the Bank's percep- tion of the quality of Ivorian development promotion has depended heavily on its view of the government's resource-allocation machinery. According to the Bank, a program of public investment as ambitious as that of the Ivorian government requires an administration strong and structured enough to select, program, ex- ecute, and control investment projee-1:s in an orderly and coherent manner. The degree to which the government has met this standard changed sharply in the later 1970s. Before 1977 the Ministry of Planning was the administrative structure responsible for the entire sequence of the puhlic investment activity. It also en- sured coordination with such other technical ministries as Agriculture, Public 37. Opinion of the current and former directors of public investments, Cote d'Ivoire. 38. Opinion of the current director of public investments, Cote d'Ivoire. 39. Opinion of a former director of the Agricultural Development Bank, Cote d'Ivoire. 40. For an example of political constraints and Bank responses, see note 97 and related text, and World Bank, "Basic Economic Mission, Ivory Coast," May 29, 1975. 41. Opinion of the director of public investments, Cote d'Ivoire. 124 COTE D'IVOIRE AND THE WORLD BANK Table 4-3. World Bank Evaluation of Project Performance, Various Period., 1974 1974-79 1980-91 All Cote d'Ivoire 91.7 68.2 62.5 73.8 (12)a (22) (8) (42) Africa region of the Bank 79.2 58.5 67.5 67 (245) (364) (246) (855) All 85.1 73.3 71.1 76 Source: World Bank data. a. Numbers in parentheses are the total number of projects evaluated. Works, and Finance.42 The process of planning, selecting, and programming public investment, orchestrated by the Ministry of Planning, was informed by a series of technical and economic studies. The agencies charged with these studies, such as the Bureau National d'Etudes Techniques et de Developpement (BNETD), had mandates that encompassed physical infrastructure (roads, bridges, dams) and multisectoral projects such as development of the Valley of Bandama and of the Southwest region (the Port of San Pedro), as well as more limited sectoral projects such as those in agriculture. Foreign consulting firms were also very active. At that time projects tended to form a coherent whole rather than a string of isolated ventures. The arbitration of the Ministry of Planning was something of a constraint on other ministries. The selection procedures for investment projects were not transparent or formal to the extent that all persons, whether or not they were members of the Ivorian administration, might evaluate them. The Bank, however, admired the efficiency with which the projects were conceived, pro- grammed, and executed during these years. The satisfaction the Bank felt in successive periods about the effiCiency with which its Ivorian projects were ex- ecuted is indicated in table 4-3. Before 1974 the performance ofeote d'Ivoire, with a 92 percent success rate, exceeded that of all countries in the Africa region of the Bank by 16 percent, and that of the Bank's worldwide projects by 8 percent. Between 1974 and 1979 the Ivorian performance remained 17 percent higher than that of the African continent, but equaled only 93 percent of that of the institution's projects worldwide. Despite the strength of the technical administration, public investment projects often were programmed or executed without the necessary inputs of technical and economic expertise. Moreover, the transparency of the decisionmaking process for public investments was diminished by the existence of parallel decisionmaking circuits. 43 The latter phenomenon particularly affected the efficiency of public enterprises. 44 The stewardship of the administrators of public enterprises was not, in general, discharged properly. The general manager of a public enterprise could 42. Opinion of a fonner minister of agriculture, Cote d'Ivoire. 43. Opinion of a fonner director of public investments, Cote d'Ivoire. 44. World Bank, "Ivory Coast Public Sector Review," July 15, 1981. COTE D'IVOIRE AND THE WORLD BANK 125 not only program unauthorized investments, but also borrow on the international fInancial market without interference from the central government's represen- tatives. A Bank document noted that "the public enterprises exercised a good deal of independence from the government and prepared investment programs based on inadequate financing plans."45 Nevertheless, public enterprises could obtain the state's guarantee of their foreign borrowings. The enterprises themselves did not generate sufficient financial resources, so the bulk of their fmancing came from loans or public subsidies. 46 The state's guarantee generally Signified that the state would service the debts. The weakness of the legal links of public enterprises to the central administration favored such an outcome. The general managers of such enterprises, who were nominated by presidential decree, did not feel obliged to follow the recommenda- tions of departmental administrators, who were nominated by simple ministerial decree. 47 After the cabinet reshuffling of 1976, when four important ministers were removed from the government, the duties of the MiniStry of Planning, which had coordinated the economic development and social poliCies of the government, were merged with the more traditional duties of the Ministry of Economy and Finance, as noted earlier. The purely financial tradition of the Ministry of Economy and Finance apparently came to dominate, and dim, the more economics-oriented approach of the Ministry of Planning; furthermore, the role of coordination was no longer clearly defined and facilitated by a well-identified administrative structure. According to the Bank, since 1975 the capability of the government to effeCTIvely implement industrial policies appears to have declined, [because1 the combining of the Ministry of Finance and Planning under a single minister has apparently led to considerable bureaucratic inertia, [and] cormption is generally considered to have become much more widespread and more serious, particularly in customs, but also in the Ministry of Commerce ... private interests are said to be taking an increasing percentage of the time of an increasing number of government officials. 48 This situation persisted until 1986-87, when a much weaker Ministry of Planning reappeared. After the submergence of the Planning Ministry, the formal economic ad- ministration weakened in favor of the parallel administration constituted by the Direction et Contralc de Grands Travaux, described above. The concentration of 45. World Bank, Ivory Coast economic memorandum, May 30, 1979. 46. World Bank, "Country Program Paper: Ivory Coast," June 20, 1980; World Bank, Ivory Coast economic memorandum, May 30, 1979. 47. Opinion of the director of public investments, Cote d'Ivoire. 48. World Bank, "Ivory Coast Industrial Sector: Back to Office Report," December 27, 1979. 126 COTE D'IVOIRE AND THE WORLD BANK functions within the DCGTX underlined the government's desire to rely on the technical efficiency of that group while relegating the technical ministries to the consideration of broader policy frameworks. The separation of the technical and the political within a government tends to be feasible only if the methods of communication between these two compartments of the administration are clearly defined and known to all. In post-1977 Cote d'Ivoire this was far from being the case. The Direction et Controle de Grands Travaux very quickly moved beyond its purely technical domain into defining general policy goals. This expansion, often unintended, sometimes arrogant, was in any case encouraged by the prestige and authority directly mandated to DCGTX by the president. The role of the parallel administration certainly permitted the realization of substantial cost savings in some public investment projects. However, the central administration found itself weakened. It did not profit from the expertise and experience acquired by DCGTX over the years because the French expatriates held a monopoly over the technical information circuits and decision centers. This problem was aggravated by the conflictual relationships between DCGTX and the technical ministries themselves, which were confined to purely routine tasks. The World Bank took note of these shifting roles and the problems they created: "The weakening of the technical ministries has been linked to the increasing prominence of DCGTX, an institution run by expatriates and directly controlled by the PreSidency. The lack of a clear delineation of responsibilities between the technical ministries and DCGTX, as well as the adversarial relationship and per- sonal animosities that have developed between them, have led to a general state of paralYSiS, with increasing recourse to the President's arbitration."49 The Bank saw a Significant deterioration in Cote d'Ivoire's project performance during this period of weakened official economic administration (see table 4-3). The official administration's weakening was aggravated when, after a first adjust- ment phase, the country faced an accelerated drop in the prices of raw materials. The Bank was constrained to conduct its dialogue on the subject with DCGTX instead of with the technical ministries, whose capacity for analysis and assessment had all but been taken away. 50 Important public investment choices had always been the personal decisions of the preSident, as the Bank observed: "Any decision of consequence, especially in the field of economic policy, is taken by the President himself."51 Moreover, all stages of major public investment projects, from concept through implementation, were subject to the same presidential control. According to a Bank document, "no high official will dare question [the president] on the nature, size or timing of any 49. World Bank, "Steering the Ivorian Economy." 50. Ibid. 51. World Bank, "Country Program Paper: Ivory Coast," November 16, 1977. COTE D'IVOIRE AND THE WORLD BANK 127 proposed project, especially if it has special presidential backing as most of the larger ones do:>52 Decisions were often based on Houphouet-Boigny's personal intuition--intuition that was at least partly responsible for the overdesign and sometimes inappropriate location of physical infrastructure. Some favored infrastructure projects proved useful, even if overdesigned, as was the case with the Houphouet-Boigny Bridge, which quicldy became too narrow for the traffic between the business district and Treichville. But other favored projects, such as the Kossou Dam and sugar factories, were outright failures. 53 Along with personal intuitions, the vagaries of puhlic investment choice could be attributed to tolerance of decision making circuits that bypassed formal ad- ministrative procedures. The president always found the financial resources for his projects even though stubbornly refusing, with remarkable consistency, to submit the allocation of Stabilization Fund revenues to transparent procedures. The Bank for a long time was completely unsuccessful in engaging in dialogue on this issue: We have argued thus far without success for a system in which a given share, 75 percent, of expected [Stabilization Fund] revenues would bc included in the investment budget, with shortfalls or surpluses carried over to the next year and, where necessary, foreign exchange reserves or foreign borrOwing could make up possible shortfalls in a given year. . . . Those problems are compounded by the ad hoc manner in which allocations to the investment programs from the [Stabilization] funds are approved. These allocations, because they do not undergo normal procedures, are frequently used for projects in which political rather than economic judgments are more important.54 The advent of relatively weak technical ministries after 1977, and especially after the mid-1980s, partly explains the central administration's inability to make routine decisions, a problem compounded by the distance between the preSident and his ministers. That this situation motivated the Bank to try to deal more directly with the president or the prime minister did not improve the Bank's relations with the regular bureaucracy. It is arguable that rather than trying to repair relations with the bureaucracy the Bank should have worked harder and earlier on its relations with the president himself, who, under the facto circumstances in Cote d'Ivoire, and whatever the bureaucratic structure, should have been the Bank's primary interlocutor. The Bank knew this full well, but often seemed to forget it. France The opening of Cote d'Ivoire toward the West has been a fundamental part of the country's politicoeconomic strategy. But this opening has not been the same to all industrialized countries. France, the former colonizer, has occupied the place of 52. Luis de Azcarate to Roger Chaufoumier, July 30, 1975, in World Bank, Cote d'Ivoire country fIles, Abidjan. 53. World Bank, Ivory Coast economic memorandum, May 30, 1979. 54. Bank documentation, 1980. 128 COTE D'IVOIRE AND THE WORLD BANK choice in all aspects of the nation's economic and political life. Indeed, the close- ness of the link has exceeded what might be extrapolated from the history of the two countries or their common language. It has been observed above that for a long time the low volume of the Bank's contribution made it a seeondary partner of COte d'Ivoire, far behind France. Cote d'Ivoire also had constant recourse to massive French technical assistance in all branches of public administration, including secondary and higher education. Technical personnel were either employees of the French government or agents recruited by private or parastatal research and consultancy groups to staff specific Ivorian government contracts. A limited number of these groups systematically divided among themselves the placement of agents in such key technical ministries as Planning, Agriculture, and Economy and Finance. Consultancy groups also benefited from the positioning of their representativcs at the heart of the Ivorian administration, where they could win public contracts for studies ordered by the government in support of its economic-development and public-investment plan- ning. Such contracting was easy because it was directed by technical-assistance expatriates employed at the Ministry of Economy and Finance. Thus the use of foreign research and consultancy groups was systematic and routine. There was lively competition among the several relevant French groups for the award of study contracts, but there was little unccrtainty about the nationality of recipients. Traditionally all technical advisers to the Ivorian administration, to the president as well as to each ministry, had been French. But from the mid-1980s onward the country's waning financial resources forced the government to accept advisers of other nationalities in some ministries. In the private sector, until recently, business was under the financial and techni- cal control of the French-a phenomenon reinforced with the dismantling of state corporations after 1980. When bad management became widespread during the crisis, expatriates took back the management responsibilities that had been given to Ivorians a few years earlier. The perSistence of massive French technical assistance has reflected a lasting conviction on the part of the highest Ivorian authorities that rapid "Ivorization" would be costly. As a World Bank document noted, "he [the president] personally did not intend to replace Frenchmen by Africans merely for tlle sake of having African ministers or advisers, until he thought they were good enough for the job. "55 The pattern of reinforcing Ivorian nationals named to lead state corporations with one or more expatriates became routine. In many cases these expatriates held the real power. The pattern was even more pronounced in the private sector. The sustained presence of expatriate technical assistance met a specific need of the Ivorian leaders, namely, to cope with the generational conflict that existed 55. J. H. Williams, note to flIes on the first visit of a World Bank president to Cote d'Ivoire, June 24, 1960, in World Bank, Cote d'Ivoire country files. COTE D'IVOIRE AND THE WORLD BANK 129 between the older Ivorian executives and the younger, more technically skilled native officials who were challenging them. The presence of an expatriate especial- ly suited the self-serving older executive, who was preoccupied with parallel ac- tivities that his decisionmaking post in the administration facilitated. Such a senior executive could count on the loyalty of the expatriate to whom he could entrust important technical matters. A corresponding wedge of distrust intruded between the older executive and the young Ivorian professional, who, possessing more prestigious diplomas, was determined to meet the challenge posed by the ex- patriate against whom he had measured himself in the French grandes ecoles and universities. In this context in which the executive delved little into the technical dimensions of issues for which he was responsible, the expatriate sought to make himself indispensable and thereby to preserve his fmancial interests. The latter were enormous; as the Bank observed: "As a rule of thumb, expatriate managers or professionals (for example, engineers) were said to cost about three times their cost in France. A typical annual cost of CFA 18 million (about $90,000) was men- tioned."56 Keeping oneself indispensable was made easier by the expatriates' con- trol of technical information. The consequence was to give the technical assistant a superiority complex with respect to the chief executive he was advising as well as to other administration managers.'57 Although Cote d'Ivoire's development strategy was widely praised before the adjustment crisis, it lagged badly in reducing dependence on the French. Quite naturally, French technical assistance was deSigned (subject to its other goals) to preserve and develop French interests in the country. Ivorian development is based on the production of agricultural commodities for industry and export, and its success has depended on agronomic research. Such research remained essentially French until the end of the 1980s. The market and feaSibility studies for agricul- tural projects were performed by French consultancy groups to the advantage of French enterprises, which generally received the contraets to carry out the projects. With agronomiC materials and cultivation techniques under the control of French researchers, such projects had a high probability of success. Feasibility studies were generally financed through the Assistance and Coopera- tion Fund, whereas the work carried out by eontracting enterprises was typically financed by the Central Fund for Economic Cooperation; both organizations were financial arms of the French government. 58 The remainder of foreign exchange needed for their projects could be obtained from multilateral lenders such as the World Bank. As already indicated, the prestige accorded participation of the Bank in financing could be used to demonstrate to other lenders, notably private ones, 56. World Bank, "Ivory Coast Industrial Sector: Back to Office Report," December 27, 1979. 57. Opinion of the director of public investments. 58. Description given by a fonner minister of agriculture, Cote d'Ivoire. 130 COTE D'IVOIRE AND THE WORLD BANK the technical quality of a project's design and the country's financial credibility, The Bank recognized these links: "It is clear that the Ivo!)' Coast's ease of access to commercial capital markets is of critical importance to its development. This is an important reason for the close relationship that has developed between the Ivo!), Coast and ourselves, since the Ivorians are aware of the degree to which sources of commercial and export guaranties agencies consult with US."59 Given the control of French technical assistance over the process of project identification and project study in the government, on the one hand, and the system for allocating public works contracts, on the other, it is that clear the Bank's financial assistance tended to contribute positively to the prosperity of French enterprises already established in the host count!)', as well as to French external trade. As long as the Bank's intervention was within this framework there would be few tensions in the dialogue between the Bank and the Ivorian administration, which, as late as 1990, was too often represented in technical meetings and loan negotiations by expatriates who were more persuasive and eloquent than Ivorians. For a long time the Ministry of Economy and Finance contained a division charged with international cooperation and headed by an expatriate. The preference this division gave to the reports of the French Central Fund for Economic Cooperation over those of all other external lenders long suggested that French enterprises were sheltered from all foreign competition.oo To this day Cote d'Ivoire's reputation in this regard has not improved significantly; the development of the government's current privatization program illustrates the point. Other Francophone economic actors---Canada, for example--have not been able to penetrate the Ivorian market despite making interest- ing offers in such sectors as energy and the drug industry. Nevertheless, with the economic and financial crisis of the 1980s the external environment changed and the Bank's role widened conSiderably. It embraced economic policy as a whole. In particular, the Bank received a mandate from most of the moneylenders, bilateral, multilateral, and private, henceforth to demand changes in the government's macroeconomic policies. Some of these policy chan- ges ran afoul of French interests. As financial constraints forced the Ivorian government to reduce French techni- cal assistance, the role and decisionmaking power of the Direction et Controle des Grands Travaux were strengthened to the point of supplanting the technical mini- stries and becoming the Bank's sole interlocutor during negotiations on structural adjustment loans. A DCGTX delegation that excluded nearly all high-level Ivorian officials represented the Ivorian government in the adjustment loan negotiations of 1989-90.61 It would seem that DCGTX played for French interests the same role 59. World Bank, "Country Program Paper: Ivory Coast," June 20, 1980. 60. Opinion of the director of public investments, Cote d'Ivoire. 61. Information from a former director of public investments who headed the official Cote d'Ivoire delegations in negotiations with the Bank. C6TE D'IVOIRE AND THE WORLD BANK 131 that French technical assistance had when the latter was all-powerful \vithin the technical ministries. This was all the more likely once DCGTX took over the letting of contracts in 1987. Three-Cornered Relations The interplay among the government, the French, and the Bank has been critical to many aspects of the Ivorian economy. Its effects in four striking ex- amples-training, economic doctrine, agricultural research, and the CFA franc exchange rate--can be cited. Many expatriates posted in public enterprises and charged with the execution of projects had much decisionmaking discretion as well as important financial inter- ests to defend. This motivated an underemphasis on training Tvorian locals, while the expatriates held onto their monopoly on technical information. The lack of appropriate candidates who might benefit from such training has constantly been evoked as an explanation for project shortfalls. Yet institutional mechanisms for planning and promoting the transfer of knowledge from expatriates to Ivorians have been inadequate. The World Bank itself, despite protestations to the contrary, has not seemed particularly well placed to accomplish the training task. 62 Although as early as 1977 a World Bank country program paper asserted that "at the sector and projeet level our influenee has been directed towards project design, institution building, Ivori- zation and training," subsequent evidence of achievements in these areas has been scant. 63 The failure of training at the project level has limited the Bank's net input to the country. Once a project ended and the experts left, the project's results could not be repeated by the Ivorians. Seen through French lenses, the Bank's more recent economic ideology has seemed not only hostile but inconsistent. Thus there is a question as to why the Bank is trying to dismantle a public sector that it once financially supported and felt was efficient in executing projects in which it partiCipated. Part of Cote d'Ivoire's French-schooled resistance to the Bank's economic prescriptions has been cultural. An example is seen in the Ivorian view of the Bank's emphasiS on the harmonization of effective rates of protection. As in France, the Ivorian official working in the economic administration does not have a doctorate; rather, he has professional training from a specialized school or an engineering diploma in one of a variety of diSciplines. He does not base his decisions on neoclassical theory. Effective rates of protecTIon and other analytical criteria invoked by Bank employees in promoting new industrial and commercial policies do not palticularly interest him. The intel- 62. Comments of David Knox, former World Bank regional vice president for Africa, July 18,1992. 63. World Bank, "Country Program Paper: Ivory Coast," November 16, 1977. 132 COTE D'IVOIRE AND THE WORLD BANK lect of the Bank's Ph.D. economists is apt to be undelValued by their Ivorian inter- locutors, and their approach, however scientific, to Ivorians seems very academic. The important case of agronomic research, however, illustrates that reform can be blocked as much by excessive Bank deference to the French as by French- Ivorian solidarity. Ivorian agronomic research rested for a long time on an essential- ly French technical and human apparatus. When the Bank wanted to support the Ivorian government's will to reorganize this sector and make it key to the medium- and long-term economic future of the country, the intransigence of the French technical assistants caused the Bank to hastily retreat, to the despair of the Ivorians, who were unable to break the stalemate. 64 The Ivorians were told to sort out their problem with France before seeking any assistance from the Bank. The Bank proved it could be more royalist than the king. French influence has also been strong in regard to the Ivorian currency prob- lem. Although the Bank has recognized that the drop in competitiveness has been a major problem for the Ivorian economy, the nominal devaluation of the CFA franc-the currency common to all African countries in the franc zone-was never part of the adjustment measures aimed at restoring the macroeconomic equi- librium of the country. Such devaluation was made institutionally impossible by the rule of unanimity within the West African Monetary Union. But even without this obstacle, the Ivorian government was fiercely opposed to the nominal devaluation of the CFA franc. This opposition was a major stumbling block in the dialogue between the Bank and the Ivorian government, and on this issue France backed the Ivorian stance. The positions of France and Cote d'Ivoire on the maintenance of the CFA franc's parity were supported by the positive effects of the franc zone on the monetary policies of Cote d'Ivoire, and on its economic performance during pros- perous years. Even though Ivorian imports were probably more expensive because they mainly came from France, Cote d'Ivoire had a very low inflation rate (around 5 to 6 percent a year over a thirty-year period), in contrast to African countries having nonconvertible currencies. 65 This modest inflation was the result of financial diSCipline imposed by the Central Bank of West African States, which since 1975 had limited the budget deficit that could be monetized by the Central Bank to 20 percent of the fiscal revenues of the previous year (the percentages had been even lower before 1975). Furthermore, the one-hundred-percent convertibility of the CFA franc and freedom of transfer within the franc zone considerably eased foreign private investment in the country, espeCially by French investors. These are believed to have been important advantages for Cote d'Ivoire's economic growth. 64. Opinion of a former director of scientific affairs at the Ministry of Scientific Research, Cote d'Ivoire, who negotiated finanCing deSigned to reinforce agronomic research. 65. Alexander J. Yeats, "Do Mrican Countries Pay More for Imports? Yes," World Bank Working Paper 265 (September 1989). COTE D'IVOIRE AND THE WORLD BANK 133 The question of oveIValuation of the CFA franc and its devaluation remained taboo until January 13, 1994, when its devaluation by 50 percent was decided upon at a summit meeting of heads of state in Dakar, Senegal. Before that date no top Ivorian civil servant could engage in technical discussions on this topic. The problem was always reduced to its purely political dimensions. 66 The political costs of devaluation were judged to be too high in comparison witb the economic benefits that might be gained from such an operation. During the period preceding the devaluation the Bank was forced to adopt a low profile on the topic, if not eliminating the subject from its dialogue with the government, at least approaching it only with the greatest circumspection. The echoes emanating from the meeting of heads of state in Dakar in 1994 emphasized the intense opposition to monetary adjustment of certain African countries-Gabon, for example-and also emphasized the firm positive commit- ment of Cote d'Ivoire. According to the African press, France pushed Franco- phone Africa into devaluing the CFA Franc, even though the large majority of African countries did not want to. France's attitude was generally interpreted as desertion of its African partners; many in Cote d'Ivoire have thought that the death of President Houphouet-Boigny facilitated desertion by France. Whether there was desertion or not, the decision to devalue the CFA frIDc was timely and necessary; it should have been done much sooner. However, there remains the danger that the devaluation, insufficiently prepared for by African countries, will not produce the anticipated benefits. In summary, Cote d'Ivoire's special relationship with France created for a long time a wall between the World Bank and the Ivorian economic administration. It harmed relations between the two partners, and because of different interpreta- tions by the Bank and France of what was in Cote d'Ivoire's best interests, often sent contradictory messages to Ivorian decision makers.67 Yet French cooperation was beneficial for the Ivorian side, for Cote d'Ivoire would not be what it is today had it not been for French technical assistance; and France has also benefited from the relationship. Ivorian-Bank Issues Many questions have arisen between the government of Cote d'Ivoire and the World Bank: macroeconomic and structural adjustment matters, as well as sectoral ones such as agricultural pricing, relations between public and private investments, the state's engagement in privatization, industrial and commercial policy, and the government's social policies. This section addresses these issues in greater detail, 66. Point of view of a director of public inve~tments. 67. Comments of David Knox. 134 COTE D'IVOIRE AND THE WORLD BANK and examines the challenges currently facing the two parties-overexposure for the Bank, economic breakdown for the country, Macroeconomics The combination of investment programs that were too ambitious, insufficient local savings, and financial management methods lacking any economic foundation could only lead to serious internal and external public disequilibria for Cote d'Ivoire, From the beginning of its dialogue with Cote d'Ivoire the Bank brought the government's attention to, and reproached the government for, the increasing macroeconomic disequilibria resulting from the budget deficit, the balance of payments deficit, and leveraging, The origin of the internal disequilibria lay in the pace of public investment, which was hard to restrict to what could be funded through the country's own resources, given Cote d'Ivoire's ability to mobilize external finances, In the Bank's view, "the government clearly wants too many things done in too short a time .... Some of the objectives are a high rate of growth in each sector and each region, a better distribution of income, and better living conditions and better opportunities for everybody. Expressed in terms of invest- ments, this adds up to a heavy investment program, and it is obvious that setting priorities and phasing in of the program have become major issues."68 The Ivorian government's will to go fast and far did not dwindle even with the deterioration of the economic situation at the end of the 1970s. The first reform that the Bank hoped to see was a psychological one: acceptance of a smaller scale and slower pace of public investment in order to reduce the budget deficit and increase public savings. The Bank also wanted to see the government, in paring down to a deficit-reducing level of public investment, eliminate low-return projects. A Bank document stated that "the Bank's net lending program of $25 million per annum [was a] level of assistance [that] would depend on the government's willing- ness to reduce its commitment to projects of low economic value . . . and to increase public savings . . . partly by gaining access to private savings presently outside the tax net."69 The Ivorian government's expansionist budget policy created a surplus in the demand for goods and services. If part of the excess demand for foreign exchange was attributable to exuberant public investments, it was driven even more by the degree to which Ivorian current-account spending absorbed foreign inputs oflabor and services. The Bank observed that the Ivorian economy has histOrically relied heavily on foreign services. Ivorization may bring some relief eventually, but inflated profits and salaries of expatriates, as well as 68. World Bank, "Basic Economic Mission, Ivory Coast," May 29, 1975. 69. Minutes of an Economic Committee review of an Ivory Coast Country Program Paper, June 28, 1971, in World Bank, Cote d'Ivoire country files. COTE D'IVOIRE AND THE WORLD BANK 135 higher interest payments on debts, 'will make the situation worse, and the current account balance will therefore be increasingly negative, It is not at all clear that the foreign capital can be found at reasonable terms to compensate for this deficit. It is therefore essential that the government development policy give priority to areas of activity which con- tribute to reducing the current account deficit. Careful estimate of future capital require- ment and the potential aVailability of capital from abroad from existing and new sources are needed,70 After the first structural adjustment program the Bank insisted on a sustained reduction in macroeconomic disequilibria: "Imperative need to further reduce external and internal imbalances in the short term, and the necessity to rapidly restore conditions for sustained gro",th beyond."71 Toward the end of the 1980s the weight of the debt became unbearable. According to the Bank, "In 1988, the Bank disbursed US$1l3 million, while receiving US$133 million in amortization and US$156 million in interest, implying negative net disbursements of US$20 million, and negative net transfers of US$176 million (about 2 percent of GOP). This situation is considered intolerable by the Ivorian authorities. . . . The year 1989 started with IBRD debt outstanding and disbursed of US$L7 billion, around 20 percent of Cote d'Ivoire overall debt. . . . Interest repayments 'will be US$151 million and principal repayments will be US$128 million."72 At the end of the 19808, Cote d'!voire had lost almost all its financial credibility. The country's fInancial situation had become so difficult that interruptions had been threatened in the Bank's disbursements to Cote d'Ivoire between December 1983 and March 1984, as they were again in 1988 and in 1989, as noted earlier, In regard to the latter interruption, the Bank commented, "In November 1988 and again in May 1989 payment arrears had reached 75 days and the Bank was about to stop all disbursements when payment was made upon the personal intervention of President Houphouet Boigny.... Unless the flow is reversed, it is unlikely that Cote d'Ivoire can continue to service Bank debt any longer."73 The deterioration in the country's financial credibility was certainly the most striking development in the history of the country and of its relations with the Bank. In 1968 Cote d'Ivoire had bcen the first developing country to obtain a credit on the Eurodollar market. A predominant portion of the country's foreign debt was owed to private creditors. Cote d'Ivoire had only occasionally availed itself of International Development Association (IDA) credits in the 1970s, which at the time was seen as an indication of its economic success and of the great confidence the country inspired in international fInancial circles. Since 1991, however, Cote d'Ivoire has been readmitted to IDA. 70. World Bank, "Basic Economic Mission, Ivory Coast," May 29, 1975. 71. World Bank, "Country Program Paper: Ivory Coast," December 1984. 72. World Bank. "Steering the Ivorian Economy." 73. Ibid. 136 COTE D'IVOIRE AND THE WORLD BANK As late as 1979, a year before the beginning of the economic and financial crisis, internal Bank evaluations had still been optimistic about the ability of the Ivorian government to maintain financial credibility and to pursue development without great difficulty. The reforms required by the SAP to reduce the volume of invest- ment and slow external borrowing, as well as to streamline and strengthen invest- ment programming procedures, were meant to slow the decline of the country's creditworthiness. But moderate reforms were not enough. Cote d'Ivoire could not escape the need for more radical restructuring. In the Bank's view, "the de- terioration of the terms of trade, the debt overhang and the loss of competitive- ness due to the overvaluation of the CFA leave Cote d'Ivoire with no option but to adjust."74 Despite the fall of Cote d'Ivoire's financial credibility and prestige abroad, the govern- ment continued to object to the Bank's proposed macroeconomic and institutional reforms. The implementation ofeconomic policies can only be effective ifthe administra- tion that puts them into is convinced of the utility of the measures. In the past, the differences between the Bank and the government over budget policies and the selection criteria for public investments were not as great as those that now emerged over basic economic policies. But the situation had now completely changed. The country no longer possessed sufficient financial resources to execute the poliCies of its cboice. The protection system put into place by the country's existing industrial and commercial policy created an anti-export environment. Thus tbe removal of export disincentives was a priority for structural reform of the kind urged by the Bank. Furthermore, the imperative to develop the export zone in Cote d'Ivoire and to broaden the range of export products would require substantial improve- ment in internal and external competitiveness. The reduction of state interven- tion and promotion of the private sector also appeared to be new directions for exploration. The structural and institutional reforms proposed for the industrial sector were intended to unleash the market, reestablish competitiveness, and improve public management. They included the follOwing: general revision of customs tariffs, replacement of quantitative restrictions hy import surcharges, introduction of a system of subsidies to value-added exports, revision of investment codes, and reform of the institutional framework of industrial promotion in favor of small and mid-level enterprises. 75 None of these reforms was put into effect. The Bank saw two reasons for this failure: first, a "hasty preparation of these measures by the Bank. ... [The] intention to proceed with an implicit devaluation lacked credibility; 74. World Bank, "Country Strategy Paper, Ivory Coast: Comments and Suggestions," September 19, 1988. 75. World Bank memorandum, "Second Structural Adjustment Loan. Reform of the System of Industrial Incentives. Report and Recommendation of the World Bank's Super- visory Mission." February-March 1984. COTE D'IVOIRE AND THE WORLD BANK 137 [and] second, frequent institutional changes (cabinet reshufflings) [that led] to the weakening of the technical ministries."76 There was also a profound disagreement between the government and the Bank on agricultural price policy and commercialization (see the section on agricultural pricing). The government was not convinced of the need to change agricultural prices to reflect a world market that, according to official speeches, was mostly affected by speculation. The government maintained that farmers' revenues should not be left at the mercy of world market fluctuations. 77 Beyond the sectoral reforms recommended, the Bank put pressure on the government to reform the macroeconomic framework to more clearly define the economic responsibilities of the technical ministries and more vigorously coor- dinate government action at a central leveL In the Bank's view, "the lack of an institution or individual responsible for macroeconomic coordination and manage- ment, together with the duplication of responsibilities, has made it difficult for the Bank to carry out its policy dialogue."78 For the Bank, establishment of an adequate macroeconomic framework by Cote d'Ivoire had become the first priority: "It was indicated to the government that the precondition for negotiating an ASAL [agricultural structural adjustment loan] is an adequate macroeconomic framework and an agreement with the IMF."79 It was the lack of such a framework that led to an interruption of Bank assistance in 1988.80 As already noted, one reason for the gap in Bank assistance was the weakening of the technical ministries, notably the Ministry of Planning. But there was also an absence within the administration of executives in sufficient quantity and of suffi- cient quality to confront the size and complexity of the reform task. This situation was explained less by a real scarcity than by the departure of existing executives when the Ministry of Planning was dismantled in 1976. Furtllermore, even when there were executives in the country, as was again the case by the early 1980s, the budget constraints of structural adjustment made it impossible for the government to recruit them. A poorly coordinated economic administration during the first decade of structural adjustment probably contributed, in thc Bank's view, to the slowness with which Ivorian civil servants perceived the linkage bct\veen inflation and thc balance of payments deficit. Finally, one of the most important points of substantive disagreement bet\veen the government and the Bank-a disagreement that existed at both the sectoral and macroeconomic levels-was over the importance of market forces in deter- 76. World Bank, "Retrospective Evaluation Report on the Cote d'Ivoire Program: 2nd and 3rd Structural Adjustment Loans," April 13, 1990. 77. World Bank, "Cote d'Ivoire Agricultural Sector Adjustment Operation," April 5, 1989. 78. World Bank, "Steering the Ivorian Economy." 79. World Bank, "COte d'Ivoire Agricultural Sector Adjustment Operation." 80. World Bank, "Steering the Ivorian Economy." 138 COTE D'IVOIRE AND THE WORLD BANK mining the government's economic polk)' in general and the agricultural pricing policy in particular. Ivorian leaders had developed a great mistrust of the inter- national market and of the signals given by that market. As the Bank put it, "He [the president] distrusts world markets, and, since he has often [been] proven right in the past, is reluctant to adapt policies to a changing external emironment."81 All of these policy disagreements between the Bank and the government made the government reluctant to accept measures proposed by the Bank, and the latter more cautious. The Bank saw the government as lacking the political will to reform and as hoping, even as it distrusted the international market, that the market would take a tum for the better. The government was obliged to implement a bare minimum of recovery measures to maintain some access to Bank resources. For its part, the Bank counseled itself that only in "the unlikely event that Cote d'Ivoire is ready to adopt more radical policies ... [should] the Bank ... be ready to increase the level of its assistance"; but such a shift on the part of the government appeared improbable: "He [the president] is likely to move slowly and, if so, only under the force of circumstance and in limited areas rather than undertaking radical chan- ges."82 Agricultural Pricing Fixing the farmgate price for coffee and cocoa was the privileged instrument of the government's agricultural policy. As noted, this producer price was generally maintained at a lower level than the price paid on the international market; the difference between the prices went to the Stabilization Fund, which then transferred this revenue to the state budget to finance public investment. The difference also served as an implicit levy on the farmer's work It is generally reCOgnized that the rate of implicit tax imposed by the Ivorian government was very reasonable, The farmer received incentives to increase his effort and produce more. The Bank had long approved of this agricultural pricing policy, considering Cote d'Ivoire to be one of the few African countries to encourage farmers to increase production by rewarding producer prices. Thus the Bank encouraged the govern- ment's policy through its financing of many projects for developing agricultural exports. For the 1983-84 agricultural season, Cote d'Ivoire and the Bank agreed on the need to increase the farmgate price of mffee and cocoa up to 400 FCFA per kilogram, a price level hitherto unequaled. This occurred in the midst of the structural adjustment period, when it was believed that the world market had become favorable again and would remain so for a long time. But there was disagreement between the Bank and the government after 1987 when the Bank 81. Ibid. 82. Ibid. COTE D'IVOIRE AND THE WORLD BANK 139 proposed a decrease in the producer price for the same agricultural products. The Bank's initiative was interpreted as a change in attitude toward the agricultural pricing policy that had been in effect-a change perceived both as abrupt and as surprising, coming as it did from a moneylender until then firmly supportive of the government's encouragement of the Ivorian farmer. Was there an attitude or policy change by the Bank? The Bank's attitude can be interpreted as having changed if considered in the context of the impaet of the agricultural price-fIXing mechanism on the budget deficit. The Bank modified its position because after 1987 the downward tendency of coffee and cocoa prices on the international market had appeared to be worsening and lasting for a long time. This unfavorable tendency was unprecedented. The already catastrophic financial situation of the Stabilization Fund did not permit the government to continue paying the producer a price higher than the international one. Such action would have contributed to a budget deficit already deemed too high. When considered in the context of the need to link the international price to the farmer through the intermediary of the price to the producer, it is clear that the Bank's attitude was consistent over time. The government, however, was inconsis- tent. It was quick to pay the international price to the producer when it was high, but it obstinately refused to do so when the international price dropped. These differing perspectives have been summarized by a Bank official: I certainly heard many times in the Bank in the 1970s that Cote d'Ivoire was almost unique in Mrica in paying decent farm gate prices instead of taxing its farmers to death. To the Bank, that was letting market forces work by passing through to the farmer world market prices with the corollary that when world prices fell sharply so too should farmgate prices. For the government, however, the perception was probably different: a policy of encouraging agricultural production with the corollary that one kept farmgate prices up even when world pric-'Cs fell If that is the scenario, and it probably is, no wonder the government felt aggrieved when the Bank criticised its agricultural pricing in the 1980s. The Bank would see itself as consistent, the Ivoirians would see it as inconsistent. 83 Social protection of the farmer was the reason for the governmcnt's asymmetrical behavior. Although the Bank's argument in favor of a link between the farmgate price and the international price was consistent, the Bank's position in regard to the Stabiliza- tion Fund was not. In the past the Bank had not questioned the stabiliZing function of the prices put into effect by the government. It reCOgnized the efficiency of that function because the incentives given to the farmers were judged appropriate. The high level ofinternational prices during the 1960s and 1970s made the stabilization function itself appear unnecessary in the Bank's eyes. But during the period of low international prices the Bank judged the stabilization function to be inappropriate and strongly recommended that the Stabilization Fund be suppressed: "The price 83. Comments of David Knox. 140 COTE D'IVOIRE AND THE WORLD BANK stabilization function would be abandoned along with the institution responsible for stabilization [the Stabilization Fund]. A variable export tax would be introduced to pennit [the] government to capture some of the benefits of windfall increases in export prices. This tax would fall to zero when prices reached a preestablished (low) level."84 The Bank's rejection of the stabilization function was even more asymmetrical because, as the Bank recognized, it had greatly contributed to reinforcing state intervention in the commercialization of agricultural exports. In essence, the Bank had helped to build the Stabilization Fund; it was therefore going back on its word. It can be said that the Bank must take responsibility for having supported a policy that gave Ivorian farmers and the governing body habits that are today difficult to abandon. Public and Private Investments Broadly, over the years, the Bank approved the Ivorian government's develop- ment policy. Public investment in infrastructure favored both the use of natural resources and private investment. By facilitapng the productive activity of private entities, particularly rural ones, public investment had become the vehicle for economic growth for two decades. On this point the views of the Bank and the government converged, with the limited difference that the government believed that even if public investment was not profitable to begin with, it could neverthe- less be constructive if and as it encouraged profitable private activities. Because this policy was effective for twenty years and enabled the country to realize remarkable growth rates, the government stuck with it even when it no longer possessed the necessary resources. The Bank, however, changed its position and opposed any increase in the volume of public investment, especially in view of the laxity of the government's selection criteria for public investment. Moreover, during the adjustment period financial constraints made it impossible for the government to continue to finance investment spending through borrowing, espe- cially if such borrOwing were not to be productive. To the Bank, it was unrealistic to believe that public investment could continue to be the principal vehicle for economic growth. For the government, it was difficult to accept the change in Bank policy. The emphaSiS on diSCiplined investment spending that circumstances and the Bank came to demand was not sudden. Throughout its dialogue with the government, the Bank had drawn the government's attention to the negative effects of soft, noneconomic investment criteria and the need to abandon them. State Engagement in Privatization When the government of Cote d'Ivoire was asked to disengage from the economy to allow more participation by the private sector, more than just the role of public 84. World Bank, "Cote d'!voire Agricultural Sector Adjustment Operation." COTE D'IVOIRE AND THE WORLD BANK 141 investment was involved: the entire economic philosophy of the Ivorian govern- ment was on the line, The Ivorian government had always thought that at this stage of the country's development there could be no private domestic sector without the state's intervention, The creation of public enterprises and the participation of the state in an enterprise's capital had the avowed objective of temporarily filling the void created by the nonexistence of local entrepreneurs. The government planned to withdraw in favor of the Ivorian private citizen in the future. The pursuit of this last objective had justified the creation of the Societe Nationale de Financement (SONAFI) (which was dissolved at the end of the 19805).85 It was generally recognized that the poor economic and financial management of most public enterprises helped create or accentuate the budget deficit of the public sector and the weight of the public debt. Consequently a streamlining of the public sector was seen to be beneficial even if it created financial and social problems for many families. However, the systematic dismantling of public enter- prises and their sale to the private sector was also seen as tantamount to increasing foreign technical and financial control over the country's economy, because Ivorians had been insolvent since the beginning of the 1980s.86 Such a change in control was precisely what the government's policy sought to avoid, despite the reform's outward orientation. In proposing reforms in the early 1980s the Bank had also understood this: "Where state participation is deemed not necessary, offer them [the public enterprises] to private purcha~ers. One restraining consideration preventing the acceleration of actions in this direction is the realization that any such moves on a large scale in the near future would require sales to foreign purchasers since Ivorians lack the capital and entrepreneurial expertise to par- ticipate on a large scale."87 Ivorians believe that a new dogmatism on the part of the Bank was introduced with such privatization proposals, for no one remembered the Bank warning the Ivorian government against the creation of too many public enterprises. On the contrary, the Bank's strategy had consisted in actively supporting the consolidation of the public sector. 88 It would be financed through plans for palm oil, rubber, and cotton projects, not to mention the improvement of cocoa plantations and a reforestation program. 89 These programs and development plans were put into effect and directed within the framework of publie enterprises or mixed-economy institutions. The Bank's subsequent evaluation of them had even recognized that the management of these agencies, through the projects it financed, was generally good. Through the financing granted to these public and mixed institutions, the 85. Opinion of a former minister of state, Cote d'Ivoire. 86. Opinion of a former minister of state. 87. World Bank, "Country Program Paper: Ivory Coast," June 20,1980. 88. World Bank, "Cote d'Ivoire Agricultural Sector Adjustment Operation." 89. Opinion expressed to the authors by all administrative executives who were approached. 142 COTE D'IVOlRE AND THE WORLD BANK Bank therefore had directly and efficiently contributed to the development of public enterprise in Cote d'Ivoire. For these reasons the Bank's change in policy bas been perceived as dogmatic. The Bank has viewed its position as more pragmatic than dogmatic. 90 It would not seem to be pragmatic, however, if it results in total foreign control of Ivorian enterprises and fails to guarantee that the price of goods and services will decrease and thus lighten the burden on families who might be affected by unemployment. Industrial and Trade Policy The Bank's position on industrial and commercial poliey has also been the subject of misunderstanding. Cote d'Ivoire was long considered an open country that knew how to take advantage of favorable external factors to develop its economy. The Bank was especially impressed that the government had created an environment favorable to private local and foreign investments; the terms of the investment code favored enterprises that agreed to invest in the sectors and activities judged priority areas. The export-oriented policy of the early 1970s was also hailed as beneficial; at that time large textile establishments were developed and systematically directed toward exports. The Bank praised the government for practicing a policy of openness to the outside rather than a policy of dosing in on the local market. However, the Bank felt that rates of protection in Cote d'Ivoire were too high and too diversified. According to the Bank, the country needed to reduce industrial protection and make it uniform at the rate of 40 percent, and replace all quantita- tive barriers to imports with equivalent tariffs. It was also strongly suggested that the country further liberalize external trade. To reduce the anti-export bias of Cote d'Ivoire's industrial and commercial policy, the Bank thus recommended in 1984 a de facto nominal (or simulated) devaluation of the CFA franc by raising the level of customs import duties while simultaneously instituting an export subSidy, as noted earlier. Manipulation of the nominal exchange rate of the CFA franc was institutionally impossible. It is difficult not to agree with the Bank about the necessity for improving the external and internal competitiveness of Ivorian industrial products, for as long as the country imports, it must export in order to pay for its imports. Because traditional agricultural exports could not be increased owing to overproduction on the international market, this profit loss would have to be compensated for by an increase in industrial exports. Stressing industrial exports and seeking to increase their range, in particular in the direction of nontraditional exports, has therefore not been a question of ideology or dogmatism but of good economic sense. The bone of contention, however, has been how to increase industrial exports. The Bank had no alternative but to recommend a devaluation. The intrinsic value of this solution cannot be doubted. But the Cote d'Ivoire government and local 90. Comments of David Knox. C6TE D'IVOIRE AND THE WORLD BANK 143 businesses had to be convinced; devaluation by itself would not be enough to develop nontraditional exports. Opponents also argued that the government was not able to pay export subsidies. The mechanism of simulated devaluation did not function because, in reality, the Ivorian government never accepted it. Nor did the government release suffi- cient funds to pay for export subSidies-perhaps because it never wanted to do so. The revenues drawn from the higher tariffs should have paid for the export subsidies; to succeed, the operation would have required a good system of duty and tax collection. But Cote d'Ivoire's institutional problems in regard to tax collection in general and custom duties in particular explain why the government could not implement the devaluation mechanism. The Bank understands well the problems of governance in Cote d'Ivoire; but in this instance the Bank wrongly minimized the instibltional problems involved. The failure of the simulated devaluation, which seemed to have worked reasonably well in some other countries, tarnisbed the Bank's prestige and credibility in the eyes of the Ivorian government and the private seetor. The principal objectives of "real adjustment," attempted in Cote d'Ivoire from the beginning of the 1980s, were to reduce the budget deficit and to restore the internal and external competitiveness of the economy (the trade-weigbted real exchange rate appreciated by around 30 percent between 1986 and 1991). The instruments utilized were budgetary and monetary restrictions, on the one hand, and tariff increases, on the other. These instruments did not achieve the goals of redUCing the cost of labor in the public and private sectors and reducing the cost of importcd inputs on which production depends. "Real adjustment," therefore, could not ameliorate internal and external economic competitiveness. Cote d'lvoire and the assembly of African countries of the franc zone finally accepted devaluation of the CFA franc in 1994, after more than ten years of hemming and hawing, and setbacks, as noted earlier. Devaluation is a powerful alternative to "real adjustment" because its principal objectives are to reduce local production costs compared to those outside, and to increase the relative price of tradeable goods in comparison with nontradeable goods and services. In summary, the advent of Cote d'lvoire's financial crisis in the late 1970s greatly strengthened the Bank's hold on the economy. At a time when the Bank's interven- tion was determined only by the profitability of individual and sectoral projects, government disagreements with the Bank could not have irreversible consequen- ces. With the onset of adjustment, the reform of an array of policies that would condition the Bank's financial assistance effected a shift in the country's entire economic philosophy. This new context has given the Bank enomlOUS power over Cote d'Ivoire's economic and social policies; its control is all the greater because the country's financial resources are so limited. 91 91. Opinion of a director of public investments, Cote d'Ivoire. 144 COTE D'IVOIRE AND THE WORLD BANK Social Policy Although foreign factors of production have occupied too great a place in the Ivorian economy, without them Cote d'Ivoire's performance would have. been impossible, The Ivorization of the economy has been the most important problem the government has had to face. The problem has been exacerbated by the economy's high growth rate, which aroused great hopes among Ivorians who legitimately desired a larger share of the economic pie. Yet the success of Ivorization will determine the future development of the Ivorian economy.92 To attain this fun- damental objective, the government put into effect elitist human resource develop- ment poliCies that raised important equity problems for groups of individuals and regions. The government must be credited with many remarkable social policies, but these achievements have been costly to society as a whole. The government's social objectives have also weighed heavily in its dialogue on adjustment with the Bank. Throughout the period of Cote d'Ivoire's economic prosperity President Houphouet- Boigny told Ivorians that despite his aversion to socialism, he had promoted bold social policies. Cote d'Ivoire had thus become one of the champions of economic liberalism in Africa. The country's poliCies for hOUSing, health, and education, among other examples, support the president's assertion. Housing policy has routinely affected the lives of citizens. The Houphouet- Boigny government favored access to affordable hOUSing and private ownership of such housing through the actions of public real estate companies, such as the Societe de Gestion et de Financement de I'Habitat (SOGEFIHA), and mixed companies, such as the Societe Ivoirienne de Construction et de Gestion Immobilieres (SICOGI). Many individuals were thus able to own their homes. However, these housing programs created equity problems. They favored salaried urban civil servants and employees of the private sector; so-called affordable hOUSing was thus concentrated in the hands of those who had money or enjoyed influential political connections. It was not the most needy who mainly benefited. In the health sector there were also bold social initiatives. Medical care in hospitals and public health centers was provided free of charge to all patients until the mid-1980s. Here too there was a problem of equity, because of the uneven distribution of the health infrastructure and medical or paramedical personnel. These were concentrated in urban centers, notably in Abidjan, whereas the majority of the population lived in the villages and had little or no access to the new facilities. Education has been the most important aspect of the government's social policy. Although education weighs heavily on a family's spending, in Africa's system of extended families access to education affects a family'S revenue only in the mid and longer terms. Educational subsidies crystallized President Houphouet-Boigny's social ambitions for Ivorian youth. Such subsidies had been antiCipated as early as 92. Den Tuinder and World Bank, Ivory Coast. COTE D'IVOIRE AND THE WORLD BANK 145 1946, when approximately 150 young Ivorians (boys and girls) were dispatched to France to learn various trades and to receive technical training in high schools and secondary schools. At that time Cote d'Ivoire was a colony that had no such institutions, and the idea of political independence had not yet crossed anyone's mind. To mark the historical nature of this venture and show their gratitude to the government for its financial support, members of the group created an association named the Compagnons de YAventure de 1946. At the time of independence in 1960 these young diploma holders and their predecessors (who had been educated by the colonial administration at the William Ponty de Goree School in Senegal, and among whom were President Houphouet-Boigny and most of his political companions) formed a core group of Ivorian executives who occupied the first positions of responsibility alongSide the French in the country's public and private administration. After independence the government had the clear policy of faVOring secondary and higher education over primary education, which had already been well de- veloped under the colonial administration. 93 The government implemented that policy by investing heavily in the construction of high schools and municipal schools throughout the country and by establishing a new national university. (A maximum of 7,000 university students was anticipated for 1963, but by 1994 more than 30,000 students were enrolled, on three campuses.) In secondary education and the university the classical French tradition, which excluded technical dis- ciplines and the engineering sciences, was followed; the government also followed French tradition by separately constructing high schools, municipal schools, and ecoles superieures for technicalleaming and engineering sciences. After the 1960s Cote d'Ivoire devoted more than 40 percent of the total state budget to education and training. Secondary and higher education, both general and technical, received especially generous subsidies. Not only was no tuition charged, but room and board for students admitted as boarders was free. Further- more, all students who had obtained their baccalaureate (the high school gradua- tion certificate) were admitted to the university and automatically received a monthly stipend. For a long time the Ivorian government offered its students some of the most generous study grants in Francophone Black Africa; only oil-rich Gabon could afford to be more generous. Housing and food services were also generously subsidized, and health care was free. State subsidies for instructors were also generous; the separation in the early 1970s of their nominal salaries from those of public officials put them into the category of the country's best-paid civil servants, on an equal footing with military officers and magistrates. The fact that the Ivorian elementary school teacher was better paid than the young civil service medical doctor illustrates the financial 93. Note of Leonard Rist, November 24, 1961, in World Bank, Cote d'Ivoire country files. 146 COTE D'IVOIRE AND THE WORLD BANK privilege attached to a teaching career. Moreover, teachers in public secondary schools and higher education had the added benefit, until 1987-88, of free housing. To bridge the country's deficit in teachers in the face of a rapidly increasing demand for education, the government called upon foreigners, both French citi- zens and non-Ivorian Africans. They were attracted hy even greater financial rewards than those bestowed on their Ivorian counterparts, and therefore re- sponded in massive numbers. The spectacular development of training in the 1960s and 1970s was the result of the government's education subsidies. Among the brilliant poliCies of the Ivorian government, combining both social and economic elements, was the regionalization of public investment. This policy was exemplified by the development of cotton and sugarcane culture in the savan- nah regions of the center and north of the country. Regionalization was also applied through the celebration of the national holiday of August 7 (later changed to December 7) outside of Abidjan every other year, in a different administrative region of the country. On the occasion of this revolving national holiday, physical infrastructure projects (such roads, bridges, and dams) and social infrastructure projects (such elementary, secondary, and mUnicipal schools, health centers, and sports equipment) were granted to the host region or built by the government. The financial crisis ended this practice in 1979. Also noteworthy was an electrification program in villages and rural centers carried out through the Energie Electrique de Cote d'Ivoire, a "mixed" company charged with the production and distribution of electrical energy. The development of cotton and sugarcane culture, the social initiatives linked to the revolving national holiday, and village electrification were partially financed by discretionary transfers from the Stabilization Fund, whose revenues came from the ell:port of coffee and cocoa produced in the richest areas of the south of the country. The beautification of Abidjan-the first Ivorian city seen by outside visitors- was another element of the nation's social policy. Whether the visitor comes from Africa or elsewhere, Abidjan surprises, for beyond the natural beauty of the site the city was constructed in a planned and orderly fashion. But it has also drawn heavy criticism because of the proliferation of peripheral neighborhoods (Marcory-sans-fu and Abobo-derriere-rails, for example) and "spontaneous" hOUSing, which coexist alongSide the affluence of the business area (Abidjan-Plateau) and the residential zones (Cocody, Riviera, and Deux Plateaux). In the beginning, the government was not overly concerned with the impact of its economic and social poliCies on the distribution of income. Its strategy consisted of attaining the highest possible level of economic growth and hoping that the benefits would later be spread over the largest possible number of citizens. But has the strategy really benefited the majority of citizens? The government's policies have been expensive and their distribution unequal; they have worsened the pover- ty of the poorest Ivorians. In regard to these distributional inequalities the Bank was inclined to he more pro-interventionist than the government, commenting that COTE D'IVOIRE A1\D THE WORLD BANK 147 "in Bank reports on the economy of Ivory Coast, we have stated repeatedly that the government should come to grips with the social aspects of its development policies and programs, including income distribution among groups and regions and the related problems of employment, population growth and ivorization:>94 Neverthe- less, the Bank did not see Cote d'Ivoire's iucome distribution problem as particular- ly severe: "Although there still exists considerable inequalities, the personal and regional distribution of income on the Ivory Coast compared favorably with [that of] other underdeveloped countries in and outside Africa."95 The Bank's opinion on Ivorian income distribution should be only partially accepted, Within Ivorian borders everyone was intuitively convinced that the distribution of income was very unequal, The political and administrative elites had easy access to financial and material advantages in an environment that had never in Ivorian memory penalized a voracious leader. Heavy-handed "rent" collection became an effective political instrument at the time of democratic pluralism, after February 1990. 96 In retrospect, however, it seems possible that an aggressive imposition of elite privileges was used to squelch political dissent during the earlier era of Single-party rule. To comprehend the cost of Cote d'Ivoire's social policies it must be remembered that education alone accounted f'Or 40 percent of the state's annual budget during the period of prosperity. The generous subsidies granted to secondary and post- secondary students, as well as the financial and material advantages given to teachers, contributed substantially to the country's budget deficit. Among the structural characteristics of public spending was the prominent share of salaries and social benefits, which represented apprOximately 75 percent to 80 percent of the Education Ministry's total budget. Thus the ministry was left with few resources with which to operate, and could not always properly realize its assigned objectives. The country also supported the supplemental costs linked to the overdesign and the architectural extravagance of the school and university infrastructure, in par- ticular the big engineering schools located in Yamoussoukro. It has been common knowledge at the World Bank and in Cote d'Ivoire that the cost of these institutions was too high. Each cost tens of billions of CFA francs, and would serve only a few hundred students; such a high per-student cost was typical of the Ivorian govern- ment's pronounced taste for grandiose public works. Extravagance of that kind might have been acceptable if the cost of the govern- ment's education policy had reaped a high return on its investment. However, it is apparent that the return was relatively low-proof of this was that expatriates effectively continued their control of private business. Foreign control even seems 94. World Bank, "Basic Economic MisSion, Ivory Coast," May 29, 1975. 95. Bastiaan den Tuinder to Xavier de la Renaudiere, in a back-to-office report of a basic economic mission, September 17, 1975, in World Bank, COte d'Ivoire country files. 96. Those toward whom justice had been tolerant could show their gratitude by not openly voting against the president's ruling party in free elections. 148 COTE D'IVOIRE AND THE WORLD BANK to have been reinforced, in the period following the crisis, in the enterprises that managed to survive. There has been an obvious gap between the education pro- vided by the system and the qualifications required for the private jobs available, a discrepancy resulting from the educational system's inability to adapt to the chang- ingjob market. The government has been aware of this problem for a long time; in 1977 it created the Usher Assouan Commission to reform the education system. Yet the commission's conclusions have remained unheeded, for unknown reasons. 97 The spatial distribution of the government's social spending contributed to the increased poverty of the most underprivileged groups in the country. Rural regions received a relatively small share of the elementary and secondary school infrastruc- ture; and as discussed above, health infrastructure and medical and paramedical personnel were concentrated in urban zones to the detriment of villages. More- over, the government's health policy favored curative medicine, as opposed to preventive care. Because the villages and rural zones harbor the majority of the population as well as the poorest people, such allocations of social spending accen- tuated poverty by reducing the access of underprivileged groups to social services. Unequal allocation probably increased the absolute number of poor people. The government's particular choices for social policy had another negative impact on poverty. By clearly opting for the development of secondary and university school- ing as a priority, the government chose to offer a promising future only to the minority of young Ivorians who were fortunate enough to obtain secondary-level schooling. It is obvious that the government's social objectives slowed down the adjustment process in Cote d'Ivoire from 1981 onward; in particular, they prcvented the govern- ment from taking the necessary radical measures to reduce the budget deficit and reorient the structure of social ~pending. Yet Cote d'ivoire waited a long time before initiating the reform of its elitist human resource policy. The public accepted the liqUidation of numerous public enterprises in the 1980s and the resultant rise in unemployment. But an intended reduction in the salaries of civil servants in the central government (forecast for 1990), and a change in the status of teachers to that of general public officials, which would have entailed a substantial salary reduction, led to social unrest. That unrest, in tum, gave birth to the multiparty system in Cote d'!voire. The Bank was concerned with the negative impact of the government's choices in matters of education and health policy-a concern expressed in a 1980 paper: 97. RefOlTIl of the Ivorian educational system is absolutely essential, because the system has related poorly to the physical and cultural environment of Cote d'Ivoire. As an essentially agricultural country Cote d'Jvoire has great need for scientists, technicians, and engineers. Yet the schools breed in young Ivorians an aversion to manual work and technical jobs and a preference for office careers in urban surroundings; agricultural and rural cultural values are generally absent from Ivorian schools. Furthermore, the Ivorian school serves as a vehicle for Western and urban values, synonymous with a certain desirable modernism; the essen- tially rural African values are rejected. If schools continue to neglect agricultural jobs, the productivity of agriculture will not improve and the progress of the country's economy as a whole will slow down. C6TE D'IVOIRE AND THE WORLD BANK 149 "Since government has consistently overdesigned schools, hospitals and other facilities, a reduction in unit costs such as we have frequently recommended, could free resources for programs to reach larger portions of the population."98 Yet a World Bank sectoral adjustment loan for the development of human resources was negotiated only in 1991, ten years after the initiation of reform policies. That delay prompts a question: What was the weight of social objectives in the Bank's adjust- ment policy? The reduction of sehool and university subsidies, as stipulated in the sectoral adjustment loan for human resources, led in 1992 to unrest at the national univer- sity, which made the political and social climate tense. The government had delayed reducing the subsidies because of their adverse impact on the student population, for with the advent of the multiparty system the students had acquired mnsiderable political strength. It must be wondered why the Bank was so patient with the reform of the government's social and emnomic policies. The answer probably lies in the Ivorian government's obstinacy-an obstinacy aroused and encouraged by the fact that events had often proved it right-as well as in the Bank's optimism and flexibility. The Bank thought that the structural problems it had discerned in the 19708 could be resolved under the favorable conditions created by the strong rise in cocoa and coffee prices after 1975 (it is easier to resolve problems when resources are available). At the same time, the Bank overestimated its ability to persuade the government. Similarly, it overestimated the government's creativity and ability to put into effect appropriate policies, and to change policies when they were no longer suited to the situation. It noted that "the Ivory Coast has shown considerable foreSight in managing its problems to date, and it is to be expected to mntinue to follow a prudent polieyin the future."99 As late as mid-1979 the Bank believed that the few reforms proposed within the framework of its routine consultant mission would suffice to enable Cote d'Ivoire to strengthen the high grovvth rate of the past and to maintain its prior exceptional financial credibility: "The Ivory Coast should be able to continue its strong gro\ovth record of the past while retaining its high creditworthiness rating .... The Ivory Coast's current public investment program and its external borrowing requirements are a reasonable path to sustained groV\th with an acceptable level of risk. "100 In 1980 the Bank even predicted that the country's credit would be completely restored by around 1990.101 The Bank clearly was mistaken about the outlook for the price of cocoa, as it was about the flUidity of the Ivorian government's economic pohcy when faced with changed cireumstances. The Bank must have known that Cote d'Ivoire could not quickly develop nontraditional exports capable of compen- 98. World Bank, "Country Program Paper: Ivory Coast," June 20,1980. 99. World Bank, Ivory Coast economic memorandum, May 30, 1979. 100. Ibid. 101. World Bank, "Country Program Paper: Ivory Coast," June 20, ] 980. 150 COTE D'IVOIRE AND THE WORLD BANK sating for the currency losses brought about by the decline in earnings from cocoa exports. It should also have understood the government's obstinate will to maintain its policies and force the course of external evcnts as it had always done with internal events. Despite its blighted hopes (notably, the failure of the simulated devaluation of the CFA franc) the Bank's optimism revived somewhat with the conception of a medium-term economic program in 1987 (covering the period 1989 to 1995). The anticipated results of this program were based on two assumptions: first, that the private sector would henceforth dominate economic activity; and second, that the institutional changes under consideration in the adjustment loans would soon free private initiative in the export sector. 102 Given the Bank's experience with the government's obstinacy, it can be won- dered how, more recently, the Bank expected to convince the government to take the radical measures it previously had refused to take. If the obstinacy had been politically based, how could the Bank neglect the political obstacles? The answer may be that the Bank relied too much on official reports of public opinion. In the Bank's view, "the need for strong recovery measures [was] well understood by the population."IQa Even the central government was seduced by flattering reports by regional authorities on tlle state of mind of the general populace. But what actually preoccupied the population in the hard light of day at the beginning of 1990 was not the necessity of the adjustment measures, but the unequal distribution of the sacrifices different social groups would have to make. Most Ivorians were convinced that their share of the sacrifice was going to be greater than that of those who had had preferred access to financial resources during times of prosperity. The Challenge to the Bank: Overexposure From 1981 to 1991 the World Bank invested US$I,432.2 million to finance adjustment programs, or 52.4 percent of all its economic assistance to Cote d'Ivoire over twenty-three years (see table 4-2). It is prudent for a bank to take such a financial risk only if it is convinced of the soundness of its client's economic and financial health. But in 1989, only two years after the official publication of the relatively optimistic medium-term economic program for Cote d'Ivoire, the Bank estimated that the country's economic future had become uncertain and that the country's financial credibility had become precarious. In the Bank's view, "this high exposure, together with Cote d'Ivoire's uncertain economic prospects and pre- carious creditworthiness, [put] the Bank in a very delicate position."J04 102. World Bank, "The Cote d'lvoire in Transition: from Structural Adjustment to Self-Sustained Growth," Report 6051 (Washington, March 9, 1987). 103. World Bank, "Country Program Paper: Ivory Coast," December 1984. 104. World Bank, "Steering the Ivorian Economy." COTE D'IVOIRE AND THE WORLD BANK 151 The fear was justified, for payment arrears to the Bank were accumulating and risked blocking Bank activities in the countryYl5 A persistent opinion, in the Bank as well as within the Ivorian government, has been that Cote d'Ivoire will probably be unable to resume servicing all of its outside debt in general and its Bank debt in particular. 106 Given the importance of the Bank's portfolio in the country (a little more than $2 billion U.S.) the institution had to be more cautious. The Bank recognized that "our lending strategy must be extremely prudent" and that "the Bank should avoid a rapid rise in its exposure."107 The Bank also had to do everything possible to enable Cote d'Ivoire to find the road to recovery, in hope of being reimbursed one day: "In this context [the Bank's West and Central Africa Department] has en- deavored to resuscitate the dialogue on economic policy reform ... and discuss possible loan conditionality."l08 But it also recognized that "trying to quickly reduce our exposure through highly negative net transfers would seriously jeopardize our preferred creditor status. "109 Cote d'Ivoire had suddenly become, finanCially, a high-risk country. It also became a high-risk country politically, because of the concentration of decisionmaking power in the hands of the president. Undeniably, President Houphouet-Boigny had been a charismatic leader whose history of economic accomplishments had confirmed his economic and political wisdom. But his ad- vanced age brought inertia to the management of the economy, even though in November 1990, in an ad hoc constitutional reform, the creation of the post of prime minister prevented governance from coming to a complete stop. However, solutions for the fundamental problems could not be achieved without the presi- dent. Thus the focus was brought back to the central problem of the Bank and Cote d'Ivoire-that is, to the dialogue with a partner who did not want to, or could not, change. The Bank's disillusionment was a measure of the excessiveness of its previous optimism about Cote d'Ivoire; it finally recognized that prospects were not as positive as it had hoped. A question therefore arises: Why did the Bank increase its financial risk by continuing substantial support for a reform policy judged relatively weak, and a government obstinately attached to its positions? The Bank's flexibility has certainly been the natural corollary of its optimism, but this flexibility, ap- preciated by Ivorians, has appeared at times to be a weakness of the Bank in regard to the Ivorian president. llo The Bank had earlier approved the liberal economic gradualism and the constructive economic program of President Houphouet- 105. Ibid. 106. An opinion prompted by our conversation with a World Bank official. 107. World Bank, «Steering the Ivorian Economy." 108. World Bank, "Cote d'Ivoire Agricultural Sector Adjustment Operation." 109. World Bank, «Steering the Ivorian Economy." 110. Comments of David Knox. 152 COTE D'IVOIRE AND THE WORLD BANK Boigny; despite the latter's excesses, the Bank wanted to support the program and the president at all costs, This may explain the institution's weakness with regard to Cote d'Ivoire. The Challenge to the Government: Disarray Cote d'Ivoire's current financial difficulties have brought to the forefront the structural and institutional problems that have been eroding the country's economy for a long time. These problems were brought to the attention of the Ivorian government by the World Bank, but the government chose to underestimate or hide them. Now that the abscess is open, it is important to build the political consensus that the creation of lasting solutions requires. These solutions cannot be discovered as long as Ivorians of all political opinions, in a multiparty environment, do not agree on a blueprint for a future society. Ivorians do not have a plan for tomorrow's society. Their earlier plan was based exclusively on the well-being easily acquired by elites who were fortunate enough to attend school and to occupy administrative and political posts, and whose influence and prestige were highly valued. But this well-being was acquired as a result of a tax levied on the hard and relentless work of the farmers. The government was unable to breed in Ivorians, especially the elites, respect for the public and general interest, which in times of trouble would have given them the will to fight collectively against the economic and financial crisis. TIlere is today in Cote d'Ivoire a social crisis that is distressing for everyone, both those who govern, and those who are governed. 11l The message that was retained and followed by the young generation of Ivorians over the last thirty years exemplified neither frugality nor saving. It encouraged even less the rigorous management of public resources. Thus the values most needed today are lacking. Although acquiring an important stock of human resources at great cost, the government of Cote d'Ivoire was unable to create within the country the capacity for a coherent medium- and long-term program, which, in difficult situations such as the country has experienced for more than ten years, is the only recourse. New ideas and project proposals have had difficulty emerging and finding expression. They have been inhibited by a pronounced taste for repeating a past that is insufficient for preparing for the future. lI2 The absence of a plan for a future society that would place emphasiS on respect for the general and national interest, and the present economic administration's lack of conc'erted thought about a medium- and long-term macroeconomic framework, have mmplicated and will continue to complicate the dialogue with the Bank, for the Bank tries systematically to place itself within such a framework.ll3 Ill. A view prompted by our conversation with the director of public investments, Cote d'Ivoire. 112. Opinion of a fonner minister of agriculture, Cote d'Ivoire. 113. Opinion of a fanner minister of agriculture, Cote d'Ivoire. COTE D'IVOIRE AND THE WORLD BANK 153 What Went Wrong? Two Intmpretations The story of the relationship between the World Bank and Cote d'Ivoire since the early 1970s is a sad one, running from a sunny start to substantial stalemate during the years of financial crisis at the end of the reign of a national patriareh, Here we try to address more deeply, and hypothetically, the question of what went wrong. We offer two answers-political and social constraints on the one hand, and structural problems on the other. They are not opposed. We tend to accept both, but the first, the more conventional, will be more widely credited. Political and Social Constraints In terms of their underlying macroanalyses of Cote d'Ivoire, the Ivorian govern- ment and the World Bank have been on the same wavelength in recent years: the country must recover its internal and external balances, by a demand-stabilizing fiscal adjustment and by relative price changes in favor of tradeables that would narrow the balance-of-payments gap. Where tbe two parties have differed is over the choice of instruments to achieve these goals. The Bank endorses the view that Cote d'Ivoire's main problems remain those of the budget deficit, the effective real exchange rate, and the lack of private invest- ment. 1l4 There is no mention of any other real structural problem. According to this view, Cote d'Ivoire would find itself in a much better situation today if it had adopted measures deSigned to raise its fiscal revenues and cut salaries in the public sector in order to cut public spending. Moreover, out of conceru for equity in relation to the private sector, and for peasants in particular, Cote d'lvoire should earlier have devalued the CFA franc to improve the economy's competitiveness. This package of measures is considered «real adjustment." Its implementation would have stimulated private investment, thereby stimulating Cote d'Ivoire's economic growth. The country's political and social constraints explain why such "real adjustment" was not chosen by tbe government. But the disinclination of economists to engage the sociopolitical constraints has made the debate over adjustment artificiaL The fiscal adjustments implemented by the government essentially have ad- dressed spending and only marginally addressed the matter of receiptsY5 To be sure, one of the first prime minister's first objectives was to recover overdue taxes, But even if it is assumed that the tax on private and foreign enterprises could be 114. Lionel Demery, "Fettered Adjustment: the Case of Cote d'Ivoire in the 1980s," April 1993. 115. Shantayanan Devarajan, "Comments on 'Cote d'!voire: The Failure of Structural Adjustment: by Christophe Charnley," in Paul Mosley, Jane Harrigan, and John Toye, eels., AID and Power: The World Bank and Policy Based Lending, vol. 2 (London: Routledge, 1991), pp. 305-308. 154 COTE D'IVOIRE AND THE WORLD BANK recovered, it is hardly likely that the taxes on private property would be similarly enforced, Arguably, the protection granted to the political class (which is also the propertied class) and to those who gravitate around it partially explains why taxes, particularly those long overdue, are not being paid. This is why adjustment efforts have focused on public investment spending rather than on revenues. Civil servants' salaries today represent too heavy a burden for the treasury. The government can reduce the wage bill either by dismissing some civil servants or by keeping them all but at reduced nominal salaries. The second approach was tried in the early 1980s; it affected a minority of employees in the public sector and in the para-public sector, whose wages were realigned with those of general civil service employees. The change went smoothly because of the small number of people involved and because the main union to which the workers belonged (the Union Generale de Travailleurs de Cote d'Ivoire) was aligned with the party in power. The same approach was tried in 1990, but without success because of the political turmoil that then threatened the regime itself, and which led to the establishment of the multiparty system-the most important by-product of the upheaval. The difference in success between these two attempts to reduce the wage bill can be explained by the determination to apply the measure, during the second episode, to all 120,000 civil servants at once. It can also be explained by the political power of the teaching trade unions (at all levels), which represented a large percentage of those civil servants. Because of its financial problems the govern- ment would have liked to cut civil service salaries, but it hesitated to do so because of the political costs. It would have been out of character for the president to have imposed such a burden on public employees. This was a costly inhibition for the country, because it left public investment to bear the bulk of the financial adjustment burden. As perceived by Cote d'Ivoire's government, the political cost outweighed the economic cost. It seems to us that the best way to reduce that political cost would be to create a national consensus on a new plan for SOCiety, a plan that would be managed by stable institutions whose mandate would be recognized by all. But to this day such a consensus has not been on the agenda. In Cote d'Ivoire until the beginning of 1994, however, the worst obstacle to orthodox adjustment reform was the adamant opposition of the government (with the government of France standing behind it) to devaluation of the CFA franc. For some years the Bank had deplored this stance, even if its protests were muted. With the death of President Houphouet-Boigny and French ap- proval of a 50 percent devaluation of the CFA franc at the beginning of 1994, the obstacles to orthodox adjustment, although by no means eliminated, on the domestic side appeared to be dramatically reduced. The question of how com- plete an adjustment may be in prospect, however, brings us to a second hypothesis on what went wrong. COTE D'IVOIRE AND THE WORLD BANK 155 Structural Problems in the Economy During the recession created or intensified by the drop in public investment, the desired cuts in imports and in domestic inflation in fact occurred; these have been the main achievements of the monetary stabilization policies. But Cote d'Ivoire's nonagricultural exports did not increase to compensate for the losses of foreign exchange in the coffee and cocoa trade. Thus the wealmess of industrial exports prevented the restoration of growth and of debt servicing. EVidently correcting the internal disequilibrium, in particular the primary fiscal disequilibrium, does not automatically create propitious conditions for correcting the external disequili- brium. More specifically, perhaps the devaluation of the CFA franc, considered the sine qua non for growth in economic activity in Cote d'Ivoire, \-vill not necessarily unleash such growth. 116 The effective real exchange rate is the most important relative price for the economy, and any policy that moves it to a competitive level is welcome. However, such a manipulation alone (or even coupled with the traditional measures that come with it) is unlikely to be sufficient to create the desired behavior at the entrepreneurial level and to modify concretely the composition of Cote d'Ivoire's production in a way required by the current economic situation. The structural change required today is to produce less coffee and cocoa for export and more industrial exports, including those associated with the two primary products. It is essential that Cote d'lvoire substitute tradeable goods for nontradeables, as recom- mended by the adjustment model used by the Bretton Woods institutions. It is our opinion that Cote d'Ivoire should go beyond such an adjustment; the country should especially seek to substitute industrial exports for the primary exports of coffee and cocoa. Such a substitution would protect the country from fluctuations in raw material prices. As long as the decline in the price for raw materials continues, a devaluation of the CFA franc is unlikely to solve Cote d'Ivoire's growth and debt problems because it cannot instantaneously increase the elasticity of technical transformation of industrial exports. The excessive reliance of Cote d'Ivoire's economy on coffee and cocoa underlies the rigidity of the system of production, the fragility of the country's financial system, and the strncture of government fiscal revenues. With the exception of Gilles Dumfle, those who recognize this fundamental stmctural problem rarely indicate the nature of the transformation required to make the economy more flexibleY7 Considering the diversification already achieved in agriculture, it is difficult to see where nontraditional agricultural exports, capable of compensating 116. Demery, "Fettered Adjustment"; Devarajan, "Comments on 'Cote d'Ivoire.'" 117. Gilles DurufIe, L'Ajustement Structurel en Afrique: Senegal, Cote d'Ivoire, Madagascar (Paris: Editions Karthala, 1988); Christophe Charnley, "Cote d'Ivoire: The Failure of Structural Adjustment," in Paul Mosley, Jane Harrigan, and John Toye, eds., AID and Power: The World Bank and Policy Based Lending, vol. 2 (London: Routledge, 1991), pp. 287-305. 156 COTE D'IVOIRE AND THE WORLD BANK for losses in foreign exchange from unfavorable coffee and cocoa sales, could come from. Only diversified industrial exports would fill this void, To this end, industrial enterprises must develop a culture of industrial exportation-that is to say, put themselves in the psychological and technical disposition necessary for a battle against stronger adversaries in international markets. Unfortunately, such an ag- gressive commercial culture is seriously lacking. The maintenance of a competitive effective real exchange rate could contribute to a culture of industrial exportation, but cannot create it. To rely on relative price adjustments as the World Bank does, when the real Ivorian constraints are structural, is to be dogmatic. However, once dogmatism is rejected, it must be recognized that in practice the country cannot wait for years for structural change to effectively bring about a more flexible system of production. The Bank quite pragmatically should use the correction of relative tradeable-goods prices as a way to win time, rather than viewing it as a measure that might definitively uproot the structural malfunctions of the Ivorian economy. While such a holding operation is under way, steps deSigned to build a culture of industrial exportation should be pursued. Otherwise need for the correction of relative prices (by devaluations, for example) will become increasingly frequent and increasingly costly. It is useful to examine, as Devarajan has done, the reasons for the country's economic growth during the period of prosperity before the adjustment crisiS. llB The massive presence of the government and the distortions associated with that presence are not new phenomena. The investment code and industrial protection have been in place since 1959; minimum wage laws date to before the 1960s; and throughout the period of prosperity public enterprises proliferated. The fixed parity of the CFA franc with the French franc was the primary distortion; it was in effect from 1946. Despite the government's presence and the distortions it created, Cote d'Ivoire's economy achieved a growth rate of approximately 7 percent in real terms over a twenty-year period (1960--80). What, then, was the engine of this exemplary growth? The answer is public investment, which opened up the agricultural sector and integrated it with domestic and external markets, and which developed the physical infrastructure (particularly Abidjan's port) and popularized improved agricultural techniques. This led to the spectacular development of an industry- and export- oriented agriculture. In our opinion, the mutual reinforcement of relative prices and productive public investment was the key to the growth of the country's agri- culture. Relative prices alone, even if appropriate, could not have produced such a result. The elimination of structural constraints-namely, communication and knowledge barriers to peasants' access to modem agricultural methods-allowed remunerative agricultural prices to have a Significant impact on agricultural pro- duction. Public investment in phYSical infrastructure was an essential facilitator of 118. See Devarajan, "Comments on 'Cote d'Ivoire.'" COTE D'IVOIRE AND THE WORLD BANK 157 agricultural dynamism, from which other sectors and private economic agents later benefitted. Because public investment is governmentally determined, it can be said that the persevering detemlination of a shrewd and creative government in elimi- nating the real constraints on modernized agriculture has been the key to the country's rapid economic growth. By redUCing public investment to the current low level, macroeconomic adjust- ment therefore has broken the engine of Cote d'Ivoire's economic growth. For this type of adjustment to succeed, the structure of the economy should have been less dependent on government activity and protection. In our opinion, the Significant drop in private investment, which was accustomed to relying on government activity and protection, is explained chiefly by the collapse of public investment. 1l9 The World Bank had always wanted the Cote d'Ivoire government to cut its public investment program, arguing that the program was too ambitious to be sustained over a long period. Thus the recent reduction, forced by the govern- ment's diminished fmancial means, is what the Bank had been seeking. But it has not paid off. Although the government deficit has narrowed, private investment, on which all hope rested, is now collapSing in an unprecedented fashion. The country is still waiting for the cut in government size to stimulate private investment. A less ambitious, more selective and timely restraint on public investment might have worked better. But the government was too slow off the mark. For a long time it chose to ignore the Bank's advice to moderate its ambitious and imprudent investment policy. From the beginning of the 1960s the Bank had emphaSized the risk that such a policy would become bogged down in untenable debt. History will show that the Bank was the first international institution to warn the government about the disastrous consequences of its policy, and the Bank was right to keep sounding the alarm right up to the eve of the crisis. Although the government began to realize in 1978 that the boom in raw materi- als in 1976 and 1977 was not yielding permanent revenue gains, and as a conse- quence delayed or canceled certain public investment projects, formal adjustment only began in 1981. This was too late to heed the Bank's persistent warnings and advice. By then the country's economic disease was too advanced to permit an easy and swift recovery. And it is true that, by the standards of orthodox adjustment therapy, the reform agenda adopted was less than optimal. Disagreements within the government led to delays, and, arguably, the reforms were wrongly sequenced. If the regime had been able to cut the number of salaried workers in the state sector, relax labor market regulations, and devalue the CFA franc before public investment was reduced, the system's increased flexibility might have accom- modated a countervailing rise in private investment. But about such a rise we are skeptical. The outlook for investment in enhanced industrial export capacity was dim unless there was a change in the mentality and 119. See PegaUenan, "Sources of Economic Growth." 158 COTE D'IVOIRE AND THE WORLD BANK behavior of industrial enteIprises that had become dependent on protected domes- tic markets. Price flexibility does not directly address the structural constraints imposed by the lack of a culture of industrial exportation. Instead of promoting it, the reforms on which the government and the Bank focused postulated that such a culture already existed. Conclusions In Cote d'lvoire the World Bank addressed a country long admired for its economic success, with strong, enduring leadership and a strong, possessive patron. Did the Bank's intervention affect the country's life and political changes? Before the crisis, the Bank had little opportunity to influence the political life in a direction that was not desired by the government, because the government could do without Bank assistance without serious consequences. Furthermore, during the period of economic prosperity the country functioned in a political atmosphere bound by unity of thought and action (at least in appearance) between the government and the population. All government decisions were generally implemented without any real chance of being modified by the populace. The Bank itself recognized the autocratic nature of the political regime in place. "The PDCI [Partie Democrati- que dc la Cote d'Ivoire], the Single ruling party, includes most elements of the country's political life. Dissent, to the extent that it exists, is underground."120 By financially supporting, in a decisive manner, the government's action, the Bank helped to consolidate a political regime. The Bank's reinforcement of the political regime was facilitated by the regime's liberal economic stance. Moreover, the Bank has admitted that by finanCing the activities of public enteIprises it contributed to reinforcement of those distortions associated "'lith the state's inter- vention that it is fighting today.121 It must also accept that through the same financing it actively supported and strengthened political monolithism instead of true democracy. With regard to the political changes during the latter years of the Houphouet- Boigny regime, the Bretton Woods institutions probably influenced not only the creation but also the choice of the prime minister in November 1990. The first to hold this position had the advantage of being well regarded because of his ex- perience at the International Monetary Fund, as the former director for the Africa region. Such experience was reassuring in view of the economic reforms that had to be undertaken. The Bank and the government, in 1991 and 1992, negotiated three sectoral adjustment loans aimed at improving the competitiveness of the economy, developing human resources, and making the financial sector healthier. If the 120. World Bank, "Country Program Paper: Ivory Coast," November 16, 1977. 121. World Bank, "Cote d'Ivoire Agricultural Sector Adjustment Operation." COTE D'IVOIRE AND THE WORLD BANK 159 extent of financing designed to support the structural and institutional measures contained in this refoTIn program reflected the confidence the Bank had in the prime minister's actions, it can be said that the Bank certainly has influenced the short- tenn economic future of the ruling political regime, About the attitude of France to the "real adjustment" recommended by the Bank it is possible to speculate. That attitude can be interpreted as a protest against the harshness of the Bank's posture, or as resistance to a liberal policy seen to go against French economic and political interests in Cote d'Ivoire, or as a combina- tion of these elements. Whatever its motivation, France's attitude clearly has tempered the Bank's forthrightness; the Bank has displayed a certain weakness vis-a.-vis Cote d'Ivoire. It can be argued that the direct pressures the Bretton Woods institutions placed on the Francophone Mrican governments by slowing down Bank and IMF financial transfers eventually paid off in that the CFA franc finally was strongly devalued. In view of the opposition of these Mrican governments as a whole, however, it is certain that this historic decision would not have been made without the turnaround of France. Similarly, the refoTIn undoubted1y was facilitated by Cote d'Ivoire's shift on the matter just before President Houphouet-Boigny fell ill in mid-I993. Can the Bank intervene in sectors that are of strategic importance to France? Cote d'Ivoire has been a beacon for the Bank's liberal policies. The country has presented an example of what needed to be done in certain key sectors such as agriculture. Thus, with a focus on tropical tree crops, the Bank has been prepared to assist the country in explOiting the economic potential it has been able to accumulate throughout the years. However, it is possible that in the future the Bank will not provide Cote d'Ivoire with all the assistance the country may desire when dealing with sectors that conflict with France's economic and political strategy, even though that assistance might be essential for effective realization of Ivorian economic potential. This may apply not just in matters of currency, but also in the development of a trained work force and to scientific research, each of which is a highly strategic activity without which economic and political sovereignty cannot be effec1:ively exerted. Given its economic and political weight, Cote d'Ivoire is an essential focal point for France's influence in Francophone Mrim, and France continues to resist the intrusion of other actors into these strategic sectors. Can the Bank support Cote d'Ivoire against French wishes? Bank deference to France might force the Bank to suspend its pressure on the Ivorian government. The ultimate sanction the Bank can exert on the government is the interruption of its programs in Cote d'Ivoire. But this pressure would not be constraining as long as France would be ready to pay enough Ivorian bills. As recently as January 12, 1994, when France decided to push African countries to accept devaluation, pressures emanating from the Bank were not very constraining. Now that the Ivorian economy has become more competitive the government again faces challenges, one of which is reinforcement of the monopoly of French 160 COTE D'IVOIRE AND THE WORLD BANK capital in the Ivorian economy. The reinforcement of French financial and economic presence is France's reward for the role it played in settling President Houphouet-Boigny's succession in favor of Henri Konan Bedie. In essence, on December 8, 1993, it was the French role that guaranteed that article 11 of the constitution would be applied quickly and fully. In accepting French monopoly, Cote d'Ivoire has chosen to remain in an expensive economic zone. At the same time, French influence in the country has been strengthened by the uncertainties of the present transitional period and by the political imponderables of the 1995 general elections. The dialogue between the Bank and Cote d'Ivoire, intensified by the CFA franc's devaluation and the accompanying measures, will always involve France. We can conclude that thirteen years after the beginning of the adjustment policy, the main objective of that policy-renewed economic growth-had not yet been reached. The fundamental structural problem of Cote d'Ivoire's economy is not directly addressed by the proposed adjustment measures, and those measures that were implemented by the government broke the engine of economic growth. The primary measures contained in the "real adjustment" proposed by the Bank involve a political price too high for the government to pay. The political context of the end of an era in Cote d'Ivoire has not lent itself to full-scale adjustment. Furthermore, intervention by France has postponed those reforms that, without uprooting Cote d'Ivoire's structural economic deficiencies, could help to move the economy in the right direction. Cote d'lvoire has chosen for a long time not to follow the Bank on a few essential aspects of its reform policy. In this complex situation the Bank's freedom of action in regard to Cote d'!voire and its protector, France, is quite restricted. Cote d'Ivoire remains a strategic country for France, even if President Konan Beme does not possess the stature of the late President Houphouet-Boigny. It would therefore not be surprising if France intervenes more often than before in the dialogue between the World Bank and Cote d'Ivoire. FIVE The World Bank in Africa since 1980: The Politics of Structural Adjustment Lending Carol Lancaster THERE is no region of the world where the World Bank is more visible and more influential than in Sub-Saharan Africa. l The Bank is one of the largest and most active providers of foreign aid in a region where most aid-giving governments and international institutions have programs. Foreign aid in Africa has become a major source of domestic investment and an important lever used by aid donors to encourage recipient governments to undertake economic and political reforms. The Bank has taken a lead role in promoting economic refonns by African govern- ments and coordination among aid donors in supporting those reforms. The role of the World Bank in Africa has not always been so prominent. During the first two decades of its lending in the region, the Bank remained a relatively Editors' Note: A valued member of the World Bank History Project's advisory committee was Philip Ndegwa, formerly a leading Kenyan official and economist. In 1992 Mr. Ndegwa and Professor Lancaster, whose work on African development had long overlapped, agreed to collaborate on a general chapter on the World Bank's ell.perience in Africa. But Ndegwa was running Kenya's national airline, and in early 1993 Lancaster became absorbed in her new role as deputy administrator of the U.S. Agency for Interuational Development. Al- though the coauthors could not get together, Ndegwa did send Lancaster extensive (,'om- ments on an early draft of the chapter. When he very sadly and nnexpectedly passed away in January 1996, Lancaster, his family, and we all agreed that his comments (very lightly edited) should be appended to the Lancaster chapter, both for their intrinsic worth and in affec- tionate tribute to this fine colleague, 1. The focus of this chapter is Sub-Saharan Africa. I will use the terms Africa and Sub-Saharan Africa interchangeably. 161 162 THE WORLD BANK IN AFRICA SINCE 1980 small and conservative donor, providing aid primarily for projects in such areas as infrastructure, energy, and education. It was only with the second oil price increase in 1979 and the ensuing balance of payments crisis that World Bank lending in Africa expanded rapidly and the emphasis in that lending shifted from projects to programs of structural adjustment. The visibility of its lending in Africa over the last decade and a half and the breadth and depth of the reforms it has advocated have made the Bank the object of considerable controversy and criticism, both in Africa and abroad. Objections have been raised about the nature and pace of the reforms it has promoted and the way its staff has pushed those reforms. More fundamentally, some Africans and outside experts have criticized the Bank's apparent degree of influence over policy- making in Africa as a new form of colonialism, threatening the very sovereignty of African regimes. These criticisms often overlook the very real constraints on the Bank's influence in Africa, which derive from the nature of the institution itself and its imperatives to lend and from the diverSity of other donors operating in the region, whose varying interests do not always coincide with the goals of the Bank. The Bank has been well aware of both the potential costs of its high profIle in Africa and the limitations on its influence there, and it has taken measures to address these I:\vo problems. These aspects of the World Bank in Africa over the past decade are relatively little known but are key parts of its activities and a major focus of this chapter. The Early Years: 1963-79 The World Bank made its first loan to an African government, Ethiopia, in 1950, to finance road rehabilitation. At that time, there were only !:\vo African members of the World Bank. In the enSuing years, the number of African member states rose rapidly as independence swept the continent: in 1957 there were still only two African members in the Bank, but by 1971 African membership had grown to forty. 2 With African countries joining at a rapid pace, the Bank struggled initially to familiarize itself with the problems and personalities of the region. The first step in dealing with a new member WdS to send out an economic mission. Once the economies were analyzed, it still took some time to propose and appraise projects. Unlike India, Pakistan, and the Latin American countries, the African countries lacked the administrative capacity to navigate projects through the Bank's rigorous project pipeline. The Bank was thereby called upon to provide technical assistance, not always evident in lending statistics. 2. Edward S. Mason and Robert E. Asher, The World Bank since Bretton Woods (Brookings, 1973), p. 65. THE WORLD BANK IN AFRICA SINCE 1980 163 Lending to countries of Sub-Saharan Africa grew steadily, reaching $2.186 billion by fiscal year 1970.3 During the 1960s, World Bank lending in Africa concentrated on transportation and power development. Loans for these purposes reflected the then prevailing Western views on the role of foreign aid in development: it was to finance the foreign exchange costs of investments in physical and human infrastructure that were necessary to encourage private investment and growth. As views on development and the role of foreign aid in supporting it shifted during the 1970s, so did the nature of World Bank lending in Africa. Lending to the region in the 1970s focused on agriculture and rural development (35 percent of total project lending for 1975-79), while transportation projects remained a large portion of total lending and education projects roughly equaled power projects (see table 5-1). During this decade, overall Bank lending in Africa rose steadily, from a total of 123 projects funded during the 1960s to 583 during the 1970s. The terms of lending softened as well, as lending by the International Bank for Reconstruction and Development (IBRD) decreased and highly concessionallending from the International Development Association (IDA) rose (see table 5-2). During the 19608 and 1970s, World Bank lending in Africa, although increasing, was still a relatively small proportion-between 10 and 20 percent-of total flows of aid to the region. The Bank's presence and influence remained limited. How- ever, those Africans involved with the Bank and the International Monetary Fund -the ministers of finance who were among the governors of the institution- organized themselves early. In 1964, African representatives met at each annual meeting, discussed issues of common concern, and presented their views in a letter to the management of the Bank. The first memo of this group to the then president of the World Bank, George Woods, and to the managing director of the IMF, urged that special attention be given to the needs and priorities of African members, especially in the agricultural and social sectors; that resources of the Bank's soft loan window-IDA-be expanded; that the Bank find ways to refinance suppliers' credits (permitting Africans to borrow further from suppliers); that the Bank reduce the interest charged for its loans; and that it finance local currency costs of its projects. Behind most of the Africans' proposals were the goals of increasing the size and flexibility of Bank lending and reducing the costs to borrowers.' In a pOint-by-point reply to this first memorandum from its African members, the president of the World Bank and the managing director of the IMF politely rejected most of the Africans' requests:5 This exchange set the pattern for the next few years, in which African governors urged the Bank to lend more and on more 3. World Bank, Annual Report, 1970. 4. "Memorandum on African Problems" from Afriean Caucus to George D. Woods, president, World Bank, IDA, and IFC, and Pierre-Paul Schweitzer, managing director, IMF, September 11, 1964. 5. Response by Woods and Schweitzer to "Memorandum on African Problems," Septem- ber 1964. 164 THE WORLD BANK IN AFRICA SINCE 1980 Table 5-1. Average Annual IBRD and IDA Commitments to Sub-Saharan Africa, by Sector, Fiscal Years 1960-94 Percent and sector 1960-64 1965-69 1970-74 1975--79 1980--84 1985--89 1990-94 Project lending sector Agriculture 17 13 24 35 31 29 18 Education I 12 11 8 7 7 10 Energy 0 0 0 0 5 1 5 Finance 0 1 4 6 6 2 2 Industrial 0 0 0 5 3 2 2 Mining 15 4 2 2 1 0 0 Other nonsector 0 0 0 5 3 2 Population 0 0 0 0 1 5 10 Power 46 10 14 6 11 7 8 Public sector management 0 5 0 0 0 0 1 Telecommunications 1 3 4 2 2 3 3 Tourism 0 0 0 1 0 0 0 Transportation 20 52 38 25 21 22 20 Urban development 0 0 0 3 3 10 8 Water supply 0 1 2 6 4 6 8 Total 100 100 100 100 100' 100· 100· Adjustment lending sector Agriculture 0 0 0 0 22 7 13 Education 0 0 0 0 0 1 11 Finance 0 0 0 0 4 26 21 Industrial 0 0 0 0 0 3 4 Mining 0 0 0 0 4 0 0 Other nonsector 0 0 0 37 70 58 46 Population 0 0 0 0 0 0 2 Power 0 0 0 0 0 0 1 Public sector 0 0 100 63 0 5 2 management Water supply 0 0 0 0 0 0 0 Total 0 0 100 100 100 100 100 Source: LCI Database. a. Includes lending for which no sector claSSification was available. favorable terms to Africa and the Bank management responded by citing what they had done and planned to do in regard to African priorities but acceded to few of the actual demands. With the election of Robert McNamara as president of the Bank in 1968, the tone of the responses to the annual memorandum from the African governors- now organized in an African caucus-became more forthcoming and in agreement with a number of the recommendations made by the Africans. McNamara, for THE WORLD BANK IN AFRICA SINCE 1980 165 Table 5-2. Bank Group Financial Role in Sub-Saharan Africa, Selected Yea~, 1970-90 Millions of 1990 U.S. dollars Debt 1970 1975 1980 1985 1990 IBRDIIDA commitments, 1,090 2,050 2,180 1,800 2,600 nonadjustment lending IBRDIIDA commitments, 0 130 180 230 1,260 adjustment lending Total IBRDIIDA commitments 1,090 2,180 2,360 2,030 3,860 Percentage IBRD 64 60 35 46 16 Total IBRDIIDA disbursements 544 1,086.4 1,168.6 2,172.6 2,852.0 IDA disbursement as 6 6 6 8 12 percentage of aDA disbursement aDA disbursements 4,400 8,200 10,866.5 15,086.5 17,407.5 Total external debt as 28 56 107 percentage of GNP Debt outstanding and disbursed 13 15 18 39 107 as percentage of GNP Total debt service as percentage 61 58 79 178 316 Source: World Bank LeI Database; World DebtTables. 1981. 1982, 1983, 1985, 1989, 1992; OECD Development Co-Operation Annual Reports, 1975, 1978, 1986, 1989, 1994. example, committed the Bank to triple its lending rate to Africa over the coming five years, to set up additional permanent missions in Africa, to lend to develop- ment finance banks, and to give greater emphasis in Bank operations to agriculture and education. The Bank management was more sympathetic under McNamara's leadership both because McNamara himself qUickly became a development en- thusiast and because Africa remained the region of the developing world with the most poor countries and the most difficult development challenges. But more practically, McNamara's goal of rapidly expanding Bank lending worldwide re- quired increased lending in Africa. And to do so with a minimum of second thoughts and haggling on the part of Africans, the Bank management had to establish morc responsive and harmonious relationships with its African member governments, Being more sympathetic to their views and requests was one way of doing so. During the 1970s, the types of projects broadened to include rural development and more social sector activities, consistent with the growing focus by the Bank and other donors on alleviating poverty and meeting basic human needs. The principal group of Africans concerned with the role of the Bank in Africa remained the government ministers, particularly ministers of fmance and planning responsible for overseeing relations with the Bank. But that was soon to change. 166 THE WORLD BANK IN AFRICA SINCE 1980 The Bank in Africa in the 1980s As the 1980s began, many of the countries of Sub-Saharan Africa faced the most severe economic crisis in their two decades of independence. The second oil shock plus inflation in the West had resulted in rapidly rising prices for their imports of petroleum and manufactured goods. Meanwhile, prices had collapsed during the latter half of the 1970s for many metals, tropical beverages, uranium, and other raw materials, causing African countries' earnings from exports to drop, sometimes dramatically. And by the mid-1980s, the fall in oil prices caused a balance of payments crisis for the petroleum-exporting countries of Africa, which had earlier benefited from the surge in oil prices. A number of African governments, hoping that their balance of payments crisis was transitory, borrowed commercially to fill the gap.6 When commercial lending to Africa dried up after 1982, a number of governments-now unable to service their foreign debts--called for debt rescheduling. Some imposed controls on allocations of foreign exchange, hoping to reduce their import bill. And many turned to their traditional sources of foreign aid and to the World Bank for extra assistance. Few believed that the increases in petroleum prices were temporary. Non- petroleum-producing countries would have to adjust their economies to export more and import less if they were to close the gap in their balance of payments. This was one of the origins of the new thrust in Bank lending, termed structural adjustment. Lending would involve a transfer of resources to an African govern- ment (a "program" rather than a "project loan," which could be used to finance imports) in support of, or-as many saw it-in exchange for agreed economic policy reforms, including trade liberalization, increases in prices for agricultural goods (espeCially export crops), reform of financial systems, and a host of other changes in economic policies and institutions. 7 At the same time, the IMF was 6. Guaranteed commercial bank debt as a percentage of total long-term debt for all Sub-Saharan African countries rose from 2.3 percent in 1970 to 19.1 percent by 1980, but then retreated to 15.3 percent by 1986. Nigeria's share in commercial debt (which jumped from 3.2 percent in 1970 to 49.0 percent in 1980) was a large factor in this marked rise, but other countries also borrowed heavily from commercial banks during this period, including Cote d'Ivoire and Kenya. World Bank. World Debt Tables, 1994-95, voL 2 (Washington: World Bank, 1994). 7. The first adjustment loan to Senegal in 1980, for instance, spelled out six realms of economic reform. Public finance reforms called for eliminating the overall budget deficit and increasing the ratio of public savings covering public investment initially to 15 percent, and thereafter to 25 percent, in addition to repaying arrears and freezing expenditures. In its investment program, the government agreed to raise the share of directly productive invest- ment in its total investment program from 43 percent to 55 percent and to improve its project selection. Some parastatals were to be privatized, and those remaining were to have greater autonomy. A de facto devaluation of 15 percent (subsidies on nontraditional exports, THE WORLD BANK IN AFRICA SINCE 1980 167 conditioning its rapidly expanded lending to African governments on their adoption of "stabilization" programs, which were intended to reduce inflation and close the gap in the balance of payments. These programs normally included an exchange rate devalua- tion, restrictions on domestic credit, and reductions in the fiscal deficit. They often overlapped with structural adjustment programs supported by the Bank. Indeed, they were often coordinated with those of the Bank and vice versa. In an effort to persuade the Bank and other aid donors to expand their assistance to Africa, the African governors at the annual Bank-Fund meeting in Belgrade in 1979 asked the Bank to prepare a speCial paper on their economic crisis, to defme the role of the international community in solving this crisis, and to produce a "special program of action" within the Bank to assist the region, both with its own resources and by mobilizing those of others. This study, published in 1981 and entitled Accelerated GrQWth in Sub-Saharan Africa: An Agenda for Action, ~'ertain­ ly called attention to the deepening economic problems facing Africa and recom- mended a doubling in aid to the region. But far more important, it argued strongly that economic policy reform was critical to any economic recovery in Africa. The "Berg report," as the study carne to be known (the principal author was Elliot Berg), provided a rationale for structural adjustment lending in Africa. It argued in particular that domestic policy deficiencies and administrative constraints impeded economic progress, and it called for policy reform in trade, exchange rates, and the agriCultural sector, as well as increased effIciency in the public sector's use of resources. Implicit in this argument, and soon to be explicit in analyses of African economic problems by the Bank and other institutions, was the conclusion that state-led development had been a failure. The role of the state needed to be diminished in favor of free markets and the private sector if healthy economic growth were ever to be achieved in the region. The Bank's report produced a storm of criticism in Africa and among many individuals and institutions working in Mrica, including Western academics, pri- vate voluntary organizations, and international institutions such as UNICEF. There were complaints ahout high-handedness on the part of the Bank for puhlicly criticizing the policies of African governments and infringing on the sovereignty of African countries if assistance was conditioned on policy reform. There were also criticisms that the policy prescriptions themselves were inappropriate, that the state still had a key role to play in development in Africa, that the amount and pace extra duties on imports) would be implemented in order to reform prices and producers' incentives. As for agricultural institutions, the government agreed to conduct a number of studies on a new cooperative structure and to reform agricultural credit. Ceilings on com- mercial debt were to be placed to reign in external debt, and in monetary policy, monthly credit ceilings were set. See World Bank, "Program Performance Audit Report: Senegal- Structural Adjustment Loan and Credit," Operations Evaluation Department, Report 5637, May 9, 1985 (SecM85-624), pp. 2-4. 168 THE WORLD BANK IN AFRICA SINCE 1980 of proposed reforms were unrealistic, and that the kinds of economic reforms proposed would be especially costly to the poor, who stood to lose jobs, subsidies, social services, and real income. Africans also saw the Berg report's criticisms of state intervention in the economy as an indirect criticism of the Lagos Plan of Action, which was signed by all African heads of state at the Organization of African Unity (OAU) meeting in 1980. Some argued that the real source of economic problems in Africa was an unfavorable and unjust world economy, which should be the major focus of reform efforts. In contrast to the widespread criticisms of the Berg report in Africa and else- where, a number of Western governments welcomed the report. It fitted their analyses of the causes of the region's economic problems, and its emphasis on freeing up markets coincided with their own ideolOgical preferences. (Conservative governments had taken office in the United States, the United Kingdom, and Germany at the beginning of the 1980s.) All of these governments were happy for the World Bank to take the lead in promoting economic reform in Africa. As a multilateral institution, the Bank would probably have fewer problems in pressing for economic change--clearly an intrusive posture-than Western governments. Africans would always be suspect of their economic and political motivations, and their relationships with African governments could be damaged by a too enthusias- tic advocacy of painful economic policy changes. During the 19805, overall lending by the Bank to African governments expanded rapidly, and the proportion of lending for adjustment expanded even more rapidly (see tables 4-2, and 4-3). The types of loans in support of adjustment diver- Sified. In addition to structural adjustment loans, which tended to be relatively large loans for a broad set of macroeconomic reforms, the Bank began to make loans in support of economic reforms in particular sectors. A third type of loan-a mix of adjustment lending and project lending-made its appearance later in the 1980s. By fiscal year 1990, $1.362 billion, or 34.4 percent, of Bank lending to Sub-Saharan Africa was in support of some form of adjustment lending. 8 Mitigating the Political Costs of Adjustment Lending Almost from the beginning of the 1980s, senior Bank officials recognized that there would be two challenges in the institution's taking the lead in adjustment lending in Africa. One was dealing with criticisms and resistance by Africans. The other was making sure that other aid donors supported the Bank's approach. Without a measure of acceptance by Africans, the Bank's ability to lend in the region would be limited; and without support from other major donors, its efforts to promote difficult policy reforms would be undercut. 8. World Bank, "Adjustment in Sub-Saharan Africa: Selected Findings from OED Evaluations, June 30, 1993, Report 2155, p. 19. THE WORLD BANK IN AFRICA SINCE 1980 169 Dealing with the Africans The first and most important challenge involved the Africans. Three aspects of Bank-supported struetural adjustment in Africa lay behind the criticisms and resistance of Africans: these programs were highly intrusive; they were also often politically painful and even risky; and they were frequently complex and controversial. REASONS FOR RESISTANCE. Adjustment programs were intrusive in that they brought costs as well as benefits (aid-financed projects normally appeared to bring only benefits), and they affected an entire society or large segments of it. A currency devaluation could Significantly raise import prices, for example, which effectively reduced the real income of those directly or indirectly reliant on im- ports. An increase in food prices would benefit the large numbers of farmers prodUcing food for salc but would also hurt urban dwellers who had to purchasc food. Trade liberalization could drive uncompetitive enterprises out of business and expand unemployment. In addition, Africans were sensitive to the appearance (and reality) of having their policy choices dictated by outside powers or institutions. This sensitivity was heightened by the experience of eolonialism, which most of them had escaped no more than two decades earlier. Finally, the sensitivity to Bank intrusiveness was exacerbated by what many Africans regarded as the high-handed and often ar- rogant style of some Bank staff. One story, widely recounted in Africa, captures this view. Early in the 1980s, the World Bank regional vice preSident for Eastern Africa paid a visit to Tanzania. The purpose of the visit was to persuade the Tanzanians to eliminate arrears in their payments to the Bank. (According to the then governor of the Central Bank of Tanzania, the failure to repay was a result of a bureaucratic mistake rather than intentional.) In a meeting with Tanzanian President Julius Nyerere (who was apparently unaware of the arrears), the Bank vice preSident declared that he "had come for his check." This greatly offended Nyerere, who demanded that his aides pay the Bank immediately regardless of the costs, asked the Bank vice president whether the issue of arrears was all he had to talk to a country's president about (the issue being more appropriately raised at the mini- steriallevel), and stood up and left the meeting. Relations between Tanzania and the Bank remained cool for some years after this incident, and the Tanzanian government resisted the adoption of a structural adjustment program. More generally, criticisms by African officials of the Bank's style often included complaints about the tendency of Bank staff to preach to Africans and at times to appear to be giving instructions to them. (These criticisms were also echoed by various officials of bilateral aid agencies based in African countries.) More substantive criticisms of the Bank in Africa, particularly in the early days of structural adjustment, included the tendency to apply similar advice to all countries despite their very different political and social characteristics and to require more reforms in a shorter period of time than African governments were 170 THE WORLD BANK IN AFRICA SINCE 1980 capable of implementing. This latter criticism appears to have been indirectly acknowledged by the Bank, as in recent years it has tried to reduce the number of reforms it requests in adjustment programs. Finally, Africans have been critical of the Bank and of foreign governments alike for not seriously addressing their debt problems. Many African countries are among the most heavily indebted in the world, and much of their debt is owed to the IMF and the World Bank. Africans have argued that structural adjustment- however extensive-is unlikely to contribute to a brighter economic future for their countries as long as their debt burdens remain so great. Structural adjustment reforms are often politically painful and even risky. They almost always create losers as well as winners, with the losses often experienced almost immediately and the benefits gained over the longer term. While the winners may be expected to act eventually as a constituency in support of reforms, it is hardly surprising that the losers are frequently critical of and resistant to the reforms. In Africa, the political equation of winners and losers has been an espe- cially problematical one. There the losers tended to be the political elites who were the same individuals charged with implementing the reforms. They typically lost their access to cheap imports, economic rents (and the ability to dispense patronage), subsidies of various kinds, and, sometimes, their jobs. The benefits of the reforms typically accrued to the least politically influential group: the small farmers who received higher prices for their products. In contrast to other parts of the develop- ing world, there were few competitive private entrepreneurs who would benefit from reforms; most of the limited private sector was dependent on government protection or largesse to survive, and this tended to diminish as structural adjust- ment measures were implemented. Thus a politically significant constituency for reform was typically very limited in Africa, as farmers had little voice in the many one-party states and authoritarian regimes of the 1980s. The extreme danger in Africa was that economic reforms would provoke political violence and instability. In fact, this occurred relatively rarely, but it remained a concern among Bank staff and others. A third element in the challenge of promoting economic reform in Africa was the nature of the reforms themselves. The economic impact claimed for the reforms by the Bank and its supporters was often challenged by Africans and others. Critics often claimed that exchange rate adjustment frequently failed to decrease outlays on imports and increase receipts from exports: indeed, it could widen the gap in the balance of payments as a result of inelasticities in the demand for imports and the response of highly competitive export markets. Another com- mon objection to the reforms was that open markets in states with small and poorly developed markets like those of Africa were seldom free of imperfections that could limit economic growth just as much as the widely acknowledged imperfec- tions of African governments. Further, a common criticism has been that the economic reforms urged by the Bank and other donors harm the poor in particular. THE WORLD BANK IN AFRICA SINCE 1980 171 These criticisms were more strident at the beginning of the 19805, but they have ncver really abated despite responses from Bank staff and others that they are inaccurate or unfmr. Perhaps the only argument that will convince the critics of reform that they are wrong will be several cases of definitive structural adjustment successes in Africa, and these have not yet occurred. A fmal criticism, related to the nature and pace of the reforms, is that they are often complex and numerous and overtax the limited abilities of African govern- ments to implement them effectively. For example, changes involving privatization of state-owned enterprises require the government to undertake a complicated and interrelated series of activities (such as evaluation of assets, preparation of assets for sale, the selling process and its management) within a limited period. African ministries tend to have very capable individuals in the few senior positions, but mid-level bureaucrats are often poorly trained and lack authority to make sig- nificant decisions. Thus responsibility for implementing reforms tends to land on the desks of the few very busy senior officials or gets stalled at middle levels of the government. Similarly, large numbers of reforms to be implemented over a rela- tively short period often prove to be beyond the abilities of governments to carry out. These criticisms have been widely acknowledged by officials inside and out- side the Bank as having a degree of validity. Yet the policy framework papers drafted by the International Monetary Fund, World Bank staff, and African government officials continuc to include large numbers of economic changes to be implemented over a three-year period. There appears to be a political dynamiC at work in which each office and institution wishes to make sure "its" reforms are included in the overall package, a phenomenon commented on by a number of observers of the Bank in the past. 9 In light of all these challenges to the effective implementation of economic reforms in Africa, the Bank recognized that it would have to push reforms in the face of African reluctance and, in so dOing, possibly provoke real resistance to or even repudiation of Bank structural adjustment lending. Vociferous and public criticisms of the Bank and repudiation of its adjustment lending by one or more major African countries would probably strengthen resistance by other critics of Bank-sponsored reforms inside and outside Mrican governments and, in the end, limit the ability of the Bank to lend for adjustment in the region. Yet it appears that the Bank very much wished to avoid such limitations. PRESSURES FOR BORROWING AND LE;-..IDING. It must be asked why Mrican governments, desperate for foreign aid even with unwelcome conditions, would reject Bank advice and adjustment lending. There were, in fact, already several 9. An internal Bank report observed "a bias for compleXity-perhaps caused by the urge to include as many novel features as possible to secure a favorable management and Board response." ("Effective Implementation: Key to Development Impact," R92-195, Septcmber 22, 1992, p. iiii.) The comment was made about projects but is equally applicable to adjustment loans. 172 THE WORLD BANK IN AFRICA SINCE 1980 examples. Tanzania and other governments (such as Zaire, Zambia, Zimbabwe, Ethiopia, and Sudan) at times threatened to reject Bank adjustment aid or for a time actually did so. African political leaders had in the past at times rejected aid when it appeared too costly or threatened their sovereignty; for example, Guinea under Sekou Toure in the early 1960s repudiated Russian and then Western aid. One African government after another broke diplomatic relations with Israel in the early 1970s (and lost the small but valued aid from that country) or with Taiwan earlier (and lost aid from that country with no guarantee that similar amounts of aid from China would be forthcoming). A few African governments, taking a public stand on principle, could set a pattern others might feel compelled to follow. It must also be asked why an institution like the World Bank, with so many demands for its resources throughout the world, would worry about being unable to lend to a significant number of African governments. There are several reasons why the Bank did not want to see its adjustment lending operations significantly restricted in Sub-Saharan Africa. First, at least since the McNamara presidency, there has been pressure within the Bank-on individual staff, divisions, and regions -to fulfill notional lending quotas by country and region. This pressure to lend has been especially strong when and where the Bank has sought to expand its lending rapidly. The force behind this "lending imperative" (which is often present in aid agenCies) is that failure to obligate available funds within an anticipated period suggests to governments contributing funds to the Bank that they are providing more than is really needed. Should there be a shortfall in lending, contributing governments would be likely to reduce the amount of their contributions to the Bank in successive replenishment periods. lO Analysts of the Bank have remarked on the pressure on Bank staff to lend, and staff members frequently acknowledge that pressure in private conversations. A critical report on the problems of implementation in the Bank's lending portfolio made its own, somewhat elliptical reference to this problem: "In the eyes of Borrowers and co-lenders as well as staff, the emphasis on timely loan approval (described by some assistance agencies as the 'approval culture') and the often active Bank role in [loan] preparation, may connote a promotional-rather than objective-approach to appraisal."ll Pressure to lend was likely to have been especially strongly felt in the Africa region, where the Bank had taken a visible and active role in calling attention to the need for additional assistance to support adjustment programs. Moreover, the institution knew from its own large pipeline of unspent project moneys (a sign that 10. This imperative to lend is obviously stronger in areas drawing on IDA funds, which are highly concessional and are dependent on replenishment by donor governments every three years. Lending programs involving the relatively hard IBRD terms rely on borrOwings by the Bank from world money markets and are not as subject to scrutiny or pressure to lend as those associated with IDA. Nearly all lending in Africa is drawn from IDA funds. 11. "Effective Implementation," p. iii. THE WORLD BANK IN AFRICA SINCE 1980 173 African governments were having trouble spending existing levels of project assis- tance) that Significantly increased assistance could be programmed only as fast- dispersing, balance of payments finandng. There were other reasons why the Bank was anxious to avoid rejection of its adjustment programs by major African governments. The institution had claimed a visible and active leadership role in promoting adjustment lending in Africa. Its reputation in the region and internationally was riding on making a success of adjustment lending in Africa. If Significant numbers of African governments began to reject Bank adjustment programs, its leadership role would be undercut and its reputation damaged. It would also lose the leadership position it had claimed with donor governments in adjustment lending. Not only does there appear to have been an eagerness to lend for adjustment in Africa, but the Bank was also reluctant to terminate adjustment lending or cancel adjustment programs even when borrOwing governments failed to comply with loan conditions. There were several cancellations of adjustment programs for nonperformance, but often these canceled programs were followed by new adjust- ment loans with many of the same conditions as the previous loan. Outside ob- servers have sometimes argued that the Bank has been subject to pressures by its major contributors to continue lending even when governments were clearly un- willing to abide by conditions. There is some evidence of these pressures, par- ticularly in Francophone Africa. But the Bank has also lent where major member governments objected (for example, in Ethiopia under Mengistu) and has canceled programs where major member states continued to lend (for example, in Zaire). The real reasons for continuing to lend for adjustment despite noncompliance by reCipients appear to come from within the Bank itself. Bank management often hesitates to \vithdraw from a country where the Bank has put in considerable effort and funding: there is a hope that things will soon improve (there is a culture of optimism in the Bank, often reflected in its reports and projections), or there is concern that if a government does decide to implement an adjustment program, the Bank will not eaSily regain influence with tllat government. (These arguments are similar to those often made in bilateral aid agenCies against terminating pro- grams.) One senior Bank official put it this way in commenting on Bank programs in two of its poorer adjustment performers: Excessive optimism about the external environment ... about government commitment to policy change, and about the extent of supply responses has characterized Bank operations for a long time .... I think the Bank has a particularly difficult time in saying no when it faces a government that is expressing a willingness, and indeed eagerness, to promote refonn .... After all, we all like to believe in the power of ideas and in our own power of persuasion .... I would submit as a general proposition that the Bank tends to give greater weight to the risks of non-involvement (either on the grounds that it would undennine the standing of the reformers in the eountry, would result in a loss of the Bank's "seat at the table," or would result in serious loss of economic momentum, in loss 174 THE WORLD BANK IN AFRICA SINCE 1980 of complementary financing, or in avoidable human suffering) than to the risks associated with lending (both risks to the country and risks to the Bank itself).12 In its concerns about fully obligating its resources, keeping harmonious relation- ships with its borrowers, and maintaining its influence and leadership, the Bank begins to resemble aid-giving governments: it has interests and goals beyond those strictly concerned with development that constrain its ability to pursue develop- ment goals alone. The amount of criticism of the Bank provoked by the Berg report, particularly from Africans, surprised senior Bank management. By the early 1980s, the Economic Commission for Africa (ECA) was beginning to voice criticisms of the Berg report and structural adjustment lending. The ECA appeared to be par- ticularly concerned that the Bank's approach to dealing with Africa's growing economic crisis (through policy reform) would eclipse the Lagos Plan of Action, which involved a broad set of actions to be undertaken largely by governments. The intent of the plan was to stimulate development through economic integration, which would create large, protected markets that were expected to boost trade and investment in Africa-in effect, an import substitution policy for the entire con- tinent. Berg and the Bank sought to dismantle barriers to trade in Africa and to reduce the role of the state in development, which was quite the opposite approach from the Lagos Plan, despite diplomatic statements by the Bank at various times during the 1980s acknowledging the plan and expressing its support for economic cooperation in Africa. BUILDING SUPPORT FOR STRUCTURAL ADJUSTMENT. To deal with the criticisms of its structural adjustment lending, the Bank commissioned an "African Perceptions" study. The study, completed in 1983, was based on interviews held with a variety of individuals in several countries of the region. It contained a number of sharp criticisms of the Bank and recommendations for addressing those criticisms. 13 The criticisms included the limited role and low quality of the Bank's resident missions in Africa, the arrogant and insensitive behavior of Bank staff, their inadequate knowledge of Africa and the demands they make on the time of senior African officials, the tendency on the part of the Bank to impose expatriate consultants on Africans when local Africans could easily act as consultants, and the ineffective public relations activities of the Bank in Africa. These criticisms caused senior Bank management considerable discomfort, and they were anxious that the report not be circulated widely and that its contents-which they saw as potentially 12. Johannes Linn, "Africa Operational Issues" memo, April 2, 1989. 13. The methodology of this study was highly controversial (relying on interviews with a limited sample of people) and its criticisms of the Bank were so incendiary that it had very limited circulation among Bank staff (summaries of its findings were circulated). Even today the text of the study is unavailable to researchers from the Brookings World Bank History Project. DeSCriptions here of the contents of this report are based on summaries in Bank documents and interviews with one of the drafters of the report. THE WORLD BANK IN AFRICA SINCE 1980 175 quite damaging to the Bank's image-not find their way into the public media. But its message was taken seriously, and Bank management held discussions to evaluate its charges. Bank management also began to take action to deal with the growing criticisms of the institution corning from Africans and others. An internal task force was set up to develop a public affairs strategy, which would include targeting major countries for special efforts at "telling the Bank's story"; strengthening contacts between influential Africans and Bank staff; sponsoring local events to provide better infor- mation on the Bank's activities and achievements; inspiring articles on the Bank in newspapers and journals; and developing lists of influential people to invite to Bank activities who would not only help inform the Bank better about their particular countries but would also, it was hoped, present the Bank in a sympathetic light to other Africans. A host of other activities were undertaken during the 1980s aimed at bUilding consensus on the need for adjustment and support for the Bank in Africa. The number of resident missions was expanded to include ncarly every African country with an adjustment program, and the level of Bank representation was upgraded. The Bank tripled the number of mid- and high-level African officials in courses on development and economic reform offered by its Economic Development In- stitute in Washington between 1983 and 1987 (totaling over 4,000 for the five-year period). It increased its use of African consultants on Bank studies and other work, and senior Bank staff visiting African countries made greater efforts to meet with prominent individuals and groups (for example, the unions or the "hajjis")Y A particularly important initiative occurred in 1988, when the Bank launched its Council of African Advisers, made up of fifteen prominent Africans, to meet with senior Bank staff twice a year to discuss and advise on Bank activities in their region. This group was seen as valuable for its advice and support of Bank activities in Africa and was described by a senior Bank official as "an important instrument for the management of the Africa region." The Bank also took other actions. Like the Fund, the Bank began to seek out and strengthen allies in borrOwing governments who supported adjustment pro- grams. (These individuals were frequently but not always ministers of finance.) The Bank understood that without some influential allies in African governments, the prospects for the adoption and implementation of reforms were limited and per- suasion or threats by the Bank were of little avail. The Bank began to use the drafting of country strategy statements with African officials as a basis for educating and building consensus within African governments on needed reforms. In 1984 the Bank created a Special Project Preparation Facility to help African govern- ments develop reform programs and investment projects suitable for external fmancing, through workshops, seminars, and visits abroad for Africans from the 14. Those Moslems who have made the Hajj to Mecca. These individuals tend to be respected and influential in their communities. 176 THE WORLD BANK IN AFRICA SINCE 1980 public and private sector, including local nongovernmental organizations. This facility was intended to help build support for economic reforms inside and outside Mrican governments. In 1989 the Bank vice president for Africa characterized it as having provided the Bank "the opportunity to make a greater impact, exercise more flexibility, and permit greater advocacy than the objectives and scope of our opera- tions by themselves allow"; it had helped "move governments toward policy or institutional change in areas in which they might otherwise be hesitant to embark."15 The most important Bank initiative during the 1980s to build consensus around adjustment programs was the African Long-Term Perspective Study, launched in 1986 and published in 1989. This study was an effort by the Bank to write a comprehensive report on Mrican economies and to identifY actions needed to promote future growth. It became a consensus-building document, with back- ground papers contributed by Africans and drafts discussed in conferences and seminars in Africa, Europe, and North America and by the Councll of African Advisers. What in the end it lacked in sharpness of focus it gained in breadth. The Bank vice president for Africa described it to the Bank's board of directors as "perhaps the most striking example of how the Bank has taken the lead in develop- ing a coherent, long term strategy to tackle the region's problems." None of these initiatives by the Bank satisfied or silenced the ECA, whose criticism of Bank adjustment lending grew in stridency during the 1980s. By the middle of the decade, the ECA decided to develop an alternative strategy to adjustment in Africa. A document was drafted and discussed by African planning ministers in Malawi in 1987. COinciding with the discussion in Malawi, the Bank issued a short report of its own on progress toward adjustment in Africa. Bank staff deny that the timing of this (apparently) hastily drafted report had anything to do with the ECA conference. But the ECA and many other observers saw the timing of the report as a tactic to draw attention away from the ECA report. Thereafter, Bank President Barber Conable asked Adebayo Adedeji, UN undersecretary- general and executive secretary of the ECA, to come to vVashington to gain consensus on development approaches in Africa. No consensus was gained; indced, Bank managers complained that "the ECA continues to criticize the adjustment process and the work of the Bank and Fund in a strident and counterproductive way." The ECA published its report in 1989. The Bank did not see the report as a real alternative to adjustment, and apparently key Africans shared that view. The African representatives to IDA treated it as a "non-event," and at the OAU meeting in Addis Ababa in 1989 not only was there "no enthusiastic support" for the report, but the Nigerian representative declared that there was no alternative to adjust- ment. 15. Memo from Vice President Edward V. K. Jayc'Ox to Senior Vice President Moeen Qureshi, October 30, 1989, reviewing the perfonnance of the Fund over the past five years. THE WORLD BANK IN AFRICA SINCE 1980 177 The weakness of the ECA report, the efforts by the Bank during the 1980s to build consensus among influential Africans for adjustment, and the fact that the Bank had money to lend and the ECA did not explain the failure of the ECA to create a groundswell of resistance to adjustment in Africa and to the Bank's lending activities in support of adjustment there. Despite the ECA's failure to create an alternative to the Bank, senior Bank staff continued to worry about the lack of consensus among Africans on the need for adjustment. In 1988 Vice President Edward V. K. Jaycox commented to the Bank's board of directors: We do not claim that there has been some great religious conversion in Africa that has moved these countries to this state of enlightenment [support for adjustmentl. Quite simply, this has happened out of desperation. There is no question about it. ... In almost every case, a country has gone right to the edge or even fallen over the edge, before it has undertaken an adequate structural adjustment program. IS However, in the same presentation, Jaycox complained that "the Bank has become too important in Africa. . . . What we do or do not do in Africa now matters too much-because when we give emphaSiS to something, everyone else tends to march over the horizon in the same direction."17 The implication of jaycox's statements is that the Bank had had a great success in its search for influence in Africa and at the same time had failed in some measure by not being able to convince African governments of the salience of adjustment before their economic problems reached crisis proportions. Dealing with the Donors The second major challenge facing the Bank in the 19808, as it claimed a leadership role in promoting structural adjustment in Africa, was coordinating other aid donors: governments and multilateral institutions. There were three parts to this challenge: ensuring that the size of adjustment lending was adequate to encourage African governments to adopt needed reforms; persuading other donors to support the general goals of adjustment lending as well as the specific program goals in individual African countries-and to make that support known to the officials of those countries; and maintaining the Bank's pOSition as the lead agency overall (though not necessarily in individual African countries) in promoting struc- tural adjustment. These concerns of the Bank related to three groups of aid donors and institutions: governments, particularly that of France; other multilaterals, prin- cipally the IMF and the African Development Bank and Fund; and the UN, including the secretariat and United Nations Development Program (UNDP). 16. Vice President Edward V. K. Jaycox, statement to the World Bank Board, SECM88- 1381, December 7, 1988, p. 4. 17. Ibid., p. 1. 178 THE WORLD BANK IN AFRICA SINCE 1980 The World Bank developed a number of mechanisms and approaches for coordinating donors: it took the direct approach, making its concerns known to governments and multilateral institutions in the field and in capitals or at their headquarters; it encouraged aid donors to engage in cofinancing of Bank reform programs; it created the Special Program for Africa in the 19805; and it expanded the use of consultative groups. Some of the approaches recounted below will give a flavor of how the Bank met this challenge and did so with remarkable success. GOVERNMENTS. The most important support for the Bank's efforts to pro- mote adjustment in Africa came from developed country governments, above all the United States, the United Kingdom, Germany, Japan, and France. For the most part, the United States, the United Kingdom, Germany, and Japan supported the overall goals of adjustment, although for diplomatic, commercial, and occasionally developmental reasons, one or another of these governments criticized or opposed Bank programs in particular countries. But the most difficult problem in coordinat- ing donor governments was \>.ith the French. The government of France had long regarded the Brctton Woods twins as institutions anglo-saxones (especially the Bank, which has always been headed by an American). In the 1960s, concerned with losing its predominant influence (vis-ii-vis other aid donors, especially the United States) in these countries, it did not welcome a Significant Bank presence in its former colonial territories. It also feared that the Bank and other donors would undertake activities that did not fit the needs of the countries and France would have to bear the cost of any mistakes. The Sahelian drought of the 19708 and the spreading balance of payments crisis of the 19805 proved beyond the willingness of the French government to finance alone, and so it chose to accept and even seek aid from other sources, including the Bank. However, its relations with the Bank about adjustment programs were sometimes unsettled. While many of the development experts within the French government recognized the need for policy reforms by Francophone African govern- ments, the political and diplomatic advisors (particularly in the president's office) were primarily concerned with maintaining harmonious political relationships with African leaders. And when leaders strongly objected to Bank programs and took those objections to the French president (as they did on occasion), the French government would at times respond by supporting the Africans rather than the Bank. The issue that most divided the Bank and the French in Africa was devaluation of the CFA franc. Fourteen Francophone African countries participated in a monetary union with France, with their currency-the CFA franc-tied to the French franc at a ftxed rate. lS It was clear from the beginning of the 1980s that the 18. The CFA franc--zone countries include Benin, Burkina Faso, Cameroon, Central African Republic, Chad, Comoros, Congo, Cote d'Ivoire, EquatOrial Guinea (the only non-Francophone member), Gabon, Mali, Niger, Senegal, and Togo. THE WOULD BAKK IN AFUICA SINCE 1980 179 CFA franc was overvalued, and the Bank believed that this overvaluation was aggravating the balance of payments gaps of these countries (by encouraging imports that were relatively cheap and discouraging ex-ports, which became less and less profitable at world prices). By the end of the 1980s, the overvaluation of the CFA franc had, in the Bank's view, become so great that it blocked any chance of economic progress in the region. Some in the French government shared this view, especially toward the end of the 1980s. Others argued that devaluation would only make matters worse because of unfavorable elasticities of supply and demand of African imports and exports (an argument Africans had often made against devaluation at the beginning of the 1980s). French officials also argued that a devaluation would break the fiscal diScipline poliCies imposed on African govern- ments through their membership in the franc zone, discourage trade and invest- ment in the region, and provoke economically disruptive speculation against the CFA in the future. Most Francophone Africans who followed these issues (that is, political elites) opposed devaluation on the same grounds and also gained consider- able benefits from maintaining an overvalued currency. But behind these economic arguments was a major political concern on the part of both African leaders and the French: the CFA franc had become an important symbol of France's engagement in Africa. A devaluation of the franc might well be seen as a sigu of lessening French interest and engagement in the region (there were already signs of this in other quarters). Neither side wanted to give such a Signal. And the French in particular were reluctant to support a devaluation of the CFA franc without African support, even though maintaining the value of the currency was reportedly costing the French treasury upwards of $1 billion a year by the end of the 1980s. 19 The issue of a CFA devaluation became so sensitive with the government of France that Bank staff were reluctant to talk about it even in private. One senior manager in the Africa department was removed in the late 1980s, reportedly at French insistence, for talking about the need for a devaluation privately to African officials. The focus of the CFA problem was on Cote d'Ivoire, although the issue came up often with regard to Senegal, Cameroon, and other of the larger Francophone African countries. By the end of the 1970s, the problem of an overvalued CFA franc had already been recognized by Bank staff. But Cote d'Ivoire had long been one of the few successful examples of African development based on relatively free markets. The Bank therefore continued to lend there (on the hard terms ofIBRD 19. Nicolas van de Walle notes that "France handed out 20 billion French francs to support the CFA franc's parity in 1988 alone." See Nicolas van de Walle, "The Decline of the Franc Zone: Monetary Politics in Francophone Africa," African Affairs, vol. 90 (July 1991), p. 393. The French, of course, benefited from their support of the CFA franc, their aid, and other support for their fanner African territories. French commercial interests often en- joyed preferential access and treatment, and France maintained its special influence in these countries. 180 THE WORLD BANK IN AFRICA SINCE 1980 loans because of the relatively high levels of per capita income). During the 1980s, the country henefited from Bank project lending as well as three structural adjust- ment loans. Despite these loans, there was little sign of economic recovery, and indeed per capita income dropped by 25 percent between 1986 and 1990. By 1987 Bank staff were warning that continued lending there was risky unless the govern- ment could deal with the problem ofCFA overvaluation. There were essentially two ways of dealing with the CFA problem: to devalue the currency or to deflate the domestic economy. By pushing down domestic prices and incomes, the demand for imports would fall and resources would be freed up to produce increased exports. It was this approach that the government of Cote d'Ivoire attempted at the end of the 19805. One key element in domestic deflation had to be a reduction in nominal salaries of civil service employees, as these salaries had remained high since independence and constituted a major portion of the government's budget. Both the Bank and the Fund urged the government to decrease salaries, and future lending from these institutions was certainly condi- tioned on these and other actions to make the economy "more competitive." However, an effort to decrease salaries in 1989 led to riots and almost toppled the government. In the wake of the riots, President Felix Houphouet-Boigny asked Allassane Ouattara (from Burkina Faso) to become prime minister and undertake an economic reform program. Ouattara was then governor of the Banque Centrale des Etats de l'Afrique de rOuest, the central financial institution for six West African countries in the CFA franc zone, and had previously been director of the Africa region of the IMF. He was highly regarded by the management of the Bank and Fund. Upon taking office, he argued that the Bank, which was threatening to cut off disburse- ments of several sectoral adjustment programs, should continue those disburse- ments while he developed a medium-term plan for restoring the competitiveness of the Ivorian economy. The French government supported him within the Bank. The French were concerned that a cutoff of disbursements by the Bank would create a net negative resource flow to the Bank, making it very difficult for the Ivorians to service their debts to that institution (there were already problems with arrears in repayments to the Bank) and causing the country to lose its international credit rating. At one point, the French promised the Bank that they wonld make good on repayments to the institution if disbursements, or, as they put it, "the rhythm of lending," continued. (They in fact did lend to a number of Francophone African governments the funds needed to servic'C their debts to the Bank on several occasions.) By 1991 little progress had been made on the Ivorian agreement on a meruum- term plan. Ouattara found that he was politically unable to implement the tough policies that would force a domestic deflation, and he would not agree to a plan he did not believe he could implement. He appealed to the Bank once again to continue its adjustment lending (even without adjustment) until he CQuld come up THE WORLD BANK IN AFRICA SINCE 1980 181 with a politically feasible way to deflate the economy. Despite supportive pressures from the French, the Bank agreed only to appraise several new sectoral adjustment programs but refused to implement them without an acceptable medium-term plan. It was clear to all that competitiveness would not be restored by deflation in any of the CFA countries, and the Bank would not continue adjustment lending without improved competitiveness. The institution's lending to Cote d'Ivoire and other CFA countries began to shrink, putting additional pressure on those countries and the French to address the devaluation issue head-on. It was undoubtedly one of the factors that contributed to a decision in late 1993 by the French and the Africans to devalue the CFA franc against the French franc in January 1994.20 After the devaluation, the Bank provided $325 million in economic recovery loans and credits to CFA countries in fiscal year 1994. The Bank was willing to intervene with other governments that did not support adjustment programs or had programs of their own that threatened to undercut adjustment reforms. Informal approaches occurred in individual African countries, typically involving a group of aid donors urging a recalcitrant government to drop inappropriate projects or programs. One circuitous effort to bring pressure on President Mobutu Sese Seko of Zaire to implement agreed reforms took place in 1989. Bank vice president Jaycox came away from a discussion with President Mobutu with the impression that the only thing that would persuade the president to abide by agreed fiscal guidelines was credible pressure from his major bilateral patrons. As a result, Bank president Conable called Brent Scowcroft, director of the U.S. National Security Council, just before a meeting between President George Bush and President Mobutu in Japan to ask that Bush "send a clear message" to Mobutu to respect existing agreements. A similar approach was also planned with the Belgian and French governments. (Bush did not raise the issue with Mobutu, but Scowcroft promised that the United States would do so in a later demarche.)21 MULTILATERALS. The second most important institution with which to coor- dinate appears to have been the IMF. Outside observers of the Bank and the Fund would be hard pressed to detect Significant differences between them in their approaches to stabilization and adjustment reforms. But Bank files suggest that periodically, at senior levels of Bank management, there was real frustration with the Fund's approach to economic reform. There were problems. First, the Fund's mission was different from that of the Bank. Stabilization-closing the balance of payments gap-could be achieved through relatively short-term demand manage- ment approaches: reductions in the levels of credit, devaluation, increased taxation, 20. Another key factor in the timing of the devaluation may have been the death in December 1993 of President Houphouet-Boigny of Cote d·Ivoire. Closer than any other Mrican officials to French leaders, he had been adamantly opposed to any devaluation. 21. Office memorandum from E. V. K. Jaycox to Moeen Qureshi, senior ,ice preSident, Operations, March 22, 1989, 'A-ith written note from Barber Conable attached. 182 THE WORLD BANK IN AFRICA SINCE 1980 and reductions in government expenditures. These were tried repeatedly in Africa during the early 1980s and were effective-for a time. But they did not address the more difficult and longer-term need to stimulate new growth. Indeed, many thought they had just the opposite effect of depressing economic activity, imports, invest- ment, and future growth prospects. The Bank recognized the need for stabilization but was concerned that it not be implemented in a way that blocked growth. Much of the fmstration with the Fund centered on the policy commitments in the policy framework papers that each adjusting government was supposed to draft and negotiate with the Fund and the Bank. (The reality, aCL'Ording to Bank and Fund staff, was that the Fund wrote the first draft and negotiated it with the Bank and the government.) At one pOint, the Bank vice president for Africa complained to a top Bank manager: We have been having what seems to us as inordinate troubles in agreeing on growth- oriented PFPs with the IMF ... pressure [from the Fund] has arisen to use the additional [adjustment] resources to avoid rescheduling rather than get investment up and avoid further consumption declines .... The idea of beefing up imports to get higher levels of investment without further contraction in per capita consumption which will lead to higher growth and eventually be sustainable is a relatively foreign concept to most of our Fund colleagues. 22 Other complaints concerned Bank staff's being left out of key meetings with African government officials on monetary, fiscal, and macroeconomic issues. Given the different missions, styles, and institutional cultures of these two institutions, it is perhaps remarkable, despite their proximity and intercommunication, that their differences during the 1980s were not greater. But the coordination obviously took work. One other multilateral institution posed a potential challenge to the Bank in the late 1980s: the European Development Fund (EDF) of the European Commis- sion, which decided to initiate its own sizable program of concessional adjustment assistance in Africa. If the EDF (the largest Single source of aid in a number of African countries but seldom an influential one) decided to compete \vith the Bank in the area of adjustment lending, offering Africans alternatives to Bank programs, the influence of the Bank would be undercut and Africans would undoubtedly play off one institution against the other, much as they did with the United States and the Soviet Union during the cold war. Bank senior management immediately reCOgnized the potential threat to its programs posed by the EDF's initiative, as did officials of the European Commission. In a memo from a senior official of the commission to a senior Bank official, the commission urged: We [the Bank and the EDFJ should set up rapid and efficient measures for intensified coordination and for resolving any divergent views that may arise.... The role of the 22. Memorandum from Jaycox to Qureshi, June 14,1988. THE WORLD BAKK IN AFRICA SINCE 1980 183 Bretton Woods institutions is very important in this, and the Commission can join you in these efforts, it being understood that we do not wish to open up parallel paths. 23 The EC signaled that although it would follow the Bank's lead in countries where there were adjustment programs with few problems, it would, on a case-by-case basis, become active in "seeking a jOint position" with the government and would seek to help "states to reach agreement with the World Bank."24 Relations with the EC appear to have been well coordinated thus far vis-a-vis African reforms. A final multilateral development institution with which the Bank made some effort to coordinate was the African Development Bank and Fund (AfDBF). For most of the 1980s, the AfDBF did not engage in adjustment lending. It was not staffed to do so, and an attempt to lend for adjustment would have put the institution's management in a particularly difficult position. It would probably have found itself under cross-pressures from its African members (who had the majority of the votes in the board) to avoid imposing difficult conditions and its developed country members (who contributed the bulk of thc institutions's funds) to impose strict conditions or follow those of the World Bank. However, there was at least one case in which the AfDBF announced its intention to make a series ofloans to the government of Zaire, with a size and purpose that threatened to undercut World Bank pressures on Mobutu to implement reforms. (The Bank made knO\,ffi to the AfDBF its displeasure with these proposed projects.)25 And the World Bank may have been concerned about the AfDBF's possible support for the ECA in criticiz- ing adjustment in Africa. In a letter from World Bank President Conable to AfDBF president N'Diaye in April 1989, Conable stressed the need for consensus among donors (a term World Bank staff often used to mean agreement on stmctural adjustment) and worried that "there seems to be a continuing divergence of views within some UN agencies. This is leading to a great deal of confusion and con- tradictions-and Africa is paying the price."26 The AfDBF was careful throughout this period to avoid actions or words of its own that undercut the World Bank. UN BODIES. The third group of institutions the Bank had to be mncerned with was the UN, including the Secretariat and the United Nations Development Program. In the case of the UNDP, the main point of intersection was in whether an individual countty had a Bank-organized consultative group or a UNDP--organized- roundtable, both comprising the country's principal aid donors and representatives of the government. These groups met periodically to discuss reform programs and coordinate donor responses. In 1980 there were three UNDP roundtables and three Bank consultative groups in Africa. By 1992 there were five and nine, 23. Memo from vice preSident, European Commission, to Bank senior vice president Qureshi, March, 1990. 24. Ibid. 25. Memorandum from Paul Isenman (World Bank) to Moeen Qureshi, senior vice preSident, Operations, World Bank, April 14, 1988. 26. Letter from President Conable to President N'Diaye, April 6, 1989. 184 THE WORLD BANK IN AFRICA SINCE 1980 respectively.27 The clear preference of Africans (as well as the Bank and most bilateral donors) was the consultative group, since the Bank was far better posi- tioned than the UNDP to legitimize a government's reform program and mobilize resources to support it. (The UND P mainly provided limited amounts of technical assistance to developing country governments and was widely regarded as weak by developed and less developed country governments alike.) At one point in the early 1980s, there was concern in the World Bank that the UN Secretariat might undertake an initiative directly involving the mobilization of aid resources for Africa. The economic problems of Africa were beginning to catch the world's attention, and a UN initiative that would actually produce additional resources under UN control had long been attractive to Africans and other de- veloping countries. Those resources would inevitably carry far fewer conditions than any provided by the Bretton Woods institutions. (For these same reasons, a number of developed country governments-in particular the United States-had long resisted attempts to create or expand UN aid programs.) At the end of 1983, the secretary-general of the UN cabled the president of the World Bank to express his increasing concern about the deteriorating economic and social conditions in Africa and his intent to mobilize a concerted international effort to help Africa address the crisis and its long-term development needs. An effort by the UN to mobilize resources for Africa presented the Bank with two challenges. First, it would probably further weaken donor contributions to the replenishment of the International Development Association, which had only recently failed to reach a $12 billion target level set earlier; as a result, tbe Bank had made a special appeal to the United States to increase its contribution. Second, a UN initiative, especially if the UN itself or one of its agencies would disburse moneys, would dilute the Bank's lead in mobilizing and influencing the allocation of adjustment resources in Africa. As a result, Bank president Clausen sent a very diplomatiC letter to the UN secretary-general underlining his concern for African development, describing the Bank's important activities in this area and arguing that the efforts of the two institutions in Africa must complement each other. A much more candid snapshot of what Bank management was thinking about the UN initiative was captured in an internal memo from the vice president for external affairs to the two regional vice preSidents for Africa, informing them of the impend- ing visit of the UN director-general for development and international economic c'Ooperation: It is not clear whether these speeches and Mr. Ripert's visit herald a formal U.N. sponsored effort to raise funds for Africa. Mr. Ripert implied that this was not the case, 27. Numbers for 1980 are from A. J. Barry, Aid Co-Ordination and Aid Effectiveness: A ReL'iew of Country and Regional Experience (Paris: OEeD, 1988), pp. 15,21. The 1990 figures are from oflice memorandum from Timothy Thahane to executive directors and alternates, January 11, 1993, pp. 2--4. THE WORLD BA:\IK IN AFRICA SI:\ICE 1980 185 but in case he is so inclined, he should be discouraged. If any institution can raise additional funds for Africa, it is the Bank, cither through special IDA contributions or, possibly, through a special cffort on Africa. . .. If and when such an effort takes off, political help from the Secretary-General would be very welcome indeed. 28 The UN later sponsored a special session on Africa in 1986, which called attention to Africa's economic and social crisis but did not attempt to raise addition- al monies through the UN itself to address that crisis. It is worth examining two mechanisms the Bank used to coordinate donors in promoting adjustment in Africa. One was the consultative groups, already referred to, and the other was the special program of action created by the Bank in 1988 and described by Vice President Jaycox as best epitomizing "the Bank's leadership and catalytic role." The consultative group mechanism has been part of the international develop- ment scene for several decades. The Bank was, however, able to use it in an espeCially effective manner to support adjustment in Africa, both to provide Afri- can governments ",1th an incentive to undertake reforms and to mobilize donor support for those reforms. The Bank was unwilling to call a consultative group for a particular country until that country's government came up with an acceptable adjustment program or it had performed adequately on previous programs. How- ever, once an acceptable performance and program were turned in, the Bank would lobby donors before the consultative group to come up with resource commitments adequate to cover estimated needs, usually for the coming year or so. The actual group meetings themselves were usually set pieces with all the impor- tant business having been accomplished before the meeting. The special program of action was a mechanism for coordinating donors to the collectivity of Sub-Saharan countries. It was created by the Bank to bring major aid donors together to keep them informed and engaged in supporting adjustment in Africa (and better able to defend that engagement with their own parliaments and peoples), to discuss the general direction of adjustment in the region and issues associated with it, to include in these discussions considerations of African debt (which had become a major problem for many countries), and, most important, to commit themselves to provide agreed levels of financing over a three-year period to support adjustment. The efforts by the Bank during the 1980s to assume a leadership role in promoting adjustment in Africa and in coordinating donors to support both its leadership and adjustment in the region were remarkably successful. However, by the early 1990s, there were still no definitive adjustment successes in Africa (although there were some encouraging gains in export levels and capacity utiliza- tion in countries implementing reforms), and many countries continued to struggle with slow growth, low savings, and inadequate levels of private investment. These 28. Memo from M. P. Benjenk to Knox and Wapenhans, January 17, 1984. 186 THE WORLD BANK IN AFRICA SINCE 1980 contradictory developments contributed to a growing unease at the senior level of Bank management of the Africa region, which reacted in two ways. It made an effort to share more widely the responsibilities of leadership in promoting reforms in Africa through the creation of the Global Commission on Africa. And it began to examine seriously why economic reforms had been so slow to produce investment and growth, in the process raising the issue of "governance." After the publication of the Long-term Perspective Study and following a recommendation contained in that study, the government of the Netherlands hosted a high-level conference on aid coordination for Africa in July 1990. The conference was cochaired by the president of Botswana, the Netherlands's minister for development cooperation, and Robert McNamara. Out of the conference came the creation of the Global Coalition for Africa (GCA), which would involve the Bank, aid donors, and Africans to build support for Africa in the international community and to monitor development progress in Africa. But there was another reason for the Bank's active support for creating the GCA; it was growing increas- ingly uncomfortable with the visibility and influence it had gained and the risks associated with its large financial exposure in a region that was still suffering from slow growth at best. Reflecting these sentiments, Vice President Jaycox explained why he was particularly interested in the establishment of the GCA: The World Bank's reputation is on the line in Africa. We have become too important and there is a default situation on the part qf Mrican countries themselves in terms of their economic management and also on the part of the international community in general which has preferred to reduee its exposure in Africa and leave the Bank to shoulder the burden. Speaking frankly, there is a tendency to let the Bank do more and more of what needs to he done and also take the risks, which are very high. Half of IDA, for example, is now allocated to Africa. If we do not suceeed in Afriea, therefore, it seems to me that the very rationale for IDA may well be undermined ... the importance of the Global Coalition for Mrica [is] to ensure that the burden and the risks that are associated \'lith external support for Afucan development are shared in a realistic way.29 The GCA was duly established; it has held a number of meetings on a variety of issues and has sponsored an array of research projects. It produces an annual report on economic conditions in Africa. But it does not appear to have done much to shift the burden of external support for Africa to other sources of financing. The other Bank response to Africa's troubled development experience was to begin to examine the issue of governance in Sub-Saharan Africa. Problems of governance-the lack of transparency, accountability, and predictability in many African countries-had been mentioned briefly in the Long-term Perspective Study, reportedly at the urging of the Council of African Advisers. The Bank and others outside the institution began to link the many inept, corrupt, and authori- 29. Vice President Jaycox, statement to the board, November 19, 1990, SecM90-1504, November 30,1990, p. 11. THE WORLD BANK IN AFRICA SINCE 1980 187 tarian governments in Africa with the failure of growth in the region, even where economic reforms had been implemented. Where there was no rule of law or there was political insecurity or instability, private investors, domestic or foreign, would not risk their resources in investments and economic recovery would not take place. The growing focus on governance in Africa by Bank senior management in 1990 coincided with an increasing emphasiS by bilateral aid donors, especially the United States, on the need for African authoritarian regimes to democratize. In part, it was argued that democracy was essential for healthy long-run growth. And, in part, it was argued that democracy, like human rights, was a worthy end in itself. These arguments hit a responsive chord within many African countries, where deepening economic crisis and the example of democratization in Eastern Europe had stimulated hopes and demands for similar changes. Indeed, such changes came about in Benin in 1990, followed by several other countries. The World Bank, it should be noted, proceeded cautiously into the area of governance. The senior management of the Africa region thought it the key to long-term growth in the region but was unsure how African governments would react to the Bank's pushing governance. In 1990, senior Bank managers, including the president, gave speeches Signaling the importance the Bank was putting on good governance. But they were very careful to talk about governance as "account- ability, transparency and the rule of law," of reducing comlption and unpre- dictability on the part of governments (no fingers were pointed at speCific governments). They did not push any particular types of political organization- like democracy--even though it is hard to emision a transparent, accountable government observing the rule oflaw without being a democracy. The Bank proceeded cautiously because it was approaching one of the most politically sensitive issues for any government: the way it organizes itself and its functions. Too direct and open an attack on these essentially political issues- particularly in the case ofindividual countries----(:ould well provoke the repudiation by key bOITmving governments the Bank had earlier avoided. But also constraining the Bank were its Articles of Agreement, which specifically state that "the Bank and its officers shall not interfere in the political affairs of any member; nor shall they be influenced in their decisions by the political character of the member or members concerned. Only economic considerations shall be relevant to their decisions."30 However, an interpretation of these articles' relation to governance issues by the Bank's legal counsel left some ambiguity and thus discretion to Bank managers: The Bank should not allow political factors or events (no matter how appealing they may seem to be) to influence its decisions unless it deems them as having direct and obvious economic effects relevant to its work. ... The staff have to establish the case for the 30. Article 4, sec. 10. 188 THE WORLD BANK IN AFRICA SINCE 1980 significant drrect economic effect in a clear and uncontroversial manner.... Reform policies cannot be effective in the absence of a system which translates them into workable rules and makes sure they are complied with .... While popular participation and democratization are indeed important goals which developing countries are generally trying to achieve. it is not clear how these goals may, in the abstract, become an operational concern for the Bank ... to insist, as a general proposition that each borrowing countIy should have a Western-style democrd.tic form of government cannot in my view be reconciled with the Articles' require- ment that neither the Bank nor its officers should be influenced by the political character of its members or interfere in their political affairs:1l What this opinion implies is that Bank staff cannot openly advocate a particular form of government nor can the Bank condition its assistance on the cxistence of such a form of government. But if a borrOwing government behaves in a manner that undercuts the economic objectives of Bank lending or makes it impossible for that government to fulfill its obligations under Bank loan agreements, then the Bank staff may be justified in urging changes that will make its lending more effective, or it may terminate that lending altogether. In at least two cases, Bank staff tested the limits of the institution's ability to press individual African governments for improved governance. The first involved the government of Kenya, which was widely seen as increasingly authoritarian and corrupt. On a number of occasions, senior Bank officials urged Kenyan president Moi to "broaden political consensus" in his country-a proxy for political liberalization and reform. Bank staff also raised the need for political reform at the consultative group meeting on Kenya in 1991. In each documented case, Bank staff were careful to cite the views of other donors urging these changes and the likelihood that other donors would withhold their aid unless a movement toward greater political pluralism was apparent. Thus, while the Bank has been quite clever in using the bilaterals to protect its visibility and exposure in Africa-both politically and for resources-the bilaterals have used the World Bank (and IMF) to push theiniews and preferences on governance issues. Nevertheless, the very fact that Bank officials cited other donors on these issues suggested that the Bank itself was in agreement with them. The Bank took a similar position at the consultative group meeting for Malawi: As the Goverument knows, ... donors believe that there is a major problem-so major in fact that a number of donors have already flagged that unless something extraordinary happens, they will not be in a position to pledge additional balance of payments support, as a result of concerns about the governance issues, including release or trial of detainees, conditions in the prisons, freedom of speech, freedom of the press, and freedom of association. Donors are pressing these concerns, not only because they believe that they are central to progress on issues like poverty alleviation, but also because they feel that human rights issues underlie the sustainability of the reform program. 32 31. Memorandum from Ibrahim F. T. Shibata, vice president and general counsel, to Barber Conable, November 9, 1990, pp. 40, 42, 51-52. 32. IBRD, "Consultative Group for MalaWi, Paris, May 11-13,1992, Chairman's Report ofproceedings," MAI92-2, August 12, 1992, p. 21. THE WORLD BA~K IN AFRICA SINCE 1980 189 It appears that after taking a relatively forward position on governance issues in these two meetings, Bank staff backed away from pushing the issue ag- gressively with individual governments. This may be a result of reported criticisms of the Bank staff's actions by members of the Bank's board, or major donors may have been uncomfortable with conditioning lending on political reforms once an election (however marred) had taken place (in Kenya). In any case, the Bank appears to have decided to restrict its role in promoting im- proved governance in Africa to reforms of the civil service, public administra- tion, and legal system. Conclusion The story of the World Bank in Africa is one of an institution seeking and achieving leadership, prominence, and influence on an important and con- troversial issue: the need for painful, complex, and often politically risky economic reforms. It achieved that goal during the 1980s only to find that economic reforms, to be successful, often needed to be supported by political reforms. As the Bank vice president and general counsel observed, "The Bank's increasing concern with issues of governance in its borrowing members seems to have come as a logical last step in its gradually expanding involvement in policy reform through adjustment lending, which has been extended to social sectors. ".33 But the Bank was limited in its ability to promote political reforms. And so, by the beginning of the 1990s, it remained in a highly exposed position in Africa, with a large outstanding portfolio of loans to countries of the region, continuing problems of slow growth in most countries, tbe absence of a definitive adjustment success, and a spreading problem of political violence and state collapse in the region, further undermining the economic health and prospects of affected countries (as well as their ability to repay loans from the Bank). Although economic reforms had been vvidely implemented and some real economic progress had been achieved, the goal of achieving sustainable, healthy growth throughout the region seemed still a long v\lay off. Appendix: A View from Africa Philip Ndegwa The main points on World Bank structural adjustment programs in Sub-Saharan Africa are well covered in this chapter. The literature on the subject, however, is vast, although some of it is not entirely useful. The chapter is interesting and for me very informative in some sections, especially the story on the CFA franc. Inciden- 33. Memo from Shibata to eonable, p. 2. 190 THE WORLD BANK IN AFRICA SINCE 1980 tally, the cost to France of the overvalued CFA franc-which it said was estimated at about $1 billion a year--does not, of course, tell the whole story. Specifically, the French were getting much in return-materially, financially, and influence-wise. In the introduction to the chapter Ms. Lancaster could refer to some of the activities and events when the World Bank was starting its programs in Sub- Saharan Africa, soon after or just before political independence. It would be useful, for example, to mention the economic missions the Bank organized. In that regard, I remember, as a young economist, having interesting discussions with Professor Edward Mason and others when the reports on the East African countries were being prepared. Some of those reports were quite useful in some ways: for ex- ample, what was more effective in developing agriculture-gradual improvement or revolution? Views from Africa, especially from African governments, have not been ade- quately articulated. \Vhile there is a lot from the World Bank-nearly a major report every year during the 1980s-much of that has taken the form of preaching to Africans, and, in some cases, giving instmctions in indirect ways. Let me also say that the Lagos Plan deserved more attention than it received in Washington circles. I agree that technically it needed more action; but the spirit behind the plan needed commendation and support. Incidentally, some think that the main pur- pose of the Berg report was to discredit the Lagos plan, in addition to promoting an alternative ideolOgical framework. 34 Reference also can be made to the UN Development Decades. I do not think that the first UN Development Decade strategy influenced the World Bank, but I suspect that the second one had some impact. Those were the years when the environmental movement got into high gear, leading to the Stockholm conference and other activities and programs. With regard to relations and respective roles in Africa between the World Bank, the UN, and other agencies, it is useful to distinguish between rhetoric and actual programs involving mobilization of resources. In that connection, during the 1980s most of the UN organizations merely talked, except perhaps for the UNDP. Even UNICEF's role was largely in the form of mobilization of public reaction-and in that regard its slogan "adjustment with a human face" was clearly useful. It can also be recalled that the World Bank brought in the UNDP through publication of their joint assessment report on adjustment measures in Africa. This was criticized by many and in my view was premature. The report's use of statistics was distorted. Incidentally, when McNamara came to Kenya in 1969 I was permanent secre- tary for the Ministry of Agriculture, with Bmce McKenzie as minister. We took 34. Under the direction of Elliot Berg, the World Bank African Strategy Review Group prepared a study that became known as the "Berg report." See World Bank, Accelerated Development in Sub-Saharan Africa: An Agenda for Action, Report 3358, Office of the Senior Vice President, Operations (R81-211) (1981). THE WORLD BANK IN AFRICA SINCE 1980 191 McNamara to various parts of the country and he was qUick to develop impres- sions. Most interestingly, McNamara had a kind of mechauical approach to de- velopment. When we discussed rural development and what the \Vorld Bank could do to accelerate it, we said, "Give us five years." He seemed to jump to the view that within five years major improvements would have been achieved. I rather shared his enthusiasm and impatience to do things, some of which appeared very obvious. Alas, the process takes much longer than that, even when what needs to be done appears very obvious and when the resources needed are available. It should be stressed that discussions between the World Bank and African countries are hardly ever conducted on what is now called "a level playing field." By and large, African countries are in desperate need of resources and therefore there is pressure to agree quickly to World Bank demands. More often than not, they do not have adequate capacity, in terms of technically competent and experienced persons, to negotiate effectively with World Bank officials. It is not unfair to say that Africa has been, for many years, something on which to cut one's teeth in both the World Bank and the IMF (the African Department in the IMF was at one time, and perhaps still is, the largest and the one that used to gather in many young graduates) . An important point is that Africa consists of many small countries. This in tum creates some difficulties in understanding each country and its people fully, which then leads to the temptation to generalize and use standard approaches. This was certainly true after the second oil price crisis. Obviously, there is much to be said about this particular aspect. On one score, in the early years of structural adjust- ment, the World Bank was rather naive and unrealistic. In the case of Kenya's first structural adjustment loan, a great variety of conditions in the program were to be met within a very short time frame. Some of them-such as population planning, land tenure reforms, and eAport promotion-could not have been achieved within the time speCified. When I went to the Central Bank and discovered what bad happened, I told the Kenyan officials involved in the negotiations that they should never have Signed the loan document. I also mentioned to the World Bank officials that they did not seem to understand the complexities involved in economic planning and in the political and economic management of countries. This chapter appears to suggest that African officials were against stmctural adjustment. I believe this is not the case. However, Afriean countries were very unhappy, and still are very unhappy, that extemal factors, including external debt, were not being addressed. This chapter should include a careful discussion of the debt problem. However, it appears that the Bank has not yet mustered enough courage to discuss the matter frankly with major creditors. Clearly, no economic recovery and growth in Sub-Sallaran Africa will take place unless there is a satisfac- tory solution to the debt problem. In the actual designing of structural adjustment programs, many African coun- tries were happy to agree to the World Bank (and 1M F) conditions if resources 192 THE WORLD BANK IN AFRICA SINCE 1980 were going to be made immediately available. There is a great deal of education to be undertaken-on both sides. l\Vo related pOints: first, the World Bank now recognizes the importance of" ownership" of structural adjustment programs, but it needs to encourage that in a deliberate fashion; second, unless much more atten- tion is given to the social dimension of adjustment, much faster progress will not be achieved-indeed, some reversals can be ell:pected. Even in Kenya we have had to work very hard to get general political agreement that the process should continue. The assessment of the impact of structural adjustment in Sub-Saharan Mriea is an important subject and is also technically complicated if it is to be done properly. This is partly because the impact and influence of other factors, especially external ones, must be taken into account. Isolating some of those factors may not be very easy. Sectoral assessments are therefore easier than whole-economy assessments. This is not to say that some macroeconomic assessment should not be attempted, but one should be aware of the danger of giving all credit to structural adjustment programs. The quality of political leadership is very important in the degree to which it inspires people to accept sacrifices and hardships. Obviously, so is manage- ment capacity, alas, too weak now in many cases. Incidentally, the turnaround in recent months in Kenya's foreign exchange position and the value of the shilling is a very interesting and supportive case. I could say more about the impact of these adjustment programs. Some of their contributions have been nonmaterial: educating politicians and the general popu- lace about the importance of interactions of various factors in the development process, such as the contribution of the exchange rate in promotion of exports (including tourism); the senselessness of having too many extension officers with- out supporting facilities; the meaning of government deficits; and the end of the era of soft options. A sensitive point: in Africa, at least, personalities have been a factor that cannot be ignored. In that connection, Conable was much better than Clausen in com- municating with Mrican preSidents, perhaps because he had been a politician himself. I remember separate meetings between our president and Clausen and Conable. With Clausen, all the time was wasted discussing liberalizing movement of maize. I felt sad. With Conable, it was a jovial meeting, where we discussed decontrol of prices, population planning, government finances, corruption, and the like. This was a much more useful meeting for both sides. It is important to refer to Hollis Chenery and his activities in the Development Policy Department of the World Bank. During that time many development specialists came to be involved in World Bank activities, at the Institute for De- velopment Studies, Sussex, for example. Some important publications resulted from those activities, including Chenery's Redistribution with Growth. Some of those economists were also involved in International Labor Organization employ- ment missions. As noted, those were the years of "basic needs" and related issues. Kim Jaycox, energetic, enthusiastic, and courageous, has been a major positive THE WORLD BANK IN AFRICA SINCE 1980 193 factor for Sub-Saharan Africa. He has been more politically aware than some of his officers. At lower levels, I remember a truly distressing situation because the World Bank "man" in Nairobi was arrogant, did not know his job, and saw himself as "ambassador" of a great institution that must he listened to. The situation and environment were changed quickly when we got a better "man."35 It is true that the World Bank has been careful in aVOiding taking dangerous or risky positions on the subject of governance. However, bilateral agencies have not been so cautious: they seem to think that political reforms can be programmed in the same way as economic reforms. This idea is dangerous because while target dates for interest rates, exchange rates, and perhaps also government deficits can be set, various developments in political reform programs must simply evolve. This is clearly illustrated by the Kenyan situation. Bilateral agencies, which appear to have expected the opposition parties to have remained as strong and vigorous after elections, are now saying that the weakness of the Kenyan opposition parties is due to obstacles and pressures created by the Kenya African National Union (KANU). This is not true. It was naive in the first place to have expected the opposition parties to be strong, especially when they were so divided during the elections and, even to this day, have no credible development agenda. Therefore, while the Bank has been quite clever in using bilateral agencies to protect its visibility and exposure in Africa-politically and resource-wise-bilaterals have used the Bank (and IMF) to push forward their views and preferences. This is clearly evident now. In consultative group meetings for Kenya, bilaterals are now raising, in loud voices, patently political matters. The situation is not made any easier by their interpreta- tions of democracy in Western terms and styles. In my view, the World Bank will have to do something to ensure that consultative group meetings continue to be usefUl mechanisms for objective exchange of ideas on development policies and programs. Additionally, it would be good to discuss how the United States could be made to pay more intelligent attention to Africa. Bokassa, Idi Amin, and other "awkward" African leaders have done a great deal of harm not only to their own countries but to Africa as a whole. As one often notices, as far as Africa is concerned, the negative is highlighted in the West. Bokassa, Idi Amin, and others seemed to give justification to the view held by outsiders that Africans cannot manage their affairs properly without strong super- vision from outside. So the harm done by awkward leaders has not only affected their countries but Africa as a while-economically, SOCially, and in undermining confidence in Africa and African leaders. A further point: the tragic situations in countries such as Uganda, Somalia, Liberia, and now Rwanda-all principally because of poor leadership-indicate to 35. Some of these general comments are covered in greater detail in Philip Ndegwa and Reginald Herbold Green, Africa to 2000 and Beyond: Imperative Political and Economic Agenda (Nairobi: East African Educational Publishers, 1994). 194 THE WORLD BANK IN AFRICA SIKCE 1980 many Africans (and friends of Africa) how weak and ineffective African institutions are in dealing with their situations. Actually, some of the country situations have contributed toward the weakening of continental institutions, by dividing citizens within countries into those in support of the ruling regime and those opposed to it. I do not think that one could make a generalized statement that African states are "suspended from above." Certainly that is not true in Kenya, Tanzania, or Zimbabwe-or also in the young country of Eritrea. I do not think the Bank has generally been "anti-state." More interesting and relevant is the fact that the Bank has been experimenting and learning. The Bank encouraged, very directly, the establishment of parastatals in Kenya, in order to provide better emoluments, fewer civil service procedures in the management of direct production sectors. Later on, as you know, the same Bank vigorously encouraged privatization. I am certain the Bank feels it has been learning within Africa. In recent years, moreover, it has been influenced by powerful members who have been advocating "market" systems. SIX u. S. Relations with the World Bank, 1945-1992 Catherine Gwin THROUGHOUT the history of the International Bank for Reconstruction and De- velopment (the World Bank), the United States has heen the largest shareholder and most influential member country. U.S. support for, pressures on, and criticisms of the Bank have been central to its growth and the evolution of its policies, programs, and practices. The United States, in turn, has benefited substantially in both foreign policy and economic terms from the Bank's promotion of develop- ment. The benefits have been espeCially Significant during the past two decades as U.s. bilateral development aid has dwindled. Underlying this half century of U.S.-World Bank relations has been a fun- damental ambivalence on the part of the United States toward both development assistance and multilateral cooperation. On the one hand U.S. support for foreign aid generally and the Bank specifically has been guided by the view that promoting economic growth and development in other parts of the world is in the national interest and that multilateral cooperation is a particularly effective way of both leveraging and allocating resources for development. U.S. policy toward the Bank, led by the Treasury Department, has conSistently emphasized these points. On the other hand tlle United States has viewed all multilateral organizations, including the World Bank, as instruments of foreign policy to be used in support of specific u.S. aims and objectives. Thus while it has supported the Bank for its capacity as a multilateral institution to leverage funds and influence borrOwing countries' economic development policies, the United States has been uneasy with both the autonomy on which the Bank's development role depends and the power sharing that accompanies burden sharing. And the United States is often impatient with the processes of consensus bUilding on which multilateral cooperation rests. 195 196 t;,S. RELATIONS WITH THE WORLD BANK This ambivalence, a preoccupation with containing communism, and the change in the relative U.S. power in the world explain much of the evolution in U.S. relations with the World Bank over the past fifty years. In addition, the U.S. Congress, unlike the legislators in other Bank member countries, has been a major influence on policy. Within the context of changing foreign policy concerns, con- gressional involvement has Significantly affected the tenor and style of U.S. par- ticipation in the Bank Having led in the establishment, early financial growth, and encouragement of the Bank's program expansion, the United States was by the 19705 at odds within itself over issues of foreign policy and foreign aid and fre- quently at odds with the Bank over its rate of growth and specific aspects of its operations. The development constituency, which had never been strong, was shattered, with groups on both the Left and the Right increasingly vocal in their criticisms of the Bank After a supportive Carter administration was unable to knit the constituency together anew, the first Reagan administration added, for the first time, an executive branch voice to the chorus of multilateral aid opponents. The debt crisis in the south and the collapse of communism in eastern Europe led to renewed U.S. interest in the Bank Simultaneously, pressure from nongoverumen- tal organizations caused the u.s. government to push for increased Bank attention to the environment. However, renewed attention to the Bank was accompanied through the 1980s and into the early 1990s by both a continuing decrease in the U.S. share of Bank funding and a unilateral (at times dogmatic) assertiveness on matters of Bank policy, a combination that antagonized other member countries. U.S. Leadership in Launching the Bank Well before the end of World War II the United States began to plan for the economic recovery that would follow the peace. The aim of the postwar planning was to design a system of international economic cooperation that would avoid a repetition of the beggar-thy-neighbor trade and currency practices of the interwar period and instead encourage economic stability, full employment, and rising levels of income through the growth of international trade and investment. Both the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development were the results of that planning effort. In contrast to the Fund, which was the outcome of intense negotiation between the United States and Britain, the Bank was largely an American creation. l The United States proposed its basic design and led the effort to get it off the ground. From 1. The U.S. role was acknowledged by John Maynard Keynes in his opening remarks at the Bretton Woods Conference when he observed that the international bank draft docu- ment being considered was due "primarily to the initiative and ability of the United States Treasury." Edward S. Mason and Robert E. Asher, The World Bank since Bretton WoodS' (Brookings, 1973), p. 13. U.S. RELATIONS WITH THE WORLD BANK 197 1945 through 1960 it provided much of the Bank's top management and staff, the active support needed for its early institutional growth and policy expansion, and, through the U.S. market, most of the capital for lending. The result was a strong and enduring American imprint on all aspects of the Bank, including its structure, general policy direction, and forms of lending. Although this early history has been much written about, a number of pOints are worth repeating because they indicate the underlying U.S. perspective on the Bank and have proved central to the Bank's operations. The White Plan Work on a plan for an interuational bank began ,vithin the U.S. government in 1941. 2 In the interwar period many countries that had borrowed heavily from private banks defaulted on their commercial obligations. The international bank, designed largely by Harry Dexter Wbite, adviser to the U.S. Treasury, was meant to overcome that legacy by facilitating an international flow of private investment and by encouraging countries to use financing effectively. Convinced that private inves- tors could not be relied on to provide the net flow of dollars that would be needed for postwar reconstruction and development, he conceived of the Bank as an institution that would guarantee foreign securities and when necessary lend direct- ly to governments. "The primary aim of such an agency should be to encourage private eapital to go abroad for productive investment by sharing the risks of private investors in large ventures. "3 The initial capital of the Bank was set at $10 billion, an amount thought adequate for this catalytic task 4 Participation by other countries in the Bank's design was minimaL John Maynard Keynes is reputed to have said that the United States got it wrong, that the International Monetary Fund should have been a bank and the Bank a fund. He also observed that the draft Bank document, "stripped, as it had long since been, of all exciting features," was "an uninspiring 2. This section on the founding of the Bank draws heavily on several histories, including Mason and Asher, World Bank since Bretton Woods; Richard N. Gardner, Sterling-Dollar Diplomacy in Current Perspective (Columbia University Press, 1980); and Robert W Oliver, Early Plans for a World Bank, Princeton Studies in International Finance no. 29, Princeton University, 1971. 3. Harry Dexter White, quoted in Mason and Asher, World Bank since Bretton Woods, p. 18. The same point was stressed by American economist Alvin H. Hansen, who proposed in 1944 an international development and investment bank According to Hansen, in the absence of basic developmental projects financed by public funds, private investments in many cases could not be undertaken. See "World Institutions for Stability and ExpanSion," Foreign Affairs, vol. 22 (January 1944), pp. 248-55. 4. Consideration was also given to establishing an international development corporation and commodity price stabilization mechanism, but these elements as well as a larger capital base for the Bank were rejected in discussions within the U.S. government before the plan for the Bank was presented to other countries. 198 U.S. RELATIONS WITH THE WORLD BANK one. . dressed, with an eye to Congress, to look as orthodox as possible."5 Nevertheless, most countries, including the United Kingdom, refrained from taking much initiative on the plan because they did not expect to be in a position after the war to make Significant contributions. The Bank that emerged from the planning effort "was not created neutral."6 U.S. views regarding how the world economy should be organized, how resources should be allocated, and how investment decisions should be reached were en- shrined in the Charter and the operational policies of the Bank. This included the decision that the Bank should not lend directly to private enterprises. Two other early decisions reflected strong U.S. preferences for close oversight of the Bank by national representatives: the choice of a permanent site for the headquarters of the Bank and the definition of the role of tlle executive directors. 7 Britain, joined by many other countrics, urged that the Bank be located outside the United States, but once it became clear that the United States would not agree, they sought at least to locate the headquarters in New York rather than Washington. As Keynes said, this was necessary to keep the institutions "clear of 'the politics of Congress and the nationalistic whispering gallery of the Embassies and Legations."'8 But the United States was strongly committed to Washington. The aim of Treasury Secre- tary Henry Morgenthau in the postwar planning effort was "to move the financial center of the world from London and Wall Street to the United States Treasury, and to create a new concept among nations in international finance." The new institutions were to be "instrumentalities of sovereign governments and not of private financial interests:>9 This same perspective shaped the U.S. position on the role of the Bank's directors. In debating the duties of the executive directors, Britain (supported by some Commonwealth and European countries) sought again to minimize the influence of national governments. It argued that the directors should be officials resident in their horne countries who would visit the Bank at regular intervals to deal with matters of high policy and leave the day-to-day affairs of the organization to management and staff. In contrast, the United States, which was committing the most money, insisted that the directors serve full time and exercise more initiative and mntrol over operations and polky. Keynes made a strong and bitter speech on this matter and fmally refused to vote for the U.S. fonnula. But the U.S. view prevailed. The arrangement, and especially the function of the first U.S. executive director, Emilio Collado, led to a power struggle behveen the first Bank preSidents and 5. Quoted in Mason and A~her, World Bank since Bretton Woods, p. 12. 6. C. Fred Bergsten, working paper of the Study Group on International Financial Institutions, Council on Foreign Relations, New York, 1980, p. 4. Cited with permission of the author. 7. Gardner, Sterling-Dollar Diplomacy, pp. 258-59. 8 . Quoted ibid., p. 258. 9 . Quoted ibid., p. 76. U.S. RELATIONS WITH THE WORLD BANK 199 the board-notwithstanding that the presidents were American citizens closely tied to the U.S. government. According to Davidson Sommers, an early member of the Bank's staff, "in the beginning [there] was the Board. . . . They, not too harmoniously but very effectively, assumed the initiative in organizing and running the affairs of the Bank . . . [But] what was really important was the very pre- dominant position of the American Director on the Board and the role that he played." Although no loans were actually made until 1947, it was "the normal thing for an applicant for a loan to stop on his way to the Bank and get the support of the U.S. Director."lO Interestingly, Collado was an appointee from the State Depart- ment, not, as later became the rule, from Treasury. The situation produced a great deal of tension and led to the early resignation of the Bank's fIrst president, Eugene Meyer, out of frustration with his position vis-a.-vis the U.S. director. Partly because of disputes between member nations, most particularly the United States and Britain, and partly because of distrust on Wall Street, he had not been able to sell a Single bond or issue any development loans. He had also found himself embroiled in a debilitating conflict with his OVIlll board of executive directors, in particular the u.s. executive director. . . . "Pete" Collado had spent his entire professional life in the Roosevelt administration, working with such liberal personalities as Harry Dexter White at the Treasury Department and Alger Hiss in the State Department. Meyer consequent- 1y considered him a brash young New Dealer. and they didn't get along. Collado and the executive directors from other nations believed Meyer should run the Bank according to policy voted upon by the board. They were eager to issue as many loans as possible, and quickly. "\'hen Meyer refused one day to approve an early loan to Chile, Collado pounded the table, demanding that the loan be approved. Meyer calmly refused, saying the Bank was not a relief agency. But such constant disputes with Collado took their toll on the seventy- one-year-old Meyer, and in December 1946 he resigned. He told his secretary, "I could stay and fight these bastards, and probably win in the end, but I'm too old for that.',ll In consultation with other members of the executive board, the United States approached several prominent bankers to succeed Meyer, including Graham F. Towers, governor of the Bank of Canada. But Towers declined, saying that a U.S. citizen had to lead the Bank if its credibility on Wall Street was to be established. The United States then turned to John J. McCloy, a Wall Street lawyer. "Some of McCloy's Wall Street colleagues saw in his possible appOintment an opportunity to take control of the World Bank away from the New Deal crowd represented by 'Morgenthau and those clucks."'12 But despite Wall Street's enthusiasm, Mc-cloy 10. Davidson Sommers, Address to Professional Staff Meeting on "The Early Days of the Bank," Washington, May .5, 1960, pp . .5, 7. 11. Kai Bird, The Chairman: John J. McCloy, The Making of the American Establishment (Simon and Schuster, 1992), p. 283. 12. Ibid., p. 285. Their enthusiasm may have been heightened by the fact that the Republicans won a resounding victory in the November 1946 elections. 200 U.S. RELATIONS WITH THE WORLD BANK initially turned dmvn the offer on the grounds that the Bank's Articles of Agree- ment placed a preponderance of power in the hands of the directors. This would make the intervention of politics into lending decisions inevitable and, as a result, make it difficult to sell Bank loans. McCloy changed his decision only after the United States and the rest of the board accepted conditions defining his role and after he was satisfied that the only potential buyers of Bank bonds, the New York commercial banks and insurance companies, were likely to cooperate. His conditions were that first, the United States would not interfere in loan negotiations; in particular, loan applicants would be directed to the Bank's management and not given a prior indication of the U.S. position. Second, the Bank president would have a free hand in administrative matters, including the hiring and firing of staff. Third, McCloy would nominate the U.S. executive director. Although the conditions were rejected by U.S. government officials, President Truman overruled his advisers and told McCloy that the United States would accept them. 13 Collado was ~ubsequently replaced by Eugene Black who, on McCloi~ insistence, simultaneously took charge of the Bank's bond operations. 14 In the summer of 1949 MCCloy reSigned to assume the position of high commis- sioner in C:xermany and urged that Black be appOinted to succeed him. Given his assertive style, McCloy's tenure had created substantial tensions with the Board, especially with the non-American members, who objected to the American "monopoly" in the Bank Although Black did much to relieve the tensions, he also (.'Ontinued the practice of nominating the U.S. director and continued to rely heavily on and work closely with both the U. S. government and its director. The decisions on the Bank's location and the role of its directors, which were to havc profound effects on its operations, facilitating daily interaction between the Bank and the U.S. government and frequent political intrusion into Bank decision- making by all member governments, reflected U.S. ambivalence toward multi- lateral cooperation. But these features also contributed to broad-based and strong support for the Bank in Congress and with the public. Congressional Approval When the legislation autllorizing U.S. participation in the Bank and the IMF was submitted to Congress, the House voted 345-18 in favor and the Senate 61-16. 15 The administration based its advocacy for U.S. membership on the impor- tance of the two institutions ensuring the stability of the postwar economy. Treasury Secretary Morgenthau told Congress that the Bretton Woods plan was "the first practical test of our willingness to cooperate in the work of world reconstruction 13. Sommers, "Early Days of the Bank," p. 10. 14. Bird, The Chairman, p. 286. 15. Jonathan E. Sanford, U. S. Foreign Policy and Multilateral Development Banks (Boul- der, Colo.: Westview Press, 1982), p. 44. U.S. RELATIONS WITH THE WORLD BAI\K 201 [and] one very important step towards the orderly, expanding foreign trade on which our agriculture and industry depends." Assistant Secretary of State Dean Acheson told Congress that the proposal represented a chance to avoid the disaster of international warfare "by acting in common with the other nations of the world to put aside the implements of economic warfare and make possible an expansion of production and consumption and trade." Assistant Treasury Secretary Harry Dexter White emphasized further that the plan was necessary for international economic peace, economic prosperity, and the revitalization of markets for U.S. goods. 16 In its deliberations Congress made two changes in the legislation submitted by the administration. The first called for the creation of a National AdviSOry Commit- tee on International Monetary and Financial Problems. This was to be a cabinet- level committee chaired by the secretary of the Treasury and composed of heads of other departments. It was "to coordinate the policies and operations of the repre- sentatives of the United States."17 In a second change, Congress required that the executive branch obtain prior authorization on major decisions regarding U.S. participation in the Fund and Bank. A minority report issued by a small group of conservative senators denounced the Bretton Woods Act for starting the United States "on a permanent policy of foreign lending and investment by Americans in huge sums, sponsored and to a large extent guaranteed by the Federal Govemment."18 For the most part, how- ever, the Bretton Woods initiative received strong support from a wide range of national groups and from a bipartisan majority of Congress and Swiftly "moved through the Congress on soaring hopes for a better world."19 The "Dollar Bank" With that broad-based endorsement the U.S. government undertook actively to help sell the World Bank to the U.S. financial market. 20 This task dominated the administrations of the first three Bank preSidents and largely determined the shape of Bank lending in its first decade. The original U.S. capital subSCription wa'l $3,175 million or 34.9 percent of the $9,100 million total. 2 ! Its overall contribution to the financial start-up of the Bank was far greater, however. Of the Bank's total initial capitalization of $10 billion, 20 percent was to be paid in and 80 percent held in reserve by member countries. 16. Ibid., p. 43. 17. Mason and Asher, World Bank since Bretton Woods, p. 34. 18. Sanford, u.s. Foreign PoliCY, p. 43. 19. Gardner, Sterling-Dollar Diplomacy, p. 142. 20. The phrase "a dollar bank" and this summary are drawn largely from Mason and Asher, World Bank since Bretton Woods, pp. 105-49. 21. Ibid., p. 779. 202 U.S. RELATIONS WITH THE WORLD BANK Of the 20 percent paid in, 10 percent was to be in gold or dollars and 90 percent in the currency of each member countI)'. During the Bank's first ten years, except for Canada's payment of part of its subSCription in U.S. dollars and a few small payments from other countries, the U.S. subSCription was the only fully usable subscription. Not until other currencies became convertible and economies re- covered did this situation change. Also during the initial ten years, 85 percent of World Bank bonds were denominated in U.S. dollars and most were sold in the U.S. market. For related reasons, the only portion of the 80 percent "callable" reserves considered a Significant guarantee to investors was the U.S. share. This became evident in 1958 when the spread between the volume of outstanding debt and the amount of the U.S. guarantee narrowed to only about $700 million, and the U.S. bond market rating services sounded the alarm. In effed, until well into the 19605, Bank borrowing was limited by the amount of the U.S. share of the guaran- tee reserve. It had been expected that the Bank would operate hy guaranteeing securities issued by others rather than by issuing bonds of its own. But in 1946 U.S. efforts to enlist the interest of banking and insurance groups made clear that large investors would prefer to hold Bank securities rather than the securities of foreign govern- ments hacked by guarantees from the Bank. 22 Two obstacles confronted early efforts to sell Bank securities, however. The Bank did not fit under existing state banking laws and regulations, and, as a legacy of the interwar period, investment in foreign securities was considered risky. The U.S. government adively confronted both obstacles. The U.S. executive director took the lead in campaigning for the necessaI)' changes in state legislation, and other officials helped the Bank's presi- dent to inform the investment community about the Bank's nature and policies. 23 These efforts qUickly paid off: by the rnid-1950s, Bank issues had achieved an AAA rating in the U.S. market and had begun to attract interest from non-American investors. In addition, until the early 1960s the TreasuI)' Department gave its reqUired consent for the issue of dollar-denominated Bank securities as a matter of course. In this early period, Bank lending poliCies were conditioned by the necessity of fmding U.S. investors who were willing to buy the Bank's securities and accept its guarantee. The management's view that the Bank's credit standing depended on the character of its loans led to an early emphasiS on finanCing capital infrastructure and little lending in the social sectors.24 By the start of the 1960s, however, the 22. Ibid., pp. 43-44. 23. To gain investors' support, Bank preSident John McCloy, his chosen vice president, Robert L. Garner, a fellow U.S. banker and businessman, and U.S. executive director Eugene Black spent much of the spring of 1947 on the road, giving speeches at bankers' conventions and lobbying various state legislatures. 24. This point is drawn from quotations from several World Bank oral histories cited in Mason and Asher, World Bank since Bretton Woods. U.S. RELATIONS WITH THE WORLD BANK 203 Table 6-1. World Bank Medium- and Long-Term Borrowings, by Country before Swaps and by Currency after Swaps, Fiscal Years 1971--91 Millions of U.S. dollars United United French U.K U.S. Year France States dollar 1971 3 296 229 0 400 0 296 219 0 775 1972 6 347 160 37 425 31 342 150 24 796 1973 5 387 614 25 0 0 371 606 0 440 1974 6 235 471 25 0 0 220 461 0 659 1975 5 526 129 5 500 0 512 121 0 2,515 1976 4 707 197 19 1,275 0 850 0 0 2,152 1977 4 1,412 20 13 1,250 0 1,394 7 0 2,181 1978 4 1,149 582 5 1,360 0 1,120 646 0 2,099 1979 6 1,033 1,191 63 0 0 1,016 1,176 0 666 1980 9 1,993 1,288 5 0 0 2,256 1,266 0 694 1981 12 1,326 971 237 0 0 1,522 1,091 216 1,611 1982 7 738 1,337 266 1,687 0 1,229 1,341 311 2,602 1983 7 1,134 1,267 8 2,041 0 1,519 1,326 321 2,036 1984 11 1,382 1,579 152 0 0 1,838 1,700 421 1,170 1985 8 1,500 1,890 146 911 0 1,927 2,199 323 1,870 1986 147 1,609 2,036 136 429 -6 2,080 1,946 131 1,478 1987 9 1,392 1,461 20 1,107 0 1,897 3,383 73 1,757 1988 192 404 4,711 5 2,404 177 1,524 5,431 596 2,849 1989 7 716 3,782 64 -822 161 657 3,754 8 5,522 1990 14 1,709 2,274 0 449 178 3,372 2,618 0 5,232 1991 5 919 611 0 114 11 3,094 1,262 4 4,519 World Bank annual reports. SOUrL'tl: a. Numbers in tbe data for Japan are elevated because of refinancing. Refinancing data for 1987-89 are available and must be subtracted from totals. lending policy was less constrained by the attitudes of U.S. investors, in part because investor confidence had by then been established by the cautious policies Bank management had pursued and in part because investors had a better under- standing of the Bank's role in promoting economic growth and development. Meanwhile, the relative importance of the U.S. market as a source of Bank borrow- ing began to decline (even though in absolute terms the volume of sales of dollar securities continued to increase). From 1956 to 1962-63 thc Bank not only saw the release of capital subscriptions from its major European contributors but also succeeded in tapping non-U.S. markets for more of its capital. In the mid-1960s, confronted with a balance of payments deficit, the U.S. Treasury for the first time briefly denied the Bank access to its capital market and most Bank funds had to be raised elsewhere. And by the late 1960s more than half the Bank's dollar borrow- ings were being bought by investors outside the United States. 204 U.S. RELATIONS WITH THE WORLD BANK At the end of the decade, incoming Bank President Robert McNamara, "vith U.S. encouragement, accelerated this trend in portfolio diversification. His aim was not only to escape the effects of U.S. macroeconomic policy on the Bank, but also to lay the foundation for a sharp rise in Bank borrowing sufficient to enable lending to double. The change in medium- and long-term borrowing is shown in table 6-l. With U.S. support having helped build a strong financial position, portfolio diver- sification was not a difficult task. But it was one of a number of early Signals of changing U.S. relations with the Bank that followed the shift in the Bank's focus from postwar reconstruction to development and accompanied the gradual decline of U.S. predOminance in the postwar world economy. The Shift to Development As it quickly became clear that needed postwar reconstruction would exceed the resources of the newly created World Bank, the United States initiated the Mar- shall plan as a separate recovery program for Europe and helped the Bank tum its attention to its second objective, development. But with the Bank's shift to the problems of development, the support of the United States, which remained dominant, became more hesitant and more conditional than at the outset. In 1947 Britain withdrew its troops from the civil war raging in Greece, an act that precipitated the Truman Doctrine. The world, Truman said, faced a stark choice between two ways of life: communism and democracy. In this unfolding context, U. S. policy toward World Bank lending took on new political ramifications. In the face of mounting Communist party pressures in Europe, John McCloy and other leading Americans insisted that European recovery required assistance so massive that it surpassed the Bank's capacity. The effort, they argued, would have to be financed by the American taxpayer through a bilateral economic recovery program, first publicly proposed by Secretary of State George Marshall. While still president of the Bank, McCloy lobbied vigorously for what came to be known as the Marshall Plan, explaining that Bank lending was constrained by the need to sell its securities in the fmandal markets. He also resisted U.S. pressure to have the Bank fund food aid to Western Europe as a temporary mea~ure until Marshall Plan aid arrived. The Bank, McCloy insisted, was no substitute, even in the interim, for massive bilateral, politically motivated aid. 2.5 FollOwing the launching of the Marshall Plan, McCloy turned the Bank's atten- tion to the less developed countries, beginning with Latin America. However, as mnstituted the Bank was ill prepared to assume a major role in development financing. Its financial resources were too small, and many of the world's poorest countries could not afford its near-market rates. Moreover, the Articles of Agree- ment prohibited lending directly to private enterprises. As a result of these and 25. Bird, The Chairman, pp. 292-93. U.S. RELATIONS WITH THE WORLD BANK 205 other constraints, Bank lending to developing countries increased only slowly. Pressure to resolve these problems led ultimately to the establishment of the Bank's two affiliates, the International Finance Corporation (IFC) in 1956 and the Inter- national Development Association (IDA) in 1960, but only after the United States dropped its opposition and agreed to support them. In both cases the U.S. endorse- ment was given grudgingly, as much in response to foreign policy considerations as to the challenges of development. An IFC and an IDA linked to the World Bank were proposed in 1951 by a U.S. advisory group appointed by President Truman to recommend ways to achieve the objectives of the Point Four Program. Point Four in Truman's 1949 inaugural address had called for a new program to make the benefits of scientific advances and industrial progress available to underdeveloped areas. A leading purpose of the new program was to strengthen key countries in the third world, particularly those surrounding the emerging Soviet bloc, and to dissuade others from aligning with the Soviets. Emphasizing the link between U.S. security interests and economic development in the third world, the program marked a historic turu in U.S. relations with developing countries and the beginnings of substantial U.S. foreign aid commitments to non-European countries. In making its recommendations, the adviSOry group emphasized the need for some form of international machinery "for emplOying the techniques which lay between pure loans and pure grants," and it urged that the United States not undertake the development assistance task on its own.26 It proposed that the United States take the lead in establishing both an IFC and an IDA afftliated with the World Bank, the IFC to mobilize capital for direct lending to the private sector and IDA to provide concessional loans to poor countries using funds contributed by governments. These recommendations elicited no immediate U.s. government response, however. The United States was at war in Korea, it was faced with a growing budget deficit, and it was not yet convinced that more was needed to stimulate development, despite mounting pressure from developing countries within the United Nations for larger amounts of development funds on softer terms. Frustrated by their inability to afford World Bank loans at market rates and emboldened by the perceived largesse of the Marshall Plan, developing countries had begun arguing in the late 19405 and early 1950s for the establishment of a new UN development agency that would provide technical and financial assistance on concessional terms and that would operate under the UN rule of one country, one vote, rather than under the Bank and its system of weighted voting. The United States strongly opposed a series of such proposals, hut in 1954 abruptly endorsed the idea of the IFC as a political concession. 27 Concerned with the escalating cold 26. James H. Weaver, The International Development Association (Praeger, 1965), p. 31. 27. Bronislaw E. Matecki, Establishment of the International Finance Corporation and United States Policy (Praeger, 1957), p. 149. 206 U.S. RELATIONS WITH THE WORLD BANK war and Soviet attempts to exploit the UN debate between developed and develop- ing countries, the United States determined that some response was necessary. "The State Department urged that the United States must make at least a gesture; and, this having been decided in principle, tbe government looked around for the cheapest thing to do, and the cheapest thing to do was the IFG"28 In the request to Congress for support, President Eisenhower emphasized the IFC's potential con- tribution to "prosperity, expanded trade, and 'the peace and solidarity of the free world. "'29 The proposal passed in both the House and Senate with little debate and a wide margin of support. 30 Establishment of the IFC did not, however, stem developing countries' de- mands for a new concessional aid agency, to which the United States remained opposed until Congress broke the stalemate. In 1958 the Senate endorsed a proposal of one of its members, Mike Monroney of Oklahoma, for an international development agency linked to the World Bank that would use surplus unconver- tible currency held by rich nations to fund projects in developing countries. As presented, Monroney's plan would have been costless but largely ineffectual. How- ever, the favorable domestic response the Senator's proposal received, combined with the growing pressure from developing countries for a SpeCial UN Fund for Economic Development (SUNFED), finally convinced the United States, in con- sultation with the World Bank's preSident, to present the executive board with a plan for the International Development Association. The plan for what became the Bank's concessional or soft loan window was accepted and submitted to govern- ments for approval in January 1960. The fact that many developing countries were quickly reaching the limits of their creditworthiness in Bank terms contributed to the U.S. decision to launch IDA. This problem had already led to the start-up in 1958 of the U.S. Development Loan Fund, a large bilateral concessional capital transfer operation, and to col- laboration between Bank President Eugene Black and Undersecretary of State Douglas Dillon on the launching of the India aid consortium, the first effort of its kind. In presenting the IDA proposal to Congress, Treasury Secretary Robert Anderson noted that "it showed the rich countries' commitment" to helping to meet the development needs of the poor nations and would help them "advance their economic life under free institutions."31 For the United States it also provided a way to get other developed countries to begin to share more of what had come to be seen as the aid burden. As in the case of the IFe, the International Develop- ment Association received strong support from a broad range of national groups, 28. Ibid. 29. Quoted in Sanford, u.s. Foreign Policy, p. 46. 30. Congress formally authorized U.S. membership in the IFC in August 1955 and approved an initial U.S. capital subscription of $35 million out of a total capital base of $100 million. 31. Quoted in Sanford, u.s. Foreign Policy, p. 47. U.S. RELATIONS WITH THE WORLD BANK 207 and legislation authorizing U.S. participation passed both houses of Congress by comfortable margins. As had been recommended in the advisory board report a decade earlier, the United States assumed a substantial (42 percent) share of the initial IDA contribution and took the lead in mobilizing the support of other countries. The End of an Era With the establishment of IDA, the start-up phase of what came to be known as the World Bank was complete. Having led in this launching, the United States over the next decade encouraged the Bank to expand its lending to low-income countries, become more involved in addressing the need for increases in agricul- tural productivity and other major emerging development problems, and take the lead in approaching politically sensitive matters sucb as trade and industrial liberalization in India. Although disagreements arose between the U.S. govern- ment and the World Bank in the I960s that tested the Bank's autonomy, for the most part relations were good. The United States was still by far the dominant member country. Its bilateral aid program remained for a time the larger and more innovative force in the enterprise of development assistance, and in many cases it worked closely with the Bank in the field. The professional development com- munity, which emerged largely in the United States, also gave intellectual support to the strategy of development advanced by the United States and the Bank. The support for the bUildup of the Bank's development financing formed part of a U.S. turn to long-term economic development assistance in the 1950s and early 1960s. Although the early geographic focus of economic aid to the third world was a few countries in East Asia, by 1960 assistance had been expanded. The poverty- ridden countries of South Asia, America's near neighbors in Latin America, and later the emerging independent states of Africa all became recipients under a program of assistance that was building in the late Eisenhower years and was expanded after President Kennedy took office in 1961. The Soviet Union had by then developed nuclear weapons, launched Sputnik, and extended its diplomatic reach into Africa, Asia, and America's neighbor, Cuba. Out of concern that the developing countries would succumb to the influence of communist ideology and the offers of support from the Soviet Union, the Kennedy administration took steps to strengthen U.S. foreign assistance. It consolidated existing aid programs into the Agency for International Development (AID), created the Peace Corps and the Alliance for Progress, and emphaSized the need for the transfer of large financial resources by both bilateral and multilateral institutions. The rationale for this new aid was based on the conviction that deter- rence of the Soviet military threat, while a necessary keystone ofU .S. foreign policy, was not in itself adequate. It was an essential American interest that the countries of the developing world achieve economic growth and social stability within a democratic framework, not only to limit the Soviet orbit of interest but also to avoid the evolution 208 U.S. RELATIONS WITH THE WORLD BANK of those nations into authoritarian systems that would be anti-American and anti- Western. These goals were believed to require a program of economic develop- ment aid to foster self-sustaining growth; and to be effective, programs of assis- tance needed to be institutionally divorced from the foreign polic)' apparatus. 32 Development activists in later years have looked back on this as a time of "high expectations ... both in the United States and in the Third World ... [and] the only time wben a true national consensus in favor of active development cooperation with the Third World prevailed." The consensus "brought together those motivated by security concerns ... [and] those motivated by humanitarianism and a belief in the United States' interest in a rapidly expanding ... world economy."33 But the consensus proved short-lived. In the context of the Kennedy administration's expanded foreign assistance policy, the United States took the lead in the first replenishment negotiations for IDA, calling for support of the Bank president's request for a fivefold, $1.5 billion three-year funding increase and seeking a reduction in the U.S. share from its initial 42.34 percent to 33.3 percent. In the face of resistance from other donors, however, it settled for a smaller replenishment (of $750 million) and only a token reduction in the share (41.89 percent). The IDA 2 negotiations were far more troubled, however.34 IDA, as distinct from the World Bank itself, required the use of tax dollars and, with the second replenishment, became the lightening rod of U.S. World Bank policy. George Woods became preSident of the Bank in 1963, taking over from Eugene Black. Woods was also a New York banker, but unlike his predecessor, he did not retain control over the appointment of the U.S. executive director, nor were relations between him and the U.S. government as close and as congenial as Black's had been. The change in relations had partly to do with personality.35 But it had far more to do with changing U.S. economic fortunes and domestic policy concerns. The change was evident in the role the United States took in the IDA 2 negotia- tions. Although it had taken the lead in promoting the first IDA replenishment, when negotiations began on IDA 2, the United States was committed to redUCing its outflow of dollars, resisting inflation, and maintaining the integrity (preventing a devaluation) of the dollar. 36 32. For a discussion of the evolution of these views see, for example, Congressional Research Service, "Soviet Poli~ and United States Response in the Third World," March 1981, p. 5. 33. Robert J. Berg and David F. Gordon, eds., Cooperation for International Development: The United States and the Third World in the 1900s (London: Lynne Rienner, 1989), pp. 1-2. 34. Mason and A~her, World Bank since Bretton Woods, p. 411. 35. According to Robert W. Oliver in his forthcoming biography of George Woods, "everyone remembered Eugene Black as a warm person who entertained Congressmen, but George Woods entertained little." The Anguish of George Woods, chap. 8, p. 29. 36. Paul A. Volcker and Toyoo Gyohten, Changing Fortunes: The World's Money and the Threat to American Leadership (Times Books, 1992), chap. 2. U.S. RELATIONS WITH THE WORLD BANK 209 Henry Fowler, secretary of the Treasury, urged Woods to lead the IDA 2 negotia- tions nhe wanted to expand the agency. woods proposed a $1 billion replenishment, which the United States favored. Concerned with aVOiding a negative effect on its own balance of payments, however, the United States pressed hard in the negotiations for special balance of payments safeguards and a significant reduction in its IDA share, an objective that was to be emphasized in all subsequent replenislunents. The United States did not gain agreement on either the "tied" or burden-sharing arrangements it sought, but it did achieve special "end of the queue" treatment for its contribution. Even with that concession, however, congreSSional debate on IDA 2 questioned so large an increase at a time when government was cutting domestic programs and raising taxes. The debate delayed approval of U.S. participation, leaving other countries to advance funding to avoid a temporary suspension in IDA lending. In 1966 in response to the difficulty that foreign aid in general and the IDA negotia- tions in particular had begun to face in the United States, Woods hired a retired U.S. senator, A. Willis Robertson, to serve as consultant and lobbyiSt. By the time the IDA 2 negotiations were completed and brought to Congress for approval, Robert McNamara had become Bank president. The difficulty he faced in getting IDA 2 approved led him to take the further step of assigning to a senior Bank staff member, William Clark, the responsibility of building and maintaining better communications with Congress. 37 In sum, with the second replenishment, a pattern of U.S. demands for concessions and delays in authorizing or appropriating its IDA contributions had emerged. By the end of the 19608 the era of innovative and active U.S. leadership in development had begun to wane. Policy Evolution and Erosion of Support Three main objectives guided U.S. policy toward the Bank in the 1950s and early 1960s. The first was to huild a strong organization as a means of promoting the stability and growth of a free and open world economy. The second was to ease the burden on the United States of prOviding economic assistance to other countries by leveraging funds from the private market and, with their recovery from World War II, from other industrialized countries. The third was to support countries of importance to the United States. Although these were to remain major objectives, during the 1970s U.S. support for and leadership in the Bank faltered. 37. Bank Vice President Burke Knapp suggested at the time that it would also be useful to have the Department of State deSignate the U.S. alternate executive director as a way to keep the department informed of Bank policies and operations. But after the removal of Emilio Collado as the fIrst director, the Treasury Department had gained increasing control of the U.S. multilateral development bank policy process, usually collaborating but at times disagreeing with the State Department on the handling of individual country cases as well as broad policy toward the Bank. 210 U.S. RELATIONS WITH THE WORLD BANK The United States had launched the Bank in a foreign policy environment different from the one that emerged in the early 19705. Three changes proved to have a major bearing on relations between the United States and the Bank. The first was the relative decline of the United States in the world economy. By 1973 the U.S. share of world CDP had shrunk to 26 percent from a level of nearly 35 percent two decades earlier. s8 Western Europe and Japan grew more rapidly through the 1960s than did the United States, which also experienced a shift from persistent balance of payments surpluses, with resultant dollar shortages in the rest of the world, to frequent deficits. The postwar economic boom had also given way to concerns about domestic poverty, unemployment, and race inequalities. The 1971 dollar devaluation and general deterioration in the country's economic situa- tion turned attention to the costs of U.S. international economic policy. As spelled out by a Treasury official in 1972, There is a ... sharply heightened feeling in the United States today that the economic interests of our country have not been given sufficient weight in international policy making. What follo'J\.'S from this is that financial and other burdens traditionally accepted v.1thout question by the United States can no longer be automatically accepted on that basis. The new international economic environment is radically different from the fami- liar "post-war" period that must now be regarded as definitively ended. l\ow, the United States is compelled to weigh its actions in terms of the benefits and the burdens that "'ill result. 39 A second change for the country was the Vietnam War and the shattering of the foreign aid constituency. The prolonged and divisive war provoked domestic dis- sent and uncertainty about the U.S. role in the world. One observer commented, "virtually all the familiar geopolitical moorings of U.S. foreign policy have become unhitched. What for years seemed axiomatic now seems dubious, if not false. John F. Kennedy may be the last President who could, without creating a credibility gap, maintain that 'we in this country . . . are-by destiny rather than choice-the watcbmen on the walls of world freedom."'40 The policy of containment that had shaped U.S. activities in the developing world in the 19505 and early 1960s "was progressively abandoned in the late 1960s and 1970s, less because of a national consensus that the Soviet threat had declined than because of a sense that the Vietnam experience demonstrated that such a policy, when severely tested, was exceSSively expensive and not necessarily effective."41 Moreover, the Agency for International Development, which had been heavily involved in Vietnam, was 38. Angus Maddison, The Worul Economy in the 20th Century (Paris: OECD, 1989), p.1l3. 39. Deputy Treasury Secretary Charles E. Walker, quoted in National AdviSOry Council on International Monetary and Financial Policies, Annual Report (Washington, 1972), p. 12. 40. Robert E. Asher, Devekrpment Assistance in the Seventies: Alternatives for the United States (Brookings, 1970), p. 19. 41. Congressional Research Service, "Soviet Policy and United States Response," p. 1. U.S. RELATIONS WITH THE WORLD BANK 211 seriously discredited. Although it maintained considerable programmatic energy into the mid-1970s, both it and foreign assistance generally lost their solid constituency. Changes in perspectives on development further shattered the coalition of support for foreign aid, including support for the World Bank. In the early 1970s, development experts and public interest development groups began to criticize the preVailing triclde-do\'VI1 theory of development. Despite McNamara's efforts to broaden the lending policy of the Bank, the institution came under attack for supporting regimes that were persistent violators of human rights and for not doing enough to aid the poor. Constituency groups, which had given nearly automatic support to U.S. funding of the Bank, became at best conditional proponents. The problem was worsened by the rapid growth of lending under the dynamic leader- ship of McNamara, which stimulated a considerable increase in public and con- greSSional attention to Bank poliCies and practices. A final change was the onset of congressional activism in foreign policy. The creation of IDA, with its requirement for regular replenishments, brought Con- gress into the making of U.S. policy toward the Bank in a significant way. Before the early 1970s Congress's role was a relatively passive one, certainly as compared to its involvement with the bilateral aid program. It had strongly supported the launch- ing of the Bank and the establishment of the two early Bank affiliates. But for the most part, early congressional action consisted of approving administration re- quests for U.S. membership in the Bank and providing funding for it. Although individual members raised particular concerns from time to time in private exchan- ges with the executive branch or Bank management, their public statements usual- ly supported administration policy. This pattern began to change in the 1960s when support for foreign aid waned and Congress dragged its feet on the first and second IDA replenishments. It was the changes of the late 1960s and early 1970s, however, that led to an increasing activism on the part of Congress. Since then, Congress has used its power of the purse to direct and restrict U.S. participation in the Bank in many speCific ways.42 The development that contributed most to Congress's more active role was the growth in the Bank's lending program and the corresponding increase of ad- ministration funding requests, especially for IDA. According to the Bank's annual reports, appropriations for all multilateral development banks rose in nominal terms from $700 million in fiscal year 1970 to $2.3 billion in fiscal year 1980. This increase attracted the attention of Congress, the press, and the development policy constituency in the United States. Although the Bank regularly fared better in Congress from the 1970s on than did other multilateral agencies or the bilateral aid program, the increases in appropriation requests provoked much greater scrutiny 42. For a detailed discussion of Congress's role in U.S. World Bank policymaking, see Jonathan E. Sanford, "U.S. Policy toward the Multilateral Development Banks: The Role of Congress," George Washington Journal of International Law and Economics, vol. 22 (1988), pp.I-1l5. 212 U.S. RELATIONS WITH THE WORLD BANK and heightened criticism of policies and practices. Although most of the criticism came from traditional opponents of foreign aid, from the 1970s on, prodevelop- ment groups, including mainly church groups and private voluntary organizations, began to lobby in opposition to an ever widening range of specific features of Bank operations. Previously the acti~e bulwarks of support, these groups became pro- visional proponents willing to endorse U.S. contributions to the Bank only if certain reforms were made in its policies and practices. Foreign aid has never been popular in Congress. Although objections were muted in the years just after World War II, Congress quickly became dissatisfied with it and distrustful of multilateral institutions. No one ever ran for Congress on a pro-aid platform nor got elected for supporting the World Bank. As a conse- quence, most members of Congress were uninterested and uninformed about the Bank's operations. Even on key committees there has been much misunderstand- ing of what the Bank did and how it operated. 43 Executive branch leadership and active constituency groups provided the initial energy and pressure to sustain support; but with both in decline by the 1970s, the increased appropriation re- quests became attractive targets. Two other forces, unrelated to the Bank's performance, were at work as well. The Vietnam War not only shattered the consensus on foreign policy but also ended the period of congressional quiescence on foreign affairs. Many members of Congress deeply objected to the escalation of U.S. involvement in the war and to the Johnson and Nixon administrations' attempts to use bilateral and multilateral aid in support of the war effort. As a consequence, Congress sought a greater role in directing foreign policy, which included more detailed oversight of U.S. participation in the Bank. At the same time, there was a breakdown of discipline and effective leadership in Congress that made it infinitely more difficult to maneuver unpopular aid requests through the labyrinthine authorization and appropriation procedures. No fewer than five committees came to have significant jurisdiction over policy toward the Bank. This arrangement provided multiple entry points for interested groups with specific policy agendas, and it created the opportunity for strategically placed members of Congress and specific issues to gain disproportionate weight in the policy process. As long as Congress was passive in making Bank policy, its basic dislike of foreign aid and multilateral institutions and its cumbersome legislative procedures were of limited significance. But as it became less deferential on matters of foreign affairs, these factors became formative influences on U.s. policy toward and participation in the Bank. A number of studies written in the late 1960s and early 1970s urged the United States to increase its reliance on multilateral assistance as a way to counter growing "aid fatigue" and improve the effectiveness of development 43. For a discussion of this problem see Lars Schoultz, "Polities, Economics, and U.S. Participation in Multilateral Development Banks," International Organization, voL 36 (sum- mer 1982), pp. 537-74. U.S. RELATIONS WITH THE WORLD BANK 213 assistance~4 Although multilateral aid had increased fomfold under the Kennedy administration, it accounted for less than 10 percent of total U.S. foreign assistance at the end of the 1960s. The proposals for a shift in favor of multilateral aid were based on several rationales. Because waning public support for foreign aid would not allow the United States to continue to increase its foreign aid program, the multilateral development banks offered the best means of leveraging funds for developing countries. By relying on multilateral institutions to promote effective development policies, the United States could depoliticize foreign assistance and avoid strains in its relations with developing countries that resulted from bilateral policy interference. Finally, the multilateral development banks could promote more coordination and fewer unproductive and costly overlaps in international aid efforts. 45 The recommendation was picked up by the incoming Nixon administra- tion, and in a message submitted to Congress in September 1970, President Nixon proposed a sweeping reorganization of the U.S. bilateral aid program and greater reliance on multilateral aid. The United States, he said, "should channel an increas- ing share of its development assistance through multilateral institutions as readily as practicable .... Our remaining bilateral assistance should be provided largely within a framework established by the international institutions."46 However, the relative increase in U.S. multilateral development bank contribu- tions occurred in the mid-1960s and, in real terms, has held fairly steady since then (table 6-2). Thus its relative share of total U.S. foreign aid has reflected more the ebb and flow of bilateral aid levels, not any real increase in the proportion of U.S. aid flows through multilateral institutions in the 1970s or thereafter. In fact, a substantial deterioration occurred in U.S. relations with the World Bank during the 1970s. This change was marked by frequent open conflict between the two over a variety of issues, repeated failures on the part of the United States to deliver on its share of replenishments within the same period as other member countries, and, by the end of the decade, the breakdown of the bipartisanship in U.S. Bank policy that had prevailed since the signing of the Bretton Woods Act. The Early 19708 The early 1970s marked a turning point that began with a souring of relations between the Bank and the U.S. Treasury. As one indication of trouble, in early 1972 44. See, for example, Rudolph A. Petersen, "U.S. Foreign Assistance in the 19705: A New Approach," Task Force on Intemational Development, Washington, 1970; Dexter Perkins, "Development Assistance in the New Administration: Report of the President's General Advisory Committee on Foreign Assistance Programs," Agency for International Develop- ment, Washington, 1968; and Lester Pearson, Partners in Development: Report of the Commission on International Development (Praeger, 1969). 45. Asher, Development Assistance in the Seventies, esp. pp. 119-24. 46. Richard M. Nixon, message to Congress, October 15,1970. Quoted in Sanford, U.S. Foreign Policy, p. 58. 214 U.S. RELATIONS WITH THE WORLD BANK Table 6-2. U.S. Foreign Aid, by Major Programs, 1946-89 Billions of constant 1989 dollars Multilateral Economic Development Food Other development support Military Year assistance aid economic aid banks fund aid Total 1946 17.6 4.6 22.2 1947 39.6 1.0 40.6 1948 15.1 1.7 16.8 1949 33.3 8.2 1.6 43.1 1950 19.3 6.0 6.3 31.6 1951 12.5 3.9 0.8 21.2 38.4 1952 8.9 0.4 1.7 1.0 21.9 33.9 1953 7.4 1.4 2.1 13.3 24.2 1954 3.4 0.3 0.5 7.4 11.4 23.0 1955 2.8 2.5 0.1 6.0 7.9 19.3 1956 1.7 4.0 0.2 5.3 10.8 22.0 1957 2.3 5.1 0.2 0.2 5.0 8.6 21.4 1958 3.7 3.4 0.1 3.4 6.6 17.2 1959 4.5 3.5 0.1 3.6 9.5 21.2 1960 4.4 4.0 0.1 0.3 3.4 9.2 21.4 1961 5.2 4.6 0.1 0.3 3.4 8.5 22.1 1962 7.2 5.6 1.1 0.7 3.2 8.2 26.0 1963 7.1 5.6 1.1 0.5 2.4 7.9 24.6 1964 7.0 5.8 0.7 0.4 1.8 4.6 20.3 1965 6.4 5.1 1.0 1.2 1.8 4.9 20.4 1966 6.5 5.7 0.7 1.3 3.3 7.8 25.3 1967 5.8 3.4 0.6 1.3 2.7 8.5 22.2 1968 5.4 4.5 0.6 1.4 2.1 9.1 23.1 1969 4.0 3.8 0.6 1.6 1.4 10.1 21.5 1970 4.2 3.5 0.5 1.5 1.5 8.9 20.1 1971 3.7 3.6 0.5 0.6 1.7 12.8 22.8 1972 4.0 3.4 1.4 0.4 1.7 14.0 24.9 1973 3.6 2.9 0.6 2.0 1.6 14.1 24.8 1974 2.8 2.4 0.8 2.0 1.6 11.2 20.8 1975 2.9 2.9 0.6 1.7 2.7 4.4 15.2 1976 2.5 2.7 0.5 0.1 2.3 5.2 13.3 1976TQ 0.8 0.4 0.2 0.7 1.8 1.3 5.2 1977 2.7 2.3 0.5 1.8 3.3 4.1 14.7 1978 3.3 2.2 0.4 2.0 3.9 4.2 16.0 1979 3.0 2.1 0.6 2.7 3.2 11.0 22.6 1980 2.8 2.2 0.9 2.2 3.3 3.2 14.6 1981 2.7 2.1 0.8 1.3 3.0 4.6 14.5 1982 2.6 1.7 0.7 1.6 3.5 5.5 15.6 1983 2.7 1.7 0.6 1.8 3.6 6.9 17.3 1984 2.9 1.8 0.6 1.6 3.7 7.7 18.3 1985 3.2 2.3 0.7 1.8 6.0 6.6 20.6 1986 2.9 1.8 0.6 1.3 5.4 6.4 18.4 1987 2.3 1.5 0.7 1.6 3.8 5.5 15.4 1988 (est.) 2.3 1.6 0.7 1.5 3.3 5.6 15.0 1989 (req.) 2.2 1.4 0.6 1.5 3.3 5.6 14.6 Total 218.9 113.8 114.8 45.4 123.3 349.4 965.6 Source: Stanely J. Heginbotham and Larry Q. Knowles, An Overview of u.s. Foreign Aid Programs (Congressional Research SeIVices, 1988), p. 17. U.S. RELATIONS WITH THE WORLD BANK 215 the United States gave ''belated and grudging" support to Robert McNamara for a second term as world Bank president. 47 According to the press, MeN amara was not the first choice of Republican President Nixon. Names of former Republican cabinet members were proposed, but the international development constituency came out strongly in McNamara's support, and European member states hinted that if the U.S. nominee were not MeNamara, they might advance a European alternative. 4S A(.'COrd- ing to a retrospective analysiS of these years by the Bank's vice president for external affairs during his term, McNamara "had irritated many important leaders in the Nixon administration. They had thought that, as an American, McNamara should be respon- sive to policy nudges, but over and over again he proved to be unnudgeable."49 The grudging support for his nomination was a harbinger of difficulties that beset his relations with the United States until Jimmy Carter's election to the preSidency. Also in 1971 at the initiative of the executive branch, the United States cast its fIrst "no" vote on a World Bank loan. The prnposed loan was to Guyana and was opposed by the United States as part of a policy condemning expropriation of U.S. private property. Although this was not the first credit the United States had opposed, it was the first time that it ehose to cast an opposing vote on the Bank's executive board and thereby put its disagreement with the Bank on the record. Two years later, in negotiations for the fourth IDA replenishment, the United States was for the first time the main donor countI)' seeking to limit the increase in contributions. It made the World Bank and other countries take over its role of conciliator, soliciting contributions and arranging compromises. Moreover, it de- manded and got a number of concessions. On the list of U.S. conditions for the replenishment were the establishment of an independent audit process for Bank operations, removal of the maintenance of value obligation that required member countries to maintain the foreign exchange values of their IDA contributions, and a commitment for a future leveling off of IDA replenishments in real terms. The United States also demanded a commitment for a reduction in the differences between U.S. official and World Bank salaries and due consideration of the U.S. position in response to the expropriation of U.S. private property in Peru. In addition, it demanded and received a substantial reduction in its share of IDA funding and agreement on stretching out its contribution over four years rather than the regular three. These arrangements allowed the United States to hold its annual payment to the same level in current dollars as in IDA 3, while other countries made sizable increases in their contributions. In asserting the U.S. position on IDA 4, the Nixon administration clearly had one eye on mounting deficits and signs of inflation in the U.S. economy and one eye 47. William Clark, "Robert McNamara at the World Bank," Foreign Affairs, vol. 60 (fall 1981), p. 176. 48. See, for example, Stephen S. Rosenfeld, "Robert S. McNamara and the Wiser Use of Power," World Opinion, July 3, 1973, pp. 19-20. 49. Clark, "Robert McNamara," p. 176. 216 U.S. RELATIONS WITH THE WORLD BANK on Congress, which was becoming increasingly restless over various aspects of the administration's Bank policy. However, the major breakpoint in U.S. policy focused not on IDA but the Bank itself, and it was brought on not by Congress but by the executive branch, which voiced strong opposition to continued growth in lending. At the outset of the first oil shock in 1973-74, the United States expressed skep- ticism about continued expansion of regular Bank lending and opposed initial efforts by McNamara to enlist development funds from oil producers with capital surpluses. In early 1974 he sought agreement from those countries on establishing an OPEC fund for development whose operations would be carried out by existing World Bank staff and whose votes would be divided equally into three groups: OPEC, developed, and developing countries. "But he had reckoned without the determination of the Americans ... to break the OPEC cartel and not to col- laborate with it in anyway. In the face of U.S. opposition the proposals sank without trace."50 Recycling of petrodollars, the United States held, was a function best left to the commercial banks. The success of OPEC in manipulating a fourfold increase in oil prices embol- dened developing countries in the mid-1970s to intensifY demands for a new international economic order. Acting in concert, they demanded a greater share of the benefits from international economic cooperation and a greater voice in the system. In staunchly opposing these demands the United States insisted on the need for developing countries to put their national economic policies in order and emphasized the importance of the Bretton Woods institutions in assisting develop- ment. In a speech written for the special session of the UN General Assembly in September 1975, which was intended to be responsive to but not supportive of the developing countries' demands, Secretary of State Henry Kissinger offered a num- ber of initiatives, including two new facilities to be linked to the World Bank and U.S. support for expansion of both the IFC and the Bank. 51 Although these were initiatives that would have had a relatively small impact on the U.S. budget, the political strategy of the State Department was constrained by strong Treasury opposition to continued growth in World Bank lending. In a dispute that came to a head at the annual meeting of the Bank in 1976, the Ford administration's Treasury secretary, William Simon, countered McNamara's call for increased Bank lending and an attendant general increase in the Bank's capital. Simon supported IDA but opposed the rate of the Bank's growth in both 50. Ibid., p. 178. This 1974 attempt had a parallel in 1980--82 follOwing the second oil shock when the incoming Reagan administration rejected an initiative to create an energy affiliate, as discussed later. 5!. Kissinger was concerned that, follOwing OPEC's actions, other third world countries would try to form cartels in strategic commodities. Therefore one of his initiatives was for a resource development bank. McNamara, as indicated in minutes of the meetings of his president's council, took Kissinger's proposal as a Signal that the United States would support Bank lending in the mining and production of minerals, but this was not to prove so. U.S. RELATIONS WITH THE WORLD BANK 217 borrowing and lending. In contrast to McNamara's emphasis on the need for increased lending in the wake of the oil price hikes, declining global growth, and mounting third world debt, Simon called for a concerted attack on inflation at home and abroad and insisted that the time had come for deficit countries to slow their borrowing and for less developed countries to adjust their economic policies to allow for greater reliance on market forces. In his statement at the annual meeting Simon foreshadowed several issues that figured prominently in the policy of the Reagan administration. In considering how the present system might be improved to the mutual benefit of all nations, we should be guided by the following prinCiples: -Development by definition is a long-term process .... Foreign aid can help, but such aid can only complement and supplement those policies developing countries adopt, which in the end will be decisive. -The role of the private sector is critical. There is no substitute for a vigorous private sector mobilizing the resources and energies of the people of the developing countries. -A market-oriented system is not perfect, but it is better than any alternative system .... -A basic focus must be on increasing savings and making the institutional and policy improvements which will enable the fmancial markets to channel those savings into activities that enhance the opportunities for people to live better lives ,52 Simon contended that the larger role McNamara sought for the Bank would result in some nations borrOwing beyond their capacity to repay and would weaken the Bank's standing in the capital markets. He insisted, therefore, that Bank lending should be temporarily frozen at current levels. In IDA 5 negotiations the United States also expressed an unwillingness to see its annual payments increase. After other countries countered by insisting that it maintain a reasonable proportional share, negotiations concluded with an agreement on a smaller replenishment than had been proposed by tlle Bank. Thus the long-standing U.S, goal of burden sharing had come to have the effect of holding down rather than increasing IDA contributions. In the view of senior Treasury officials, the Bank was out of control. According to the u.s. executive director, they were concerned that the rapid growth in lending, which had resulted in massive undispersed commitments, was mortgaging the Bank's future borrOwing capacity and that Bank management was not respon- sive to donor criticism. Treasury also raised questions about the bankability of new projects undertaken as part of the Bank's emphasis on alleviating poverty and about the Bank's support for widening the role of governments in the development process. 53 To 52. Statement by William E. Simon, Summary Proceedings ofthe 1976 Annual Meetings of the Boards of Governors (Manila: IBRD, 1976), p. 190. 53. Charles A. Cooper, working paper for the Study Group on International Financial Institutions, Council on Foreign Relations, New York, March 1980. Cited with permiSSion of the author. See also National AdvisOry Council on International Monetary and Financial POlley, Annual Report to the President and to the Congress, July 1, 1975-June 30, 1976 (Washington, 1977). 218 U.S. RELATIONS WITH THE WORLD BANK others in the Bank and on the executive board, however, U.S. opposition to the rapid growth of the Bank appeared to reflect two quite different concerns. First, with u.s. bilateral aid shrinking, a growing Bank might displace the U.S. economic, and therefore political, leverage in developing countries. Second, with the increase in Bank borrowing in non-U.S. markets, the United States would lose its influence over how and where Bank funds were spent. Opposition to an increase in the capital subscription ofJapan, which would have eroded the U.S. veto, was taken as an indication of the latter concern. 54 One effect of a policy less supportive of the Bank was that the United States fell behind in its contributions to the Bank and IDA. The delay eroded U.S. relations with other member countries, a problem the Carter administration sought to remedy later in the decade. But it had to contend with, and itself contributed to, the worst period in relations between the World Bank and Congress. The Proliferation of Legislative Restrictions By the time President Carter came to office, Congress had established a practice of tying directives to its approval of World Bank funding bills. These restrictions proliferated rapidly in the second half of the 1970s because of the personalities in key congreSSional positions, the growing criticism of the Bank from both liberal and conservative members of Congress, and the mismanagement of legislative relations by Carter administration officials. The Foreign Operations Subcommittee of the House Appropriations Committee, which essentially held the House purse strings on foreign aid, was chaired from 1955 to 1977 by Otto Passman of Louisiana Passman "voted against every foreign aid authoriza- tion after the 1947 Greek-Turkey loan and he gave the program a skeptical treatment during the twenty-two years he chaired the panel."55 In 1977 Clarence Long of Maryland took over as chair. Although he was more supportive of the goals and purposes of the U.S. foreign aid program, he was generally critical of the World Bank. His criticism focused particularly on what he viewed as the Bank's failure to help the poor, but many have claimed that the death of his son in Vietnam made him a staunch and unrelenting critic of Robert McNamara and his tenure in office. The rise in congreSSional opposi- tion to the Bank was not limited to Long and the subcommittee, however. It was fed by public interest groups on both the Left and the Right and by increased coverage of the Bank in the media as each replenishment required larger funding bills. ParadOxically, one effect of Congress's increased attention was to bring develop- ment issues more into focus in the formation of policy toward the Bank. In the 19508 and 19608, when bilateral aid was the dominant force in development 54. John Lewis and Richard Webb interview with Robert S. McNamara, May 10, 1991, transcript, p. 7. 55. Sanford, U.S. Foreign Policy, p. 120. U.S. RELATIONS WITH THE WORLD BANK 219 assistance, the United States interacted closely with the Bank in the field, and U.S. policy toward the Bank was mediated, to a considerable extent, by coordinated actions of the Bank and USAID within countries. This interaction was especially intense in South Asia when the United States was giving large amounts of aid to India and Pakistan and in Latin America during the Alliance for Progress. Although the agencies continued to interact, by the mid-1970s USAID had become a less innovative force in development. U.S. relations \vith the Bank were left largely to the Treasury and State departments, which brought little development interest or expertise to policyrnaking. With no place in the executive branch to consider the development policies and perfonnance of the Bank, the development community turned to Congress, which from the 19708 on showed more concern and interest in the effectiveness of development assistance programs than did the bureaucracy. Congress's initiative in 1973 to set "new directions" for the U.S. aid program was a clear example of this interest. 56 Although the new directions legislation did not succeed in shOring up waning public support for foreign aid, it did set guidelines for the executive branch in the uses of aid dollars appropriated by Congress. In subsequent years Congress gave increasing attention to new directions issues in its deliberation of Bank funding bills. Thus in the late 1970s and throughout the 1980s, Congress held hearings, requested studies, and at times mandated that the United States use its voice and vote in the Bank to strengthen the development impact of Bank lending, particularly in alleviating poverty. The interest of some members of Congress in development was not sufficient, however, to withstand the general waning of support for foreign aid and grmving attacks on the Bank from both traditional opponents and proponents of foreign aid. As a result, the effort of securing money for the Bank came to dominate policy- making. Congressional reluctance to appropriate funds for the Bank mounted. This reluctance led, nrst, to delays in voting the full amount of funding requested by the executive branch, and the United States failed repeatedly to deliver its shares of negotiated replenishments on time. One of the most dramatic instances of this was the 1974 defeat of the IDA 4 funding bill in the House. Although Congress had held up approval of the nrst three IDA funding requests, the IDA 4 bill was the first to be defeated. The action was taken in a burst of anger over the economy and was actually less an indication of Congress's attitude toward the Bank than of a general discontent in the wake of Watergate, oil price hikes, and stagflation. Although the action was successfully overturned in a later vote after heavy administration lobby- ing, the defeat clearly demonstrated a new vulnerability of Bank funding requests. In subsequent years Congress not only delayed making appropriations but also, from time to time, appropriated less, sometimes far less, than the amounts re- quested by the executive branch and less than what was required to meet pledges 56. Foreign Assistance Act of 1973, P.L. 93-189. 220 U.S. RELATIONS WITH THE WORLD BANK made by the United States in international negotiations. As a consequence, the United States became the only donor to fall into arrears to the Bank. In this environment, "particularism ... found fertile soil. "57 In effect, Congress became the staging ground for criticisms of the Bank that multiplied as funding requests grew larger. More and more, committee chairs had to cater to members' particularistic views to obtain the support necessary to move authorization and appropriation bills. Vocal minorities exacted concessions on an array of narrow, short-rnn issues, or committee bills were altered by floor amendments proposed with little regard for their ultimate impact on the operations of the Bank. In the absence of a strong constituency that could be mobilized by the floor leadership to counter particularistic amendments, an extensive body of legislation built up that required the United States to go to the Bank and seek numerous speCific concessions. Many of the issues that were built into legislation were brought to Congress by outside groups, but not all. One of the first issue-specific legislative actions was the Gonzalez amendment of 1972, which reqUired the United States to oppose World Bank loans to countries that had ell:propriated U.S. private investments without proper compensation.58 In the 1960s Congress had passed legislation barring U.S. bilateral aid to countries that confiscated U.S. investments (the 1962 Hickenlooper amendment) and requiring the United States to vote against Inter-American De- velopment Bank loans to them. The 1972 legislation extended the restriction to loans of all multilateral development banks. The World Bank, at U.S. urging, had adopted operational guidelines in response to expropriations, and the administra- tion had sought to discourage expropriations through a variety of diplomatic efforts, but the Gonzalez amendment ovenuled a reluctance within the bureaucracy to adopt a formal, blanket statement of opposition.59 Although expropriation policy was the speCific issue, support for the amend- ment was driven by a broader concern with Congress's role in the overSight ofU.S. aid policy. Having increased its control over the bilateral aid program through various legislative restrictions and earmarkings, Congress was unwilling to see its directives circumvented by the relative increase in multilateral aid that the ad- ministration sought at the start of the 1970s. As a House Appropriations Commit- tee report stated in 1972, The Committee is deeply concerned over the trend to direct an increasing amount of U.S. foreign assistance through the multilateral institutions while at the same time decreasing the bilateral aid program .... The same degree of detailed examination which is possible in the bilateral foreign assistance programs is not possible in the multilateral 57. Bergsten, working paper, p. 14. 58. The amendment added section 21 to the 1959 Inter-American Development Bank Act, section 11 to the 1960 International Development Association Act, and section 18 to the 1966 Asian Development Bank Act. 59. Sanford, u.s. Foreign Policy; and Jessica Pernitz Einhorn, Expropriation Politics (Lexington, Mass.: Lexington Books, 1974). U.S. RELATIONS WITH THE WORLD BANK 221 assistance programs. The Congress does not know when, where or how the budget requests will be disbursed by these multilateral organizations because they do not justify their requests by specific project. 50 This broader concern was repeatedly voiced in subsequent years, with attention focused on the inadequacy of executive branch consultation with Congress, the need for more information from the Bank, and the need for more independent and more transparent evaluation and audit procedures. At Congress's request the General Accounting Office undertook several assessments of the management of U.S. Bank policy and the evaluation and audit procedures.61 On the basis of a 1978 report, Congress passed legislation directing the United States to establish an independent review mechanism. But the reforms that followed did little to quiet the charge that the executive branch was using support for the multilateral development banks as a way around congressional restrictions on bilateral aid and that the Bank was unresponsive to Congress's requests for more information and more transparency. A Senate report said in 1978, "for more than five years the Committee has pressed the banks to open their doors and encourage both their supporters and the media to make informed judgments as to how well and how efficiently they are carrying out their international mandate. It is apparent that our exhortations have fallen on deaf ears. "62 Criticism was even more strongly worded in a House minority report that same year: "By making our contributions through multi- lateral institutions, Congress has lost the ability to have control over how American tax dollars are spent and who will receive them.... The fact that the administration wants to put even more of these tax dollars into multilateral aid programs will remove even further the oversight capability of the Congress.'>6:) And in 1979, under the leadership of Clarence Long, the House Appropriatious Committee issued an investigative report that strongly criticized the ability of the United States to influence the Bank, the inadequacy of audit and evaluation systems, the limited flow of infonnation to Con- gress and the public, and the Bank's record on lending to the poor. 54 In addition to congressional overSight and Bank transparency, five other issues dominated congressional debate through the 1970s and into the 1980s (there were 60. House Committee on Appropriations, Foreign Assistance and Related Programs Appropriation Bill, 1972, report 92-711, 92nd Congo 1st sess. (1971), p. 33. 61. See, for example, General Accounting Office, "More Effective United States Par- ticipation Needed in World Bank and International Development Association," 1973; and General Accounting Office, "Effectiveness of the World Bank's Independent Review and Evaluation System," 1978. 62. Senate Committee on Appropriations, Foreign Assistance and Related Programs Appropriation Bill, 1978, report 95-352, 95th Congo 1st sess. (July 1977), p. 124. 63. House Committee on Appropriations, Foreign Assistance and Related Programs Appropriation Bill, 1978, report 95-417, 95th Congo 1st sess. (June 1977), pp. 72-73. 64. Although the executive branch countered most of the charges, the report \'l'aS picked up in the press and darkened the Bank's image with both Congress and the public at large. 222 U.S. RELATIONS WITH THE WORLD BANK many more). Through successive pieces of legislation, these matters became de- mands that the government was instructed to pursue within the Bank MANAGEME~T AND PERSONNEL PRACTICES. Congress's attitude that the Bank was excessively closed and arrogant was inflamed by the high Bank staff salaries and the difficulties Congress encountered in getting information on them. Whether or not the issue was deliberately fanned by those opposed to foreign aid, and particularly multilateral aid, it seriously undermined Hill support for the Bank. A Senate subcommittee report commented in 1975, "many who are said to be dedicated servants of the poor receive unseemly compensation for their service."65 A year later Congress indicated that future IDA appropriations would be affected by progress on redUcing salaries, and the follOwing year it adopted legislation directing the administration to seek to keep Bank and IMF salaries and benefits at levels comparable to those paid by private employers and the U.S. government. Subsequently, the Bank and the IMF agreed to personnel guidelines that closely followed a U.S. proposal to set salary schedules by reference to a basket of compen- sation packages of civil servants of several member governments and the U.S. private sector.66 This action reduced the level of controversy for a time, but it did not eliminate the salary issue. In 1989 Congress recommended that the Treasury make known to the Bank its "extreme displeasure" with a salary increase and "the damaging impact such a large increase has on support for the World Bank in Congress."67 LENDING TO SPECIFIC COUNTRIES. Before the mid-1970s, Congress voiced little concern over World Bank country allocations, with the notable exception of lending to countries that expropriated U.S. private property, After the mid-1970s, however, Congress frequently expressed opposition to loans to particular countries. India was an early target of criticism, and support in Congress for IDA replenish- ments was undermined by India's large share of IDA resources, which exceeded 40 percent at its peak. Legislation targeted particularly at India instructed the U.S. representative in the Bank to consider whether a recipient country had detonated a nuclear device or refused to sign the Treaty on Nonproliferation of Nuclear Weapons. And in response to congreSSional pressure the administration made the reduction of India's share a condition of IDA negotiations. More controversial and more strident was a late 1970s effort, led by Representative Bill Young, to stop lending to Vietnam and five other socialist countries. Young and other conservative 65. Senate Committee on Appropriations, Foreign Assistance and Related Programs Appropriation Bill, 1975, report 94-39, 94th Congo lst sess. (March 1975), p. 142. 66. U.S. civil service salary scales were lower than those of some other developed countries and salaries were capped for much of the time after 1968, which added to resentment of rising salaries in an international institution just blocks away from the Treasury Department and other offices. 67. Senate Committee on Appropriations, Foreign OperatiOns, Export Financing, and Related Programs Appropriation Bill, 1990, report 101-131, lOlst Congo 1st sess. (Septem- ber 1989), p. 72. U.S. RELATIONS WITH THE WORLD BANK 223 members of Congress strongly objected to what they viewed a~ the Bank's support of socialist regimes and statist solutions to development problems. Young believed that indirect U.S. aid to Vietnam through multilateral development banks was especially objectionable, and his opposition led to a major dispute over a proposed earmarking of U.S. contributions to the Bank. PROTECTION OF U.S. PRODUCERS. From 1976 through the 1980s, Congress also objected to Bank lending to increase the production of commodities that could compete with U.S. commodities. In 1977 Congress adopted legislation requiring U.S. executive directors at each of the multilateral development banks to oppose loans for the production of palm oil, citrus crops, and sugar. 68 In 1978, Congress mandated U.S. directors' opposition to all loans for the production of export commodities, including mineral commodities, that were in surplus in world mar- kets and that could cause substantial injury to U.S. producers.69 Proposed but not passed was a more stringent amendment to the 1987 Omnibus Trade Act that sought to prohibit the United States from participating in future funding agreements for multilateral development banks that made loans for the production of agricultural and mineral commodities in surplus in the world market. And in 1989 Congress extended its legislative restrictions by mandating the U.S. executive director to vote against loans that would subsidize development of export industries in countries engaging in dumping or other unfair practices against the United States. AID TO THE POOR. Consistent with the new directions policy, Congress also mandated that the United States pressure the Bank to increase the share of its assistance going to the poor and expand its emphasis on projects designed to meet basic human needs. Despite recognition of the efforts made under the leadership of Robert McNamara, both supporters and opponents of the Bank expressed a strong sense of frustration over the lack of assistance to the poor in the late 1970s, charges leveled mostly by liberal and conservative development groups. In the 1980s Congress forced renewed U.S. emphasiS on alleviating poverty when it requested studies on the effects on poverty of structural adjustment and urged the administration to make attention to poverty alleviation a condition of its continuing support for IDA. HUMAN RIGHTS. In 1975 an effort by Representative Tom Harkin led to a provision requiring the U.S. representative to the Inter-American and African De- velopment banks to vote against loans to any country whose government violated its citizens' human rights. In 1976, although it lacked legislation covering World Bank lending, members of Congress nonetheless sought to persuade the adminis- tration to vote against Bank loans to Chile because of its human rights violations. But the Ford administration, wary of the effects of introdUCing human rights 68. For a review of the congressional debate and legislation, see House Committee on Foreign Affairs, Congress and Foreign Policy, 1977 (1978). 69. For a review of the congreSSional debate and legislation, see House Committee on Foreign Affairs, Congress and Foreign PoliCY, 1978 (1979), esp. pp. 88-92. 224 U.S. RELATIONS WITH THE WORLD BANK criteria into Bank lending decisions and convinced that it could not rally enough votes of other memher countries to prevent the loans to Chile, voted in favor. In response, key members of Congress decided to enact new human rights legislation in the subsequent Congress, and a legislative battIe ensued with the Carter administration. The Failed Efforts of the Carter Administration The Carter administration entered office committed to expanding U.S. develop- ment assistance, eliminating the arrearages that had built up in its payments to the multilateral development banks, and making the banks the keystone of U.S. de- velopment policy. Its support for the banks was clearly reflected by Michael Blumenthal in his confirmation hearings for Treasury secretary: I would hope that to the largest extent pOSSible, whatever we do as a country with regard to economic assistance be handled through multilateral organizations where we can be one of a group of countries who work together and contribute to the solution of these problems. I think that the time for a large national program or a bilateral program for economic aid is probably past, except in certain exceptional circumstances. I expect our work in these international organizations to be very intense and very active. 70 A report issued in the administration's first year further set the tone of its development assistance policy by calling for efforts to improve conditions in poor countries through economic and technical assistance, funds for meeting basic human needs, and increased multilateral lending. 71 This orientation was reiterated by President Carter in summit statements and in the congressional testimonies of Treasury and State Department ofllcials. The administration immediately tried to win support for IDA funding and for the general capital increase that the Ford administration had opposed. The Carter administration was heleaguered, however, by deteriorating economic conditions at home and abroad and, late in its term, by a consuming concern with the Iran hostage taking and Soviet expansionism in Afghanistan. As a result, despite its encouragement of the multilateral development banks and its close relations with McN amara, it was unable to build a political constituency for its development bank policies. 72 A concerted effort succeeded in convincing Congress 70. Testimony ofW. Michael Blumenthal, Nomination ofW Michael Blumenthal, Hear- ings before the Senate Committee on Finance, 95th Congo 1st sess. (GPO, 1977), quoted in Sanford, u.s. Foreign PoliCY, p. 68. 71. Mark F. McGuire and Vernon W. Ruttan, "Lost Directions: U.S. Foreign Assistance Polk:y since New Directions," Journal of Developing Areas, vol. 24 (January 1990), p. 137. 72. For example, McNamara was invited to participate in National Security Council meetings in the \Vhite House that dealt \vith gaining support for IDA 5 and the general capital increase that the Ford administration had opposed. U.S. RELATIONS WITH THE WORLD BANK 225 to appropriate in a single package funds for the last payment of IDA 4 and the first of IDA 5. This action put the United States back on the same schedule as other donors, but it also meant that the IDA appropriation crossed the $1 billion mark for the first time. To sweeten the package, the Carter administration took on the contentious issue of World Bank salaries that had first been raised in the early 1970s. While indicating that it supported both the IDA funding and the general capital increase for the Bank, the administration informed the Bank and its board that it would not take a formal position on refunding until the compensation issue was resolved. Thus in 1978 the United States made a proposal to the Joint Commit- tee on Compensation of the Bank and the Fund that, after much debate, became the basis of an across-the-board salary cut and the guideline for future salary increases. The U.S. formula did not, however, resolve the salary issue, which remained a major irritant in relations between the United States and the Bank and one of a growing number of matters emphasized by an increaSingly hostile Congress. VIETNAM AND THE DISPUTE OVER EARMARKING. Congress and the Carter administration came into their greatest conflict in a dispute over Bank lending to Vietnam and an attempt by members of Congress to earmark U.S. contributions. The opposition was led by an alliance of liberal human rights activists and conser- vative opponents of foreign aid. In its early days the Carter administration spoke of human rights as a center- piece of its foreign policy. But like previous administrations, it sought to limit proposed legislation to a requirement that the United States use its voice to advance human rights concerns in countries that were borrowers of the Bank rather than use its vote to oppose loans to countries defined by the United States as violators of basic rights. Although human rights activists in Congress were willing to give the Carter administration the flexibility it sought, a coalition of the most active rights proponents in the House and conservative opponents of the development banks won passage of a provision that mandated the United States to vote "no" on loans, those except for meeting basic human needs, to any country with a poor human rights record. In the midst of this debate an even more restrictive amendment was proposed by Representative Bill Young that sought to prohibit U.S. funds from being used for multilateral development bank loans to various socialist countries, including Viet- nam and Uganda. Such earmarking had become a common practice with the bilateral aid program, but until the debate over supporting human rights, Congres- sional activism on MDB issues had mainly taken the form of cuts in appropriations and instructions to Treasury to use the U.S. voice and vote in the Bank to advance certain positions. Had the Young amendment become law, the Bank would have had to refuse the U.S. contribution because its charter prohibited it from accepting earmarked funds. To break congressional deadlock and to avoid having its total foreign aid request put into a continuing resolution vvith funding levels far short of 226 U.S. RELATIONS WITH THE WORLD BANK what was being sought, the Carter administration struck a compromise with Young. In a letter to Congress, President Carter promised that the U.S. directors would vote against all MOB loans to the countries in question. 73 His promise did not, however, end the earmarking debate. In 1978, over a U.S. objection, the Bank board approved a $60 million IDA loan to Vietnam for agricultural development. In response, the House of Representa- tives approved an amendment to its fiscal year 1979 appropriation bill that prohibited U.S. funds from being used for loans to Vietnam and several other countries. This action "served to place moderate members opposed to earmarking in the uncom- fortable pOSition of having to go on record opposing a measure to halt aid to Vietnam." Although the amendment was ultimately defeated in House-Senate conference, Young introduced a similar one in 1979 that led to heated debate on the Senatc floor between conservatives in favor and moderate Democrats who supported the administration's stand against earmarking. Again the amendment went to con- ference, where it gave rise to "the most acrimonious foreign aid debate of the 1970s."74 At that point, McNamara took the unusual step of meeting with twelve mem- bers of Congress to assure them that a lending freeze had been imposed on Vietnam. But Young refused to back down until McNamara sent a letter to Con- gress stating that because of "a very serious question" about Vietnam's commitment to a rational development policy, there would be no new IDA loans to the country in the coming year. 75 Although the McNamara letter temporarily ended the ear- marking conflict, the debate over aid to Vietnam reduced congressional support for the Bank to an all-time low and contributed significantly to shattering the tradition of bipartisanship on MOB policy. BIPARTISANSHIP SHATTERED. Until the late 1970s, partisan divisions were not a major factor in congreSSional deliberations of U.S. Bank policy. 76 Democratic members of the House tended to vote in larger majorities for Bank bills than did their Republican counterparts, but the differences were not dramatic. Many mem- bers from both parties often voted in favor or against administration funding requests and a majority of Republicans often supported World Bank legislation. 73. Letter from Jimmy Carter to Clarence D. Long, chairman of the Subcommittee on Foreign Operations and Related Agencies, House Committee on Appropriations, October 6, 1977. CongresSional Record, vol. 123 (October 18,1977), p. 34093. 74. Schoultz, "Politics, Economics, and U.S. Participation," pp. 568-69. 75. Letter from Robert S. McNamara to Clarence Long, chairman of the Subcommittee on Foreign Operations and Related Agencies, House Committee on Appropriations, No- vember 1, 1979. Reproduced in Congressional Record (December 3, 1979), p. 34415. Reference to a second letter from McNamara apolOgizing to Treasury Secretary G. William Miller for not going through usual channels is in Bartram S. Brown, The United States and the Politicization of the World Bank (London: Kegan Paul, 1992), p. 189. No subsequent loans have been made to Vietnam. 76. Discussion of the politicization of MD B legislative action draws heavily on Catherine Gwin, interview with Jonathan Sanford, CongreSSional Research Service, May 14,1991. U.S. RELATIONS WITH THE WORLD BANK 227 Beginning in 1978, however, a series of highly critical minority reports were issued as part of the annual House Appropriations subcommittee report on foreign assistancc. Then in 1980 Republicans made it clear that they were prepared to oppose enactment of the large development bank funding bill proposed by the outgoing Carter administration. That same year the Republican presidential plat- form statement strongly emphasized bilateral rather than multilateral aid. Further- more, in 1978 and again in 1980 legislative decisions on multilateral development banks became issues of electoral politics. Some Democratic incumbents were attacked by their opponents for allegedly supporting aid to Vietnam when they voted against the MDB earmarking amendments. Because the attacks appeared about the same time and in the same words in different parts of the country, the Democrats concluded that the Republican national electoral organizations had orchestrated the effort.77 In response, Representative David Obey demanded that the incoming Reagan administration issue a statement opposing such attacks, and the House Democratic leadership told the new administration that it vvould have to mobilize more Republican support for future MDB legislation if the Democrats were to join in.78 The Democrats held to this on a major funding bill that the Reagan administration, in its early days, had to bring to Congress as a piece of unfinished business of the Carter administration. At the end of the decade the Carter administration entered into negotiations for both a sixth replenishment of IDA and a further capital increase for the World Bank. As it had done in 1977, it sought major concessions that it hoped would help win congressional approval for the refunding agreements. In the negotiation for a capital increase, the United States pressed to lower to 7.5 percent the amount of the increase that was to be paid in. It also insisted on further redUcing the U.S. capital share and, in opposition to all other member countries, refused to accept the obligation to maintain the value of its commitments to the Bank against foreign exchange fluctuations. In the IDA 6 negotiations the United States made additional 77. See, for example, the remarks of Congressman David Obey stating that he had been so attacked, in Foreign Assistance and Related Programs Appropriations for 1982. pt. 4, Hearings before the House Committee on Appropriations, 97th Cong, 1st sess. (GPO, 1981), pp. 186-88. 78. House Committee on Foreign Affairs, Congress and Foreign PoliCY, 1981 (GPO, 1982), p. 50. A letter from President Reagan did not, however, end the Republican party's attack on Demoeratic supporters of the World Bank and IMF up for reelection, In 1983 Phil Gramm proposed that the C.S. executive director to the IMF be directed to oppose any use of IMF credit to "communist dictatorships." His motion passed in the House 242-185, and h'lo weeks later the :;-Jational Republican Congressional Committee began distributing press releases in the districts of 21 Democrats who voted against the Gramm amendment, charging them \vith voting in favor of communism. The Republican administration having sought the quota increase, House Democrats demanded and received a letter from Presi- dent Reagan expressing his strong appreciation for their support of the IMF legislation and their opposition to the amendment. See Juan Williams and Hobart Rowen, "Reagan Thanks Democrats for IMF Bill Votes," Washington Post, October 25, 1983, p. A4. 228 U.S. RELATIONS WITH THE WORLD BANK demands. Although it endorsed an increase, it again insisted on a smaller share and an increa<;e in the roster of donors. Allowing for inflation, its pledge was thus the same as it had been for IDA 5. In addition, it demanded that the Bank increase lending for energy production and poverty alleviation projects, introducing into the IDA negotiations policy issues that other member countries viewed as in the purview of the board. The outcome was a substantial broadening of burden sharing but also a further fraying of U.S. relations with Bank management and other member countries. Even with these concessions, lack of enthusiasm in Congress for the negotiated funding package and inept handling by the administration of the request to Con- gress delayed action on the replenishments. As a result the Carter administration left office recommending, but not having attained, adoption of the largest MDB package ever put before Congress, including 812 billion for the Bank and IDA combined. It also left U.S. policy toward MDBs in shambles. Despite its pro-Bank orientation, the administration had sought to achieve a multipliCity of objectives that it could not reconcile into a coherent and compelling strategy. Instead, in an effort to patch together the necessary margin of support for continued U.S. con- tributions to the Bank, the administration firmly established a practice of tying policy demands to replenishment agreements. In the aftermath of its election defeat, the Carter administration reached agreement with the incoming Reagan administration on a mutually acceptable, but not strong, nominee for McNamara's successor as president of the Bank; but it had to leave an unfinished agenda to a new administration, key members of which were openly critical of multilateral assistance. 79 Retrenchment and Reassessment under Reagan The Reagan administration came into office in January 1981 critical of the World Bank and other multilateral institutions on both ideolOgical and political grounds and in favor of reduced U.S. support for them. This position represented a breakpOint in U.S. policy toward the Bank in two regards: previous Bank policy goals had been largely bipartisan in character, and disputes on specific issues notwithstanding, all previous administrations had supported the Bank as an impor- tant instrument of U.S. policy. The 1980 Republican platform statement described America as dangerously adrift in a perilous world. 79. The Carter administration also initiated monetary and fiscal actions (continued by the Reagan administration) aimed at bringing down double-digit inflation that had a far more devastating immediate effect on developing economies than aid transfers helped them. For a discussion of these effects, see John P. Lewis, "Can We Escape the Path of Mutual Injury?" in John P. Lewis and Valeriana Kallab, eds., U. S. Foreign Policy and the Third World Agenda, 1983 (Praeger for Overseas Development Council, 1983), pp. 7-48. U.S. RELATIONS WITH THE WORLD BANK 229 Our country moves agonizingly, aimlessly, almost helplessly into one of the most dan- gerous and disorderly periods in history.... At home, our economy careens, whiplashed from one extreme to another.... Overseas, conditions already perilous, deteriorate. The Soviet Union for the first time is acquiring the means to obliterate or cripple our land-based missile system and blackmail us into submission. Marxist tyrannies spread more rapidly through the Third World and Latin America. Our alliances are frayed in Europe and elsewhere. Our energy supplies become even more dependent on uncertain foreign suppliers. In the ultimate humiliation, militant terrorists in Iran continue to toy with the lives of Americans. The platfonn promised dramatic changes in V.S. foreign policy, including a return to bilateral assistance programs "wbenever possible." Bilateral programs, it stated, "provide the best assurance that aid programs will be fully a(.'Countable to the American taxpayer, and wholly consistent with our foreign policy interests." It also criticized the Carter administration for diminishing the role of military assistance and foreign anns sales and pledged to "refonn and rebuild" the military assistance programs.so Immediately follOwing the 1980 election, the new administration Signaled its intentions not only to emphasize bilateral over multilateral programs and security over development assistance but also to seek a substantial reduction in foreign aid. This position was set out by the director of the Office of Management and Budget, David Stockman, in a planning memo leaked to the press on January 27, 1981, which called for a "foreign aid retrenchment." In his own account of the memo, Stockman described its rationale and objectives: The Gramm-Stockman budget plan had called for deep cuts in foreign economic aid on the basis of pure ideolOgical principle. Both Gramm and I believed that the organs of international aid and so-called Third World development ... were infested with socialist error. The international aid bureaucracy was turning Third World countries into quag- mires of self-imposed inefficiency and burying them beneath mountainous external debts they would never be able to pay.8l Stockman also maintained that if Congress was to be persuaded to make cuts in domestic programs to achieve a balanced budget, aid increases of the size that had been proposed by the Carter administration would be out of the question. The memo proposed, therefore, to cut V.S. bilateral and multilateral aid by 45 percent, which would have amounted to a $13 billion reduction for 1982-86. The proposal would have revoked the V.S. pledge to contribute $3.2 billion to IDA 6 and reopened negotiations with other IDA donors to cut contributions in half. It would also have tenninated all future V.S. contributions to IDA and the other multilateral 80. U1980 Republican Platform Text," Congressional Quarterly Almanac, vol. 36 (Washington: Congressional Quarterly, 1980), pp. 58-B, 83-B. 81. David A. Stockman, The Triumph of Politics: How the Reagan Revolution Failed (Harper and Row, 1986), pp. 116-19. 230 U.S. RELATIONS WITH THE WORLD BANK development bank soft loan windows, frozen contributions to all UN agencies, held bilateral development assistance to no more than 3 percent growth while increas- ing the relative share of military assistance, and phased out both the Peace Corps and the P.L. 480 food credit sales program. Strong State Department pressure blocked OMB and Treasruy Department in- clinations to renege on the Bank and IDA commibnents that had been negotiated by the Carter administration. However, in agreeing to meet the commibnents, the Reagan administration moved to advance its own policy perspectives. In its request to Congress for funds for IDA 6, it proposed a schedule of appropriations-$5oo million in year one, $800 million in year two, and $1.8 billion in the third year-that it knew Congress would not acc'ept without stretching out the U.S. payment over four years. 82 The administration also made dear in its statement~ to Congress that its support for IDA 6 and a general capital increase should not be taken as a Signal of future funding policies. It would, it announced, undertake a broad reassessment that would establish policy guidelines and a budgetary framework for u.s. participation in the multilateral de- velopment banks in the 1980s. Representative Jack Kemp, a staunch critic of foreign aid and IDA, then led the effort to line up support for the administration's 1981 World Bank request, organizing conservative Republican votes for IDA in exchange for Democratic support for bilateral military assistance. The assessment that was subsequently undertaken was led by the Treasury Department. 83 It entailed an account of the role of the multilateral development banks in the international economic system, a review of criticisms of the banks over the years, and an evaluation of the ability of the United States to achieve its objectives through the banks. It also outlined a plan to improve MDB polic)' effectiveness and provided specific U.S. funding and policy recommendations. Although it discussed nineteen criticisms leveled against the banks, ranging from excessive salaries to support for statist development approaches to emphasis on loan quantity instead of quality, its tone was positive. To the surprise of many, the assessment approved the overall performance of the MDBs and noted the benefits to the United States of participation in them. The main policy conclusions were not, however, wholly consistent with the body of the report. There were three core recommendations. First, U.S. support for the MDBs should be deSigned to foster greater adherence to open markets and greater emphasiS on the private sector as the main vehicle for growth. Second, the United States should work to ensure that loan allocations were made conditional on policy reforms in recipient countries. Finally, the United States should reduce its expen- ditures on the banks. This third recommendation, the report suggested, should be 82. Although other donors objected to this unilateral move, they a(lliered to the rds over and above their regular three-year schedule and later agreed to provide additional funds to enable IDA to continue its regular operations during the fourth year. 83. Department of the Treasury, United States Participation in the Multilateral DevelqJ- ment Banks in the 1980s (1982). U.S. RELATIONS WITH THE WORLD BANK 231 accomplished in two ways. The United States should develop a plan to reduce and eventually phase out new paid-in capital for the hard loan windows of all MDBs. And it should reduce, in real terms, its future participation in all MDB soft loan windows, especially IDA. In other words, countries should be encouraged not only to adopt more market-based policies but also to rely more on private sector financing than on World Bank and other public sector finanCing. The international debt crisis that burst onto the international stage not long after the Treasury assessment was completed required the Reagan administration to revise its views on graduating countries out of the ranks of World Bank borrowers. But it did not dampen the administration's criticism of the MDBs nor its own pressure for more focus on the private sector. In September 1983 President Reagan addressed the annual meeting of the World Bank and reiterated the policy direc- tives contained in the Treasury report. The societies that achieved the most spectacular, broad-based economic progress in the shortest period of time have not been the biggest in size, nor the richest in resources and certainly not the most rigidly controlled. What has united them all was their belief in the magic of the marketplace. Millions of individuals making their own decisions in the marketplace will always allocate resources better than any centralized government plan- ning process. 84 He also expressed the willingness of the United States to support the replenish- ment and capital increase agreements negotiated by the previous administration. But he made it clear that U.S. policy toward multilateral development banks was now set on a new course, one based on sharp criticism of the operations of the banks and an ideolOgical opposition to centralized direction of development. In effect, the Reagan administration did what the Carter administration failed to do: it identified strategic program objectives for U.S. participation in the Bank. One outcome was that the United States dropped its previous opposition to the Bank management's proposal for a new kind of policy-based, stmctural adjustment lending. The administration came to view this new lending as an important way to advance market-oriented reforms. However, because the administration's objec- tives were stated in highly ideolOgical terms and aimed at redUcing U.S. funding for the Bank, the United States was often at odds with the Bank and other members of the board during the 1980s design and implementation oflending policy. During the IDA 7 replenishment talks in 1983, the United States insisted on holding its pledge to an amount less than it contributed to IDA 6. This position, advanced by the Treasury Department, was supported by President Reagan against the recommendations of the Department of State and the National Security Coun- cil. Although other countries expressed willingness to discuss a $12 billion to $16 billion replenishment if the United States carried an appropriate share, the Reagan ad- 84. Opening remarks by President Ronald Reagan, Summary Proceedings of 1983 An- nual Meetings of the Boards ofG:)vernors (Washington: IBRD, 1983), p. 2. 232 U.S. RELATIONS WITH THE WORLD BANK ministration indicated that the maximum it would agree to was a $750 million annual payment and a 25 percent share. The result was a total replenishment of only $9 billion, 25 percent lower than the IDA 6 level. One of the Bank's reasons for recommending a large replenishment was to accommodate the entry of its new client, China. A key element of the administration's stance, however, was that India and China should rely more on commercial borrowing. In 1985 the administration declined to participate in the new IDA Special Facility for Africa. The Bank and other donors had deSigned the Facility as a temporary mechanism to channel additional resources to African governments that agreed to implement specific policy reforms after the reduction in U.S. funding had resulted in holding down the size of the IDA 7 replenishment. Also in 1985 President Reagan stated in a budget message to Congress that although the ad- ministration intended to honor existing commitments to IDA and other MDB concessional windows, in light of severe fiscal pressures it was "not budgeting at this time for the future replenishments of these particular institutions."85 But Congress, which after a brief interlude had returned to a Democratic majority in both chambers, did not concur. It opposed putting a five-year ceiling on IDA refunding. Congress also authorized $225 million for the IDA-related Special Facility for Sub-Saharan Africa, which the administration had opposed. At the time of the IDA 7 negotiations, the administration had explained that Congress would not exceed the funding ceiling. However, congreSSional staff indicated in interviews with me that legislative support for the Special Africa FaCility was mobilized in explicit contradiction to that claim. And even though the administration never requested appropriation of the special Africa funds, Congress stipulated that some $140 million be allocated in subsequent legislation. Then before negotiations for the next IDA replenishment began, James Baker replaced Donald Regan as Treasury secretary, and the administration rediscovered the importance of the World Bank as an instrument in the deepening debt ofless develope'd countries. THE DEBT CRISIS AND RENEWED r~TEREST IN THE BANK. In August 1982 Mexico suspended payment on its international debt. For more than five years analyses had been warning of impending trouble, but they were the minority view and neither the U.S. government nor the World Bank had forecast the extent of the crisis that ensued throughout the developing world. 86 The initial reactions of U.S. 85. Quoted in Hobart Rowen, "U.S. May End Support of IDA Programs," Washington Post, Febmary 5, 1985, p. Cl. 86. For early indications of impending problems, see Multinational Corporations and Foreign Policy, pt. 15, Hearings before the Subcommittee on Multinational Corporations of the Senate Committee on Foreign Relations, 94th Congo 1st sess. (GPO, July-October 1975); and The Wittaveen Facilitlj and the OPEC Financial Surpluses, Hearings before the Senate Subcommittee on Foreign Economic Policy, 95th Congo 1st sess. (GPO, September- October 1977). For a review of the unfolding of the international debt crisis see Karin Iissakers, Banks, Borrowers, and the Establishment (Basic Books, 1991). U.S. RELATIONS WITH THE WORLD BANK 233 officials to the financial crisis in Mexico has been described as a "dialogue of the deaf."87 After months of deliberation a bridging loan was arranged, followed by longer-term rescheduling negotiations in conjunction with an IMF stabilization loan. With active U.S. support, the IMF pressed commercial banks to keep lending to Mexico and, subsequently, to others. The IMF and the World Bank also in- creased their own lending by limited amounts. In 1982 the United States considered the crisis a problem of short-term liquidity that would recede when the prolonged worldvvide recession ended. In 1983, as debtor after debtor experienced continuing difficulties, the Reagan administration reluctantly supported a quota increase for the IMF to enable it to playa catalytic role in mobilizing new lending by commercial banks. The objective of the increase was to avoid the collapse of the international banking system and, to that end, to buy time to allow for renewed growth in the debtor countries. But, consistent with its insistence on the short-term nature of the problem confronting the less de- veloped countries, the administration continued until 1987-88 to oppose a general capital increase for the World Bank. With an easing of the global recession in late 1983 and 1984, the official U.S. view was that recovery from the "liquidity" problem would follow. The administra- tion also maintained that existing resources were adequate and opposed raising a tightly set ceiling on World Bank policy-based lending. Yet, even after reschedul- ing, most severely indebted developing countries continued to experience difficul- ties in servicing their debts, and few showed any resumption of groV\,th. By early 1985 most analysts had concluded that the countries reqUired serious policy re- forms and access to more financial resources or debt relief than they were getting. Faced vvith the deepening financial crisis in the developing countries and mounting criticism of its policy, the United States revised its policy in the fall of 1985. Although it still considered the debt crisis a short-term liquidity problem, the administration conceded that a more concerted effort was reqUired. In a speech at the World Bank-IMF annual meeting Treasury Secretary James Baker called for new money and a greater role for the Bank. By all accounts the Baker initiative was deSigned hastily and with little consultation vvith international financial institutions, other creditor governments, or debtor countries. Nonetheless, the plan included a lead role for the \Vorld Bank. Its main elements were a $9 billion increase over planned amounts in World Bank and Inter-American Development Bank lending to fifteen heavily indebted countries, a $20 billion net increase in lending by private banks over three years, and further policy reforms by debtor countries. Combined vvith previously planned finanCing, the proposed increase was expected to amount to $20 billion in net new lending by the MDBs after repayments of loans coming due. According to Baker, these steps would help debtor countries adjust and grow their way out of debt. 87. Joseph Kraft, The Mexican Rescue (New York: Group of Thirty, 1984), p. 11. 234 U.S. RELATIONS WITH THE WORLD BANK At least three considerations converged in the redesign of the U.S. debt strategy. First, as commercial banks virtually halted new lending, severe recessions in the debtor countries caused a noticeable decrease in U.S. exports. Second, because the limited size and scope of U.S. bilateral aid precluded substantial funding of the heavily indebted countries and because there were strong pressures from Congress not to bail out the banks, the international financial institutions had to play the lead role in helping to renew growth. Finally, the administration had become convinced that the World Bank's new form of structural adjustment lending could be used as a way to respond to the debt crisis and to advance market liberalizing and private sector policy reforms at the same time. Thus for the next four years the United States encouraged multilateral banks to support policy reforms and pushed them to take the lead in prOViding new monies themselves and in coordinating the activities of commercial banks. Nonetheless, the Baker plan foundered, as many predicted it would, because ofinadequate fmancing. The private banks failed to provide the full amount of their targeted lending and official capital flows decreased because of negative net IMF flows and decreases in bilateral (mainly export credit agency) flows that were not offset by increased MDB lending.88 In mid-December 1988, President-elect George Bush called for a reassessment of the prevailing U.S. international debt strategy. And in March 1989, at the start of the Bush administration, Treasury Secretary Nicholas Brady proposed a successor debt plan that introduced the element of voluntary debt reduction. In offering this proposal the administration adopted what had by then become the prevailing view. The case for debt reduction had been building in academic and other analytic circles for several years. 89 It was being promoted by members of Congress who argued that the United States and other developed countries should do more to help relieve the debt hurden of developing countries. The Baker plan, some members argued, only prOvided a way for the World Bank to bailout the commer- cial banks; it did not do enough to help countries reduce their deht and restore investment and growth. 90 Also, by the time of Brady's speech, debt reduction was being publicly espoused by some in the banking community and by the managing director of the IMF.91 The major banks had by that time built reserves and taken 88. William R. Cline, "The Baker Plan and Brady Reformulation: An Evaluation," in Richard O'Brien and Ingred Iversen, eds., Finance and International Economics, vol. 3 (Oxford University Press for American Express Bank Review, 1989). 89. See, for example, Rudiger Dornbusch, ed., Alternative Solutions to Developing- Country Debt Problems (Washington: American Enterprise Institute, 1989). 90. Debate on debt-related issues held up approval on the U.S. contribution to the Bank's general capital increase for over a year in 1988-89. See Richard Lawrence, "World Bank Contribution on Congressional Compromise," Journal of Commerce, August 12, 1988, pp. lA, lOA; and Hobart Rowen, "David Obey's World Bank Crusade," Washington Post, November 12, 1989, pp. HI, H4. 91. See, for example, Third World Debt Panel of the Economic Policy Council of the United Nations Association of the United States of America, 'Third World Debt: A Re- examination of Long-Term Management" (New York, September 7, 1988). U.S. RELATIONS WITH THE WORLD BANK 235 other steps that had left them in strengthened positions and removed securing the international banking system as a primary concern. The Brady proposal, like the Baker plan, insisted on policy reform in the indebted countries as a condition of external support, but it also called for two innovations. First, instead of focusing on new lending, it encouraged multilateral institutions to use their funds to support voluntary write-offs of commercial bank debt. The target was 20 percent, or $70 billion, of the $350 billion debt outstand- ing. The Brady initiative also proposed that the IMF no longer withhold its own lending to countries until commercial banks agreed to reschedule. As Anne Krue- ger, former research director of the Bank, has observed, "the Brady Plan gave official acceptance-so long denied-to the view that the existence of debt itself might be a barrier to the resumption of growth in heavily indebted countries. In that way it offiCially sanctioned debt reduction, whereas earlier V.S. policy had vigorously rejected that alternative."92 The idea that World Bank resources might be used to support debt reduction measures was discussed with senior Bank management before being announced. In those discussions the Bank agreed to make a statement that welcomed the new ideas on debt strategy and agreed that a broader menu of options, including measures to reduce the stock of debt and service payments, was important support for countries that performed well. The Bank also indicated preliminary support, pending review of the legal feasibility and costs, for a V.S. idea to use Bank funds to help countries cover interest payments. As stated in a letter from a senior Bank official to the V.S. Treasury, "assuming there are no legal impediments, the for- mulation of us making a loan, beyond our normal country program limits, seems a very attractive way to cover interest payments .... If we can guarantee interest, we should also be able to lend for it and the loan approach would avoid a lot of balance-sheet and perceptual problems [with which] we have been concerned:>93 But this time the V.S. initiative met with strong opposition among some members of the Bank, particularly the V nited Kingdom and Germany, who argued that financing debt reduction was not an appropriate use of World Bank resources. Only after intense debate, which limited the measures that the Bank could take, did the executive board approve a program for implementing the Bank's part of the Brady initiative. In the implementation of both the Baker and the Brady plans, the V.S. Treasury and the Federal Reserve Board (whose concern was the stability of the banking system) were active participants in IMF, World Bank, and commercial bank nego- tiations with debtor countries. They also urged commercial banks to continue lending in the first half of the 1980s and to accept some debt reduction in the second half. Finally, according to former chairman of the Federal Reserve Paul 92. Anne O. Krueger, Economic Policies at Cross-Purposes (Brookings, 1993), p. 97. 93. Letter from Ernest Stem, World Bank senior vice president for finance, to Charles Dallara, assistant secretary of the Treasury for Policy Development, March 7, 1989. 236 u.s. RELATIONS WITH THE WORLD BANK Volcker, they "directed" the lcnding of the Bank. 94 Within the Bank this direction at times raised concerns ahout the viability of the arrangements being put together for individual countries and the possible effect on the Bank's own portfolio. Two Bank documents, worth quoting at length, disagree with the United States over the adequacy of financing packages and the role of the Bank in securing them. The first is a note prepared for President Barber Conable before a luncheon with Treasury Undersecretary David Mulford. I want to follow up on the eomment made to'you by David Mulford to the effect that the difference between the Bank's approach to the Brady Initiative and that of the Fund is a matter of "activism" on the part of the Operations Complex. Naturally, I resent the allegation that the Bank is behaving irresponsibly. But more importantly, this comment indicates a lack of understanding on the of the U.S. Treasury as to the real reasons why tlle two institutions have taken somewhat different approaches to a eommon concern. In the case of the Fund, the Brady Initiative is being implemented by increasing access to Fund resources, with a specific though legally indirect link to debt and debt service reduction. While this may be a somewhat artificial activity for the Fund, the resourc'es being provided are like all other IMF resources, namely additions to the country's reserves, which the country then uses to effect debt reduction. In the case of the Bank, we are making specific loans that are explicitly for the purpose of debt and debt service reduction. Since this is not an activity that normally falls under the specific investment projects clause of the Articles, we have to justifY such lending under the exceptional circumstances provisions, hence we have to satisfY ourselves about the materiality of benefits in terms of growth and increased investment. This has two important implications. First, the Bank more than the Fund has to be concerned with the adequacy of the finanCing package over the medium term. If the finanCing is not adequate, growth may not take place and the material benefits for investment will not be realized. The IMF need not be as concerned with medium term effects; if debt reduction is part of a one-year program, the only tlling that would prevent the Fund from supporting it (apart from conditionality) is the Fund's own policy objective of tying debt reduction support to the EFF-something that the Board of the Fund can deal with on a case by case has is. Seeond, if the financing package negotiated by the eountry is inadequate, the Fund can insist on a change in the program, including further adjustment on the part of the eountry. If fmancing is too tight to permit growth, that alone would not prevent the IMF from supporting the program of debt reduction. But it eould prevent the Bank from doing so, again because of the materiality criteria. In other words, it is significantly more difficult for the Bank to make loans for debt and debt service reduction than it is for the Fund to increase access for this purpose. This is not a matter of management style. It is anchored in the legal differences in the two institutions. For this reason also our approach to the review of progress under the Brady Initiative was different from that of the Fund. In dealing with financing assurances, the Fund was able to throw the problem back onto the country. In our case, we need to stress 94. Catherine Gwin, interview with Paul Volcker, May 27, 1992. U.S RELATIONS WITH THE WORLD BANK 237 up-front the importance of adequate financing. This has a tendency to come across as more interventionist than the Fund, but the alternative is either to let ourselves be 'rolled' on lending standards or bloek transactions that are already negotiated on grounds that they do not meet the materiality test. We do not have the alternative of simply lending for debt reduction operations as though they were isolated investment projects, detached from the overall medium term adjustment program and financing plan. . . . This is a matter both of the Articles and of credit risk management, not 'activism.' It is ironic that the Treasury perceives the Fund to be more supportive of the Brady Initiative than is the Bank. A close look would show that the Fund management is actually more reserved about the program and-if asked-probably grateful that they do not need to ... expend as much management energy defending their support for the Initiative on an ongoing basis?5 The second document, which expresses many of the same points of disagree- ment, is an internal Bank memorandum reporting on a meeting with the U.S. Treasury to discuss papers reviewing the Brady debt strategy. After noting that the "tone of the meeting was informal, friendly and constructive," the memorandum went on to outline points in disagreement between the United States and the Bank on the handling of both official and commercial debt. The diseussion covered a number of topics but two points seemed to be of particular mncern: first, Treasury staff are upset at the lack of prior consultation on "proposals" for official debt; sCL'Ond, they have serious reservations about a more pro-active role for the Bank and the Fund in commercial bank debt negotiations .... On commercial bank negotiations, Treasury staff criticized the papers as being unbalanced and failing to give adequate recognition to what had been achieved. They seemed most mneerned about the suggestion that the Fund and the Bank would get more directly involved in the negotiations, perhaps imposing restraints on the terms of transactions, seeking to shape the modalities of debt and debt service reduction and/or intervening to get the financing gap closed [A senior official of the department] reiterated the Treasury's view that the "strengthened debt strategy" involves a change in the gap process, and a need on the part of the official institutions to live with more uncertainty and financing risk. He argued that the previous approach produced a false sense of comfort about financing packages and that the new approach could not be launched .vithout the official institutions adopting a different approach on financing assurances. [The Bank and Fund representatives1~tressed that the key issue is how to strike the right balance between the old critical mass approach and the completely hands-off acceptance of whatever financing could be raised on a voluntary basis. In our view, the pendulum has swung too far away from a disciplined and pre agreed financing plan based on fair burden sharing of all parties. Instead, the commercial banks take the amount of Bank and Fund finanCing as a given and expect the two institutions to support whatever package they have negotiated with the countries concerned. We do not regard a hands- off approach as acceptable but acknowledge that the degree of intervention required is a matter of judgment. 96 95. World Bank internal memorandum, May 2, 1990. 96. World Bank internal memorandum, March 29,1990 (confidential). 238 U.S. RELATIONS WITH THE WORLD BANK In sum, in response to the debt crisis the United States turned-belatedly and reluctantly-to thc international financial institutions. Consistent with the tilt to- ward the Fund and Bank, the United States supported an IMF quota increase in 1983, a $12 billion replenishment for IDA in 1987, and a doubling of Bank capital in 1988. It did not support the debt strategy with other policy initiatives in such areas as aid and trade. 97 But it displayed an unprecedented assertiveness within the Bank in the implementation of the debt strategy and in regard to other policy matters that arose in the second half of the 1980s and the early 1990s. A New Assertiveness In the 1987 IDA 8 negotiations, which were completed relatively quickly, the United States agreed to a replenishment that brought IDA lending back to its 1981-83 level in nominal terms and that increased the U.S. annual payment in current dollars to $958 million while holding its share to 25 percent At the same time, the United States achieved agreement on four policy changes. Two of them- a larger proportion of the total IDA lending dedicated to policy-based lending and a larger IDA share for Sub-Saharan Africa-met with little disagreement from other donors. More controversial were U.S. demands for redUcing the maturity of IDA credits (which the Treasury claimed it sought to help win passage of the IDA bill once it went to Congress) and a limit of 30 percent of annual IDA funding that would be available to India and China combined. In the fall of 1987 in a reversal ofits previous opposition, the Reagan administra- tion agreed to a general capital increase of $74.8 billion, but it delayed making a request to Congress until after IDA 8 was approved. As part of the negotiations the United States agreed to release a portion of its Bank shares to other countries, including Japan, but only after obtaining agreement on a change in the Articles of Agreement of the Bank that protected the U.S. veto power. 98 In presenting its request for the capital increase to Congress, the administration emphasized three points: that the Bank, in having taken on a broader responsibility in the debt crisis, had increased its disbursements by more than 40 percent since 1985 and needed additional capital; that the Bank was acting as an important catalyst for economic 97. Kmeger, Economic Policies at Cross-Purposes, chap. 5. 98. The veto applies to matters requiring more than a simple majority, notably decisions regarding the Articles, not specific loans. Japan's willingness to provide more of the IDA 8 replenishment had been made contingent on substantial expansion of its Bank share, which would make its share significantly greater than that of Germany and signal that it stood second only to the United States. A major improvement in Japan's position could only occur, however, if the United States agreed to let its own share slip below 20 percent (which was the percentage that ensured its veto). During the IDA 8 negotiations the United States indicated its intention to seek a change in the Articles to enable it to retain it~ veto with only 15 percent of total share and thereby accommodate an increase for Japan without sacrificing its own position. U.S. RELATIONS WITH THE WORLD BANK 239 refonns; and that under its new president, Barber Conable, it had completed a swift and Significant reorganization intended to be responsive to matters of high administrative costs that had been raised by the United States for many years. Mter a year of wrangling \vith a coalition ofliberal congressmen, who objected to a Bank bailout of commercial banks, and conservative congressmen, who continued to condemn the Bank for shoring up socialist regimes, the administration won solid support for the capital increase. The outcome was in part a vote of confidence for Conable, a fonner member of Congress, and in greater part the result of a renewed executive branch effort to gain support for the Bank. Three years later in the IDA 9 replenishment talks, the United States again agreed to maintain lending levels in real tenns, but it insisted on a ceiling for its own contribution, which led to a further decrease in its share to 21.6 percent. It again demanded the adoption of a number of its policy positions, including con- tinued emphasis on Africa, efforts to improve IDA-IMF collaboration, and greater attention to poverty alleviation as a criterion for IDA allocations, as well as new measures to protect the environment. In contrast to the general policy demands the United States had made in previous replenishment talks, its environmental demands included specific policy and operational refonns: environmental impact assessments of proposed projects, environmcntal action plans for borrower countries, and disclosure of assessments and plans to local nongovernmental organizations and other concerned groups in advance ofloan approvals by the Bank board. 99 The demands were devised, developed, and successfully advanced in a skillful campaign by nongovernmental organizations. They worked through Congress to forcc thc administration to take up environmental protection and allied themselves with like-minded groups in other countries to build an international consensus on the greening of the World Bank. In early 1983, environmentalists in the United States had begun actively to investigate the environmental impact of Bank project lending and persuaded the House Subcommittee on International Development Institutions and Finance to hold the first oversight hearings on the MDBs and the environment. As one of the leading environmental activists commented in recount- ing the development of the green campaign against the Bank, witnesses at the hearing described "case after case of environmental and social disasters financed by the Bank, and its sister institutions: huge dams that displaced indigenous peoples, botched irrigation schemes that contributed to the spread of waterborne diseases such as malaria and schistosomiasis . . . cattle ranching schemes that destroyed tropical forests, and massive resettlement projects." Representatives of indigenous peoples' human rights organizations testified on the harm being done to tribal peoples by such projects as the Polonoroeste loan in the Amazon of Brazil. 99. The discussion of environmental policy issues from early 1983 through mid-1987 draws heavily on Bruce Rich, "Greens Lay Siege to the Crystal Palace," a chapter in a forthcoming book on the World Bank and the environmental movement. 240 U.S. RELATIONS WITH THE WORLD BANK Several months later the U.S. Treasury forwarded the rebuttals of the MDBs to the House Subcommittee on International Development Institutions and Finance -more than 1,000 pages-that the environmental groups called "evasive and misleading."loo FollOwing a review of the MDBs' responses, the subcommittee, in consultation with nongovernmental organizations, issued recommendations for reform of the World Bank's environmental protection procedures, many of which Congress passed into law (P.L. 99-190) in late 1985. The law called on the Treasury Department "to monitor environmental aspects of Bank activities, to facilitate constructive U.S. involvement in assuring that sound environmental policies are implemented by multilateral agencies supported by the U.S., and to expedite the flow of information between the Banks and the U.S. Congress, other relevant federal agencies and the public regarding environmental considerations."lol But the environmental campaign of the nongovernmental organizations did not end there. In 1984, U.S. environmental activists working together with groups in Brazil developed an extensive research dossier on the Bank's by-then controversial Polo- noroeste project, which became the basis of further congressional hearings. A letter was signed by leading individuals and groups that urged the Bank to cease disbur- sements for Polonoroeste and take steps to improve the ecolOgical design and review of its projects. Dossier and letter were then sent by a representative of Congress to the Bank. A month later the Bank sent a bricf response, indicating that Polonoroeste was a carefully planned regional development program and that the Bank would continue to monitor the situation closely and consider concerns raised as the project continued. Senator Robert Kasten of Wisconsin, to whom the environmentalists next turned, sent a letter to Bank President A. W. Clausen, describing the response as a "brush off' and an "insult, and another letter to Secretary of the Treasury Donald Regan, calling it "outrageous." In March 1985, Clausen aides told Kasten that the environmentalists would get a credible response in a meeting with Clausen and senior management of the Bank. In that meeting, held on May 22, 1985, the Bank acknowledged what had been known for two months-that it had decided to halt funding for Polonoroeste to prevent environ- mental damage. The Polonoroeste campaign became, in a real sense, the beginning of effective action by like-minded groups around the world. They used modem communications technology to inform one another of crises and to mount in a matter of hours international letter-writing and lobbying campaigns to protest other objectionable projects. In June 1986 the United States cast its first vote against a Bank loan out of conceru for the environment. By late 1986 several other countries, including Gennany, Sweden, the Netherlands, and Australia, were instructing their executive 100. Ibid., msp. 98. 101. Department ofDtfense Appropriations Act, 1986 (H.J. Res. 465). U.S. RELATIONS WITH THE WORLD BANK 241 directors to demand environmental reforms that echoed those urged by the United States. And in May 1987 Bank President Barber Conable announced a series of organizational and operational reforms. To the environmental action groups, the Conable reforms were a marked improvement over previous practices, but they did not go far enough in ensuring that the Bank would regularly take effects on the environment into account in its project and program lending. Therefore, as a result of continued pressure from nongovernmental organizations, U.S. legislation in 1989 (P.L. 101-240) further enjoined U.S. executive directors to the Bank and the other MDBs to propose procedures "for systematic environmental assessment of development projects for which the respective Bank provides financial assistance, taking into consideration the guidelines and prinCiples for Environmental Impact Assessment promulgated hythe United Nations Environment Program."I02 The act further required the multilateral banks to make environmental assessments or comprehensive summaries of the assessments available to affected groups and local nongovernmental organizations. While nongovernmental organizations working through Congress mobilized U.S. pressure for change in Bank environmental policies and practices, it was the U.S. Treasury that took the initiative and promoted examination of the other major U.S. policy issue involving the World Bank: the role of the Bank in the development of the private sector. In marked contrast to the NCO environmental campaign, the promotion of this issue by the Treasury Department involved far less effort to seek international consensus on changes to be sought in Bank policies and less analysis of the challenges and implications for the Bank The 1981 Treasury assessment of the multilateral development banks had clearly Signaled the Reagan administration's intention to move MDB lending policy away from support for state-led growth and toward direct support for development by private enterprise. This effort continued under the Bush administration. But frustrated by its ability to instigate marked change in Bank support for private sector development, the administration brought the issue to a head in the 1990-91 negotiations for an International Finance Corporation capital increase. Initially, the United States, along with Japan, opposed an IFC capital increase. But when the Japanese government dropped its opposition, the United States, as a condition for its support of the increase, sought to extract concessions on policies it had been promoting for several years. In particular, it sought to tie reforms in the Bank to the IFC negotiations. What it proposed were internal reforms intended to strengthen the Bank's capacity to aid private sector development, a study to explore changes in the Articles of Agreement to remove the prohibition against direct lending to private enterprises (a provision the United States had demanded when the Articles were written), and agreement on a target of 50 percent of total Bank lending in support of the private sector by 1995. 102. International Development and Finance Act of 1989 (H.R. 2494). 242 U.S. RELATIONS WITH THE WORLD BANK Although other donor countries agreed with the United States that help in developing a country's private sector had become a central challenge for the Bank in light of marked change in development strategies throughout the developing world and the collapse of communism throughout the crumbling Soviet empire, they resented the manner and rejected the content of the U.S. demands. They opposed the demand for a change in the charter and the related lending target. As a fallback position, the United States pressed to get a commitment for a study of Charter reform and for organizational changes within the Bank, but it continued to withhold support for the IFC capital increase while these points were being debated. In the meantime, in late May 1991 the Foreign Operations Subcommittee of the House Appropriations Committee recommended in a funding bill the $40.3 million U.S. share of the negotiated capital increase, in spite of the fact that the Treasury had not asked for the IFC funds. The subcommittee also chastised the Treasury Department for failure to consult with Congress on its agenda for change in the Bank. The subcommittee report registered regret that the IFC negotiations were being used as a lever to change the Bank and disagreed with the administration's proposals for change. In addition, the subcommittee made its approval of $100 mil- lion for the Enterprise for the Americas Initiative (a high priority of the Bush administration) conditional on U.S. support for the IFC. Several weeks later, at a board meeting scheduled to address the IFC capital increase, the U.S. executive director announced that the United States was pre- pared to support the increase and called for discussion of papers prepared by the U.S. Treasury on changes proposed in the IFC and the Bank. The board expressed strong opposition to many of the points. The U.S. executive director, on instruc- tions from Treasury official David Mulford, said that under the circumstances the United States would withdraw its support. The meeting was then adjourned on a technicality, the issue was left unresolved, and a week later the United States reversed its position again and agreed to the IFC capital increase, leaving a bitter taste in the mouths of all involved. Overall, the U.S. lack of analytic rigor and highhanded manner hindered its effectiveness in advancing what was, in fact, a timely and important issue for the Bank. Many serious questions about how the World Bank responds to the fundamental changes in the development strategies being pursued by both its long-standing and its new borrowers were glossed over by the U.S. demarche and remain to be answered. Ironically, the Reagan and Bush administrations, which had wanted to cut back on U.S. participation in the World Bank and other international financial institu- tions, wound up relying heavily on those institutions to handle problems that the United States could not (for budgetary and other reasons) manage bilaterally. They also pressured the Bank to expand its role in debt relief, macroeconomic policy reforms, environmental protection, private sector development, and the transfor- mation of eastern Europe and the former Soviet Union. Similar U.S. pressure has U.S. RELATIONS WITH THE WORLD BANK 243 had great influence on the evolution of Bank activities during its fifty-year histo1)'. However, the United States can now no longer exercise the kind of unilateral influence over Bank policies and practices that it once did. There has been a waning of U.S. power in the Bank, due only in part to its steadily declining share of both Bank and IDA funding, and a corresponding change in the way it has sought to exercise its influence in recent years. Influence on the Bank Over the years there have been two conflicting opinions of U.S. influence on the Bank. One, held by many members of Congress, argues that the United States has too little influence on what the Bank does. The Bank, it continues, is run by highly paid, aloof bureaucrats, unresponsive to U.S. concerns and accountable only to themselves. The opposite opinion, held by considerable numhers of the Bank staff, nongovernmental groups in borrower countries, and other member countries, maintains that the Bank is run by and under the thumb of the United States. Analysis of the record supports neither position. U.S. influence on the Bank has been important but not absolute. From the outset the United States eonsidered the Bank an instrument of U.S. foreign policy and used its influence to t1)' to ensure that Bank practices promoted development in ways that complemented U.S. long-term goals and short-term political and economic interests. Although the United States is not the only donor country to use its influence to pursue national interests, the wide scope, frequency, and intensity of its pressure distinguishes it from other donor countries. Its position on specific issues has not always preVailed, but where it has defined an issue as a matter of priority, it has usually had its way. Still, various factors limit the exercise of U.S. influence: the importance to financial markets of nonpoliticized lending decisions; the centrality of burden sharing as a U.S. policy goal; the foreign polic), advantage for a donor country to be insulated from tough loan deciSions, a protection lost if it is seen as dominating decisions; the clear understanding of all World Bank presidents that the role of the institution depends on its being independent and being seen as independent; and more prevalent opposing views of other donor countries. The Sources and Strength ojU,S, Influence The basis of U.S. influence derives, on the most fundamental level, from the origins of the Bank and the fact that its Charter and guiding principles have a distinctly American cast. Over the years the United States has used its influence to ensure that those principles are not disregarded. Other sources of U.S. influence include its position as the largest shareholder in the Bank, the importance of its financial market as a source of capital for the Bank 244 U.S. RELATIONS WITH THE WORLD BANK Table 6-3. U.S. Contributions and Voting Shares, World Bank and International Development Association, Selected Years, 1946-90· Millions of U.S. dollars unless otherwise specified Contributions and shares 1946 1950 1960 1970 1980 1990 World Bank Subscription 3,175.0 3,175.0 6,350.0 6,350.0 9,347.9 19,606.0 Paid in 158.8 635.0 635.0 635.0 934.8 1,627.6 Percent of total 41.4 38.0 32.9 27.4 23.4 15.7 Voting share (percent) 34.1 30.3 24.5 21.1 15.1 WAh Contribution C 320.3d 1,112.3e 6,405.6 f 14,764.9g Percent of total 35.4 31.6 32.9 27.0 Voting share (percent) 31.3 25.3 21.5 17.2 Source: World Bank annual reports. a. For World Bank, expressed in U.S. dollars as ofJuly 1, 1994; for IDA, expressed in U.S. dollars as ofJanuary 1, 1960. b. IDA was established in 1960. c. Cumulative subSCriptions and supplementary resources. d. Figures are as of June 30, 1961, the date of publication of its first annual report. e. Expressed in U.S. dollars as of January 1, 1960. Cumulative contribution through IDA 2. f. Cumulative contribution through IDA 5. g. Cumulative contribution through IDA 8. (and in the early days the only source), its hold on the position of Bank president and other senior management positions, and the close attention the United States has paid to Bank activities, reinforced by the Bank's location in Washington, D.C. Although its relative importance in many of these dimensions has declined, the United States remains the dominant member of the Bank, in large part because no other country or group of countries has chosen to challenge it. THE U.S. POSITION AS LEAD SHAREHOLDER. The United States has al- ways had dominant influence on the Executive Board and management of the Bank by virtue of being the largest shareholder and largest contributor to IDA. This is a position it maintains, although the relative size of its Bank shareholding, its share of IDA replenishments, and its corresponding share of votes have decreased (table 6-3). As a result, Bank management may listen to the views of other donor countries more than it once did, but as in any corporation, it cannot afford to run afoul of its largest shareholder. The United States is also the dominant member on the Bank's board-but only in part because it is lead shareholder. Formally, most Bank decisions, including those affecting lending levels and loan allocations, require a simple majority vote of the board. This means that the United States, as a major but not majority share- holder, can be outvoted and must marshal support for its views to be decisive. Decisions are, however, often worked out between the United States and Bank management before they ever get to the board, or among members of the board U.S. RELATIONS WITH THE WORLD BANK 245 before they get to a vote. And most board decisions are taken by consensus. It is the weight of its voice, therefore, more than the exercise of its vote that gives the United States effective power on the board. And the weight of its voice has been determined by its influence over other major donor countries, especially Germany and Japan. THE IMPORTANCE OF THE U.S. CAPITAL MARKET. As table 6-1 shows, U.S. capital no longer plays so dominant a role in total borrowing as it did in the Bank's early years. With the globalization of capital markets and the diversification of the Bank's portfolio, the importance of the U.S. market and U.S. dollar have fluctuated relative to those of other countries. Nonetheless, the United States still accounted for 20 percent of Bank medium- and long-term borrowing by country (before swaps) between 1980 and 1990. The requirement that the Bank obtain the permission of any country to borrow in its currency has meant that the United States could influence its policies and practices by threatening to deny it access to the U.S. market. That possibility was one of the reasons why Robert McNamara moved quickly after becoming Bank president to diversifY the Bank's portfolio and dilute its dollar dependence. The United States has, however, not often denied the Bank access to its market. 103 Even less frequently has it used this authority to put pressure on the Bank. In one instance in the mid-1970s, thc United States postponed granting permission to borrow as a means of signaling its displeasure over the Bank's rate of gro\Nth. And in 1984 a Treasury official told the Bank's vice president, Ernest Stem, that since it had consistently ignored U.S. concerns about lending to the energy sector, the United States was "reviewing whether the Bank should continue to have access to the U.S. capital markets."104 In the end, accommodation on energy sector lending was reached and the seriousness of the threat never tested. For the most part, the imperatives of U.S. monetary policy, not concerns about Bank activities, have been behind the occasional denials or postponements. In the early 19805, for example, the Reagan administration denied permission to borrow because it said that it wanted to avoid pressure on interest rates. Apparently, it also meant this action to send other members of the Group of Seven advanced in- dustrialized nations a message. The other G-7 countries were concerned that the United States was not managing its fiscal and monetary affairs effectively. The United States told the Bank to raise the funds it sought elsewhere and maintained that this would show the other G-7 countries just how committed it was to prndent economic policy. At the same time, however, the Reagan administration took the lead in getting member countries to agree to liberalize consent procedures for Bank borrOwing. The authority to grant or deny access to its market has been, in other words, more an implied than an applied source of power. 103. Catherine G>w'in, interview with Eugene Rotberg, Washington, D.C., August 14, 1991. 104. Bank memorandum, April 6, 1984. 246 u.s. RELATIONS WITH THE WORLD BANK Far more significant a source of influence is that were the United States to express serious disinterest in the Bank or serious concern over its financial state of affairs, the effect on the financial markets would likely be immediate. 105 It is this perhaps more than anything else that makes the Bank take particular note of U.S. views. This influence has gradually been tempered by the Bank's leverage over the United States as a result of the large stake that U.S. bondholders have come to have in it and the size of the claim on U.S. callable capital that could be made should Bank lending run into serious trouble. These mitigate interference on political grounds in either the Bank's borrOwing or lending operations. THE U.S. HOLD ON THE BANK PRESIDENCY AND STAFF. By tradition rather than formal rule, the United States has the prerogative to name the president of the World Bank. It has always nominated a U.S. citizen. This prerogative was initially granted not only because the United States was the Bank's largest shareholder but also because it was the key guarantor and principal capital market for Bank bonds. The market's view was important, for example, in the appointment of John McCloy instead of Graham Towers of Canada. But as U.S. support for the Bank has waned and the relative importance of the U.S. market has declined, this privilege has been called into question. Had the United States not nominated McNamara to a second term, it is likely that other countries would have usurped the privilege. And when it came time to select his successors, concern that conservative influences in the Reagan and Bush administrations would put forward candidates unacceptable to the international community led to talk of finding non-American alternatives. For example, having decided to resign, Barber Conable worried that Treasury Secre- tary Nicholas Brady had no serious interest in the appointment of his successor and therefore appealed directly to President Bush. Noting that there was a lot of dissatisfaction with U.S. leadership in the Bank, Conable warned the president that unless he nominated a person of stature, the Europeans and Japanese would take the privilege away from the United States. 106 In each instance, however, an accept- able U.S. candidate was identified and the American prerogative sustained. The history of the World Bank shows that the choice has been critical to the life of the institution, although the impact of the person selected has not always been foreseeable. The United States has a record of nominating people who have Wall Street or Washington, not development, experience but who end up fervently championing both the institution and the need to tackle global poverty. This was as true of George Woods as of Robert McNamara, whose appOintment reflected more a way for McNamara to escape the stigma of U.S. Vietnam War policy than a commitment on President johnson's part to strong Bank leadership. Not surpris- ingly, there was much international consternation over the appOintment. Each 105. Catherine Gwin, interview with Eugene Rotberg. 106. John Lewis and Richard Webb, interview with Barber Conable, Washington, D.C., MayS, 1991. U.S. RELATIONS WITH THE WORLD BANK 247 Bank president has also asserted independence from the United States. Even Conable. who of all the recent presidents was criticized for being too much under the thumb of the U.S. government, sought in the later years ofrus term to assert the Bank's independence. In 1990, for example, he pushed the executive board to support renewed lending to China despite congressional and administration op- position. Nonetheless, the privilege of selecting the Bank's preSident has ensured, at a minimum, a general policy orientation compatible with that of the United States. The high proportion of Americans on the Bank staff has also been said to provide the United States with reinforcing influence. This claim has become moot as the proportion of U.S. nationals on the professional staff has contracted from 60 percent in 1951 to 26 percent in 1991,107 Nonetheless, the United States has regularly urged that U.S. citizens be put in key management positions. For a time, it insisted on having U.S. directors in charge of the Latin American, Central American, and Caribbean regions (though this has not been true since the mid-1970s). And in many years Americans have held one or more vice presidential positions. Perhaps more significant, many staff members have been trained in the United States. But the U.S. economics profession is not itself of one mind, so the nature of the selection from within the profession is what seems to reinforce and sustain an institutional mind-set. Many on the outside view this inbreeding as extending not only to those brought onto the staff but also to the circle of consultants used to referee or participate in research efforts. u.s. ATTENTION TO THE BANK. The United States has paiddoser attention to the Bank than has any other major shareholder and has frequently flexed its muscle. As a result, even with its relative loss of power in the Bank, the United States still dominates largely by default. Neither Japan nor the western European nations as a group have yet shmvn sufficient interest to challenge U.S. leadership. The United States is tlle only country that carries out detailed reviews of every Bank loan proposal and the only one to maintain constant contact with the Bank through government officials in addition to its representative to the board. Often, the United States will question a prospective loan early in the preparation process. And during final deliberation of a loan proposal by the Bank's executive board, it will make comments deSigned to draw attention to general matters of concern in order to influence future lending. Bank policy papers, evaluation reports, and special studies are also closely monitored. Executive branch officials have often emphasized that these procedures provide the United States with a substantial measure of influence and have repeatedly offered examples to illustrate the extent 107. For the 1951 figure see Mason and Asher, World Bank since Bretton Woods, table 4-3; for the 1991 figure see World Bank, Hummi Resources Data, Annual Review, FY 1993 (Washington, 1993), p. B-1. 248 U,S, RELATIONS WITH THE WORLD BANK to which the Bank has been willing to make changes in loan and policy proposals on U,S. recommendations. lOB Formal responsibility for conveying U.S. views and carrying out U.S. policy in the Bank rests with the U.S. executive director, who with other directors has the authority (under Article V; sections 1 and 2) over all Bank decisions. Far more important than the executive director, however, is the direct and constant interac- tion between the Bank and the U.S. Treasury. This interaction occurs daily at the staff level in regard to the detailed reviews of loan proposals and other routine matters. It occurs frequently at higher levels at the initiative of both the Bank and the U.S. government, especially, but not only, in regard to countries of importance to the United States. The intenSity of Bank-Treasury interaction is a unique feature of U.S. relations with the Bank, obviously facilitated by the Bank's location in Washington. As Bank files indicate, the U.S. government has privileged access to it that differs sig- nificantly from that of other member countries. The United States is sometimes consulted on a matter before other members are. It has regularly received early drafts of papers and studies, (they are now also cireulated to other members in draft). And the top management of the Bank spends much more time meeting with, eonsulting, and responding to the United States than it does any other member country. Although this intense interaetion has ehanged little over the years, the way the United States mobilizes other member countries in support of its views has changed conSiderably. Initially, it was so predominant that its pOSitions and the decisions of the board were virtually indistinguishable. For the most part, other member countries simply followed its lead, not only because of the strength of its support of the Bank but also because of the quality of its leadership.109 But as the strength and quality declined, the United States could not count on automatic support. It began, therefore, to go outside the board with increasing frequency. Since the late 1970s it has made demarches to C-7 counterparts in national capitals as well as to exeeutives on the Bank board. Building a working relationship "vith C-7 counterparts in capitals was a deliberate strategy of the Carter administration and was largely aimed at counteracting the mounting opposition to the Bank in lOS. See Sanford, u.s. Foreign Policy. See also statement by C. Fred Bergsten, Hearings before the Subcornrnittee on International Developrnent Institutions and Finance of the Cornrnittee on Banking, Finance and Urban Affairs, 96th Congo 1st sess. (GPO, April 24, 1979); and statement, Hearings before the Subcornrnittee on Foreign Operations of the Cornrnittee on Appropriations, 96th 1st sess. (GPO, March 27, 1979). 109. This included for a time the U.S. executive director, but as interest in the Bank waned so too did the quality of the appointees. After the first few appointments, the executive director has been selected by the Treasury and has been on its staff. The most notable decline in quality and stature came not surpriSingly in the first half of the 19S05 when the Treasury itself was openly critical of the Bank. U.S. RELATIONS WITH THE WORLD BANK 249 Congress. Although this strategy broke down during the Reagan retrenchment, the Treasury returned to it in the second half of the 1980s in an effort to mobilize support for policy initiatives on debt in less developed countries, on China, and on the environment. The Treasury has exerted decisive pressure by threatening to withhold its sup- port from replenishment and capital increase negotiations. Although in earlier years the aim was to pressure others to a larger share of IDA funding, the tactic came to be used for other purposes. In the late 1970s, in response to repeated congressional delays in the passage of IDA funding bills, the United States and the other donor countries developed procedures or triggers that defined the level of commitment required for replenishment to go into effect. These triggers were set at a level of 85 percent of IDA voting stock so as to require U.S. participation. While the intention of the triggers was to hold U.S. feet to the fire, they gave the United States a de facto veto over IDA refunding because a threat to withhold its contribution could put not just the U.S. share but an entire replenishment negotia- tion in jeopardy. And this is a power the United States has come to use to assert its views on major issues of policy. That is, it has made major decisions on policy issues conditions of its participation in IDA replenishments and Bank and IFC capital increases. In this way it has furthered positions for which it may not have had majority support on the executive board. The Exercise of U. S. Influence Over the years the United States has used multiple sources of influence per- vaSively, episodically, and often inconSistently in pursuit of both long-term foreign policy goals and short-term political and economic interests. In so doing it has been driven by contradictory but Simultaneously held attitudes toward the Bank. On the one hand it has looked to the Bank to promote development and an open world economy. On the other hand it has considered the Bank but one of its many instruments of foreign policy-a source of funds to be offered or denied to reward friends, punish enemies, or advance any number of other objectives defined by domestic constituency groups or immediate foreign policy aims. To a considerable extent the United States has used its influence in ways that have strengthened and supported the dominant mission of the Bank. One of the major longer-term U.S. aims has been to increase the resources available for reconstruction and development while containing the burden on its own budget of providing that finanCing. In this effort it has been more than moderately successful. As its annual reports show, total Bank lending increased from $250 million in 1947 to $21 billion in 1992 (including IDA but not IFC loans), but the U.S. share of the amount shrank Significantly. Thus a dollar of U.S. budgetary outlays leverages conSiderably more development resources now than it did at the start-up of the Bank. A second U.S. objective has been to develop the Bank's capacity to promote 250 U.S. RELATIONS WITH THE WORLD BAI\K development-in ways consistent with U.S. political and economic interests. The United States has brought considerable influence to bear on matters of broad policy, specific country and sector lending decisions, and Bank administration and management. . DEVELOPMENT POLICY. The United States generally endorsed expanding both the geographiC and substantive scope of the Bank's lending program. This support has not precluded it from using its influence at times to block or water down proposals to change Bank policies and practices. For example, during the drafting of the Bank's Charter, the United States argued against allowing direct lending to private enterprises. It resisted proposals for substantial increases in program lending in the 1950s and 19608 and fought proposals to increase local currency costs of projects. In the late 1970s it opposed the idea of structural adjustment lending proposed by the Bank's management. Among the reasons given were that the initiative contravened the Articles of Agreement of the Bank and that limited program lending had already been tried and had failed. It took Bank management three years to sell structural adjustment lending to the United States and other skeptical member countries. Not until confronted with the debt crisis and the need to find a way to avoid a collapse of the international financial system did the United States revise its position. For the most part, however, on the broad issues of development policy and strategies, U.S. and World Bank views have evolved together, at least until disputes in the 1980s over specific polk, issues, notably the increased support of private enterprise. Major changes in Bank development poliCY, espeCially changes in the sector allocation of Bank lending, were actively if at times belatedly supported by the United States. In the 1950s and early 1960s the United States initiated and encouraged major changes in development assistance policy, especially the in- creased focus on agricultural production. The Bank followed the U.S. lead and worked in concert with the U.S. bilateral aid program in the field. This interaction was particularly intense when the United States was providing large amounts of aid to India and Latin America at the time of the Allianee for Progress. In the 1970s the MeNamara Bank and the United States shifted simultaneously toward more pover- ty-oriented development poliCies. Thus the United States supported the Bank's reorientation from infrastructure projects to agrieulture and rural development and later to education, health care, and population control projects. These changes were advocated by members of the development profession in the United States, viewed as shared goals of member countries, and considered generally nonconten- tiousYo But in the 1980s this close coincide nee of views broke apart. llO. Former Treasury official C. Fred Bergsten in testimony before a subcommittee of the House in April 1979 made this point, although, for domestic political reasons, hc overstated the strength of U.S. influence. According to Bergsten, starting in 1972 the World Bank began to alter the nature of its lending to reach the poorest populations in bormwing countries more directly. "The U.S. Government strongly influenced this change in direction, U.S. RELATIONS WITH THE WORLD BANK 251 The United States, the Bank, and most member countries came to broad agreement on the importance of crucial economic policy reforms to be advanced through Bank lending for structural adjustmcnt. Indeed, this approach was labeled "the Washington consensus" in recognition of the convergence of views on reforms advocated by Washington-based institutions, the Bank, and the IMF. But beyond agreement on a core of reforms needed to bring about macroeconomic equi- librium, the consensus did not hold. And the United States, whose positions on some issues conveyed a strong ideological orientation favoring the private sector, was often sharply at odds with both Bank management and other member countries. For instance, the United States expressed concern that the Bank was not serving, as it should have, as a lender oflast resort. In opposition to the Bank's view that adjustment often required substantial financing, the U.S. pushed for reduc- tions in lending levels while urging the Bank to increase pressure on countries to reform. Disputes between the United States and the Bank on this matter emerged in regard to lending to countries such as India that the United States believed ought to be relying more on private finance, lending for oil and gas exploration, and more generally in discussions about replenishments and capital increases for IDA and the Bank. Also, although the United States and thc Bank agreed on the need to promote market-based reforms, they differed on. the importance to be attached to private ownership and, more generally, the role of the state in the economy. This difference was particularly marked in the U.S. response to Bank lending in the energy sector. Although neither the Bank management nor other member countries agreed, the United States sought to prohibit loans to national oil companies. The handling of the debt crisis was another major policy matter on which U.S. and Bank views diverged. Through most of the 1980s the Bank followed the U.S. lead on handling the crisis and did not venture proposals for new actions. Before the announcement of the Brady proposal, the Bank was widely criticized for not taking more initiative and for being reluctant to cross the U.S. Treasury. In early 1988, for example, commercial bank lenders to Brazil tried to get the Bank to insure a portion of a new loan package under negotiation, but the Treasury opposed the idea on the grounds that it was unnecessary and might foster the impression that such guarantees should be common.l1I Later in the spring, Con able sent to the board a Bank debt study suggesting the need for an expanded Bank role in facilitating new money packages and other fonns of fmancial relief, including debt-reduction schemes. The report also noted that consensual debt relief, includ- ing outright forgiveness, might be the only workable solution for some debtors. In and the Congress played a major part in so dOing. The United States was able to attract wide support within the Bank and among member countries for the reaching-the-poor thrust, and the progress made is unarguable." Statement, Hearings before the Subcommittee on Foreign Operations of the Committee on ApproprUitwns, 96th Congo 1st sess. (GPO, April 3, 1979). 111. Walter S. Mossberg, "World Bank's Conable Runs into Criticism on Poor Nations' Debt," Wall Street Journal, June 21,1988, pp. 1,25. 252 U.S. RELATIONS WITH THE WORLD BANK its annual world debt report released early the follOwing year, the Bank noted again that the debtor countries' position had stubbornly failed to improve and that "imagination and resolve" were needed. But absent from this public document were any recommen- dations of its own. Only after the Brady proposals were made did the Bank publicly endorse debt reduction and an expanded Bank function. In implementing the Brady initiative, however, the Bank was at times at odds with the United States, especially on the size of the financial packages that needed to be put together for some countries. The most visible dispute, however, was over the U.S. effort to tie the 1991 IFC capital increase to major refonns in the Bank's private sector development ac- tivities. In a sense this marked the culmination of a decade-long effort to force the Bank to take direct actions to promote development of the private sector in borrOwing countries. Although other member countries-both developed and developing-generally concurred that the Bank needed to support private sector development more strongly, they did not accept the ideolOgical tenor of the U.S. pressure nor many of the specific refonn notions the U.S. sought to impose. In 1992 the Japanese government requested that the Bank review the Asian develop- ment experience, which represented an alternative market-based development approach distinct from the U.S. model and prescriptions. COUNTRY AND SECTOR ALLOCATIONS. The country and sector allocations of Bank lending have also experienced U.S. influence, though less heavily than is often assumed. Bank lending and U.S. policy interests have usually converged, and the United States has not often interfered directly in specific loan decisions. Along with other donor countries, it has accepted Bank lending to countries with which it was not on good tenns. And, more often than not, it has accepted the sectoral composition of Bank lending in individual countries. But the United States has repeatedly used its influence, directly and controverSially, to affect decisions relat- ing to both particular countries and certain commodity areas. The record is mixed on the actual impact of this pressure. In many cases the Bank resisted the inter- ference. In the early 1970s, for example, it made loans to India and Egypt despite U.S. objections; in the midst of the Vietnam War, it resisted U.S. pressure to lend to South Vietnam; and despite congressional opposition, the Bank has made loans to various developing countries to expand production of palm oil and other com- modities competitive with U.S. products. Yet a heavy U.S. hand has been laid on some loan decisions, and although instances of strong U.S. interference do not account for the direction of most Bank lending, they have been a source of tension between tbe United States and both the Bank management and Bank board. In the main, the United States has been willing to have money put where it is most needed or could be used most effectively. And it has been willing to vote against a loan to a friendly country on economic or technical grounds, sometimes to the dismay of the State Department. Nonetheless, like some other donor countries, the United States has regularly encouraged the Bank to lend to favored countries. As a fonner Bank official said in 1970, "the French are always pressing us to slant U.S. RELATIONS WITH THE WORLD BANK 253 IDA funds toward French Africa. Similarly, the Japanese, whose interest is in Southeast Asia, are persuading us to put more assistance into that area. And the United States, I need scarcely add, is always telling us that more funds should be channeled into Latin America."ll2 More than other donor countries, the United States has also tried to block loans to "problem" countries. In those instances in which lending has been reduced or denied, the Bank has always had reasoned economic arguments for its decision. Strictly speaking, therefore, it has often concurred with rather than conceded to U.S. pres- sures. But throughout the Bank's history there have been particular cases of strong pressure from high-level U.S. officials either to lend or not to lend to specific countries. This pressure has been in evidence since the Bank's earliest days. In 1947, for example, John McCloy, with the encouragement of the U.S. Department of State, decided that the Bank's first loan would go to France. The Communist party had won a minor position in the coalition government, and the U.S. government feared that it might increase its mandate in the next election. The loan carried tough terms, which the French government protested but accepted. The Bank would lend only half of the $500 million the French requested, and it would closely supervise the French economy to ensure that the government took steps to balance its budget, increase taxes, and cut consumption of certain luxury imports. In addition, the State Department "informed the French that they would have to 'correct the present situation' by removing any communist representatives in the Cabinet. The Communist party was pushed out of the coalition government in early May 1947, and within hours, as if to underscore the linkage, McCloy an- nounced that the loan would go through."1l3 Also in the spring of 1947 the Bank entered into negotiations with Poland for a $128.5 million loan for coal-mining eqUipment-much scaled down from Poland's request for $600 million. The New York Times reported that although the Polish loan was considered a sound investment, the United States objected, fearing "the political effect of such a credit to Poland's Communist-led govemment."1l4 None- theless, the Bank sent a team to Poland in mid-1947 to evaluate the project. The resulting favorable staff report was followed in the fall by a visit to Poland by Bank President McCloy and the subsequent start of formal negotiations of a loan for some $50 million. But the Department of State made clear that it would oppose even a small loan, and McCloy "privately made it known" to interested Bank members "that he now thought his Wall Street investors would not approve." 112. J. Burke Knapp, "Detennination of Priorities and the Allocation of Resources," in John P. Lewis and Ishan Kapur, cds., The World Bank Group, Multilateral Aid and the 19708 (Lexington, Mass.: Lexington Books, 1973), p. 50. 113. Bird, The Chairman, p. 291. 114. ''World Bank Loan to Poland Stymied," New York Times, November 5, 1947, p. 43. See also Robert W. Oliver, International Economic Co-operation and the World Bank (Macmillan, 1975), pp. 241,244-45. 254 U.S. RELATIONS WITH THE WORLD BANK Instead, in their negotiations with the Poles, McCloy and Garner now began to raise conditions that they knew to be unacceptable. They demanded that Poland first stabilize its currency according to gUidelines issued by the International Monetary Fund. Instead of $45 million, the Bank's loan committee suggested $25 million, and even that was to be contingent on the Poles' agreeing to sell their coal to Western Europe and use the hard-currency proceeds to make payments on the Bank's loan. Poland's executive direc- tor at the Bank and its ambassador in Washington-both anticommunists-tried to persuade their government to accept these unusually tough terms. But, since they had originally sought $600 million, the $25 million the Bank offered now was hardly incentive enough for the Polish Communists to agree to such concessions also. Simultaneously, a firm consensus developed within the Truman administration rejecting the notion that Western aid might help preserve the coalition government in Warsaw.... So, finally, in mid-1948, Eugene Black told McCloy that he had been formally instructed by the Truman administration to vote against any loan for Poland. McCloy then suspended all further negotiations with the Poles. 115 The rejection of a loan to Czechoslovakia at roughly this same time underscored the V.S. position against World Bank lending to Eastern Europe. In both the Czech and Polish cases the World Bank justified its refusal on the grounds that political uncertainty undermined each country's status as a good credit risk As stated in the Bank's 1948 Annual Report, the Bank is not unmindful of the importance of the economic development of its member countries in Europe which are not participants in the ERP. It is unfortunate but nonetheless true that the existing political difficulties and uncer- tainties in Europe present special problems which have thus far prevented the Bank from making loans in those countries. The Bank is fully cognizant of the injunction in its Articles of Agreement that its decisions shall be based only on economic considerations. Political tensions and uncertainties in or among its member countries, however, have a direct effect on economic and financial conditions in those countries and upon their credit position.ll 6 The political situation did not change in ways that opened prospects for Bank lending, and Poland and Czechoslovakia withdrew from Bank membership in the 1950s. There are additional examples in each decade of decisions not to lend follOwing strong V.S. pressure. For the most part the cold war provided the reason through the end of the 1980s. The effort in the 1950s to negotiate financing for the construction of the Aswan Dam in Egypt prOvides an illustration. 1l7 In July 1956 the withdrawals of American and then British offers to join the Bank in financing U5. Bird, The Chairman, pp. 295-96. 116. International Bank for Reconstruction and Development, Second Annual Report, (Washington, 1947), p. 17, quoted in Brown, United States and Politicization, pp. 128-29. 117. This summary account draws on Mason and Asher, World Bank since Bretton Woods, pp. 627-42. U.S. RELATIONS WITH THE WORLD BANK 255 the dam were followed within a week by President GamaI Abdel Nasser's decision to nationalize the properties of the foreign-owned Suez Canal Company. In re- sponse, France, Britain, and Israel initiated military action against Egypt. The Bank's relation to the Aswan Dam project had been a long and complicated one. Suffice it to say here that despite the staffs support for the project, which would have carried with it stiff conditions agreed to after difficult negotiations with Egypt, the United States and Britain were deterred from joint financing largely by Nasser's expression of Arab nationalism and support for discontented elements in several Arab countries. As Bank negotiations were nearing closure, support in the U.S. Department of State for a resolution of the affair began to diminish, in part in response to growing congressional opposition. "In March 1956, when the foreign aid bill for the fiscal year 1957 was presented to a House Subcommittee on Appropriations, no congressman defended the Aswan Dam financing against at- tack."1l8 In mid-May, Nasser gave diplomatic recognition to Communist China, which further diSSipated State Department support. Although Bank president Eugene Black and the Egyptian ambassador in Washington continued to promote the project, Secretary of State John Foster Dulles indicated on July 19, 1956, that the United States had decided not to participate. The follOwing day the British fmancing offer was 'h'ithdrawn. Ultimately, the Bank's offer lapsed, since it no longer had any financial partners. During the 1960s and into the 1970s the United States sought to block Bank lending in a number of cases involving disputes over the expropriation of U.S. private property, especially in Latin America. Under pressure from the United States, the Bank had developed a formal policy, explained in a 1969 publication: The Bank is charged, under its articles of agreement, tD encourage international investment. It has, therefore, a direct interest in the creation and maintenance of satisfactory relations between member countries and their external creditors. Accordingly, the nonna! practice is to inform governments who are involved in such disputes that the Bank or IDA ~ill not assist them unless and until they make appropriate efforts tD reach a fair and equitable settlement. 1l9 Thus a settlement need not have been reached as long as "appropriate efforts" to this end were made by a prospective borrower. This left room for interpretation of the facts and disagreement with the United States, which generally urged a strict ruling but did not always get its way. Strong U.S. pressure was followed by reduced Bank lending to Peru after its nationalization of the International Petroleum Company in 1969. In contrast, the Bank made a loan to Guyana in 1971 despite U.S. opposition. Although the U.S. government did not consider that Guyana was doing enough to resolve an expropriation dispute, Bank management and a ma- jority of the Bank board did. 118. Ibid., p. 638. 119. International Bank for Reconstruction and Development, Policies and Operations (Washington, 1969), cited in Brown, United States and Politicization, pp. 162-63. 256 U.S. RELATIONS WITH THE WORLD BANK The Bank suspended lending to Chile from 1970 to 1973 follOwing the election of Salvador Allende and his nationalization of the Chilean copper mines. Although the suspension is often cited (even by the U.S. government) as an instance in which U.S. pressure was decisive, the actual record is complex. Indeed, the details provide a particularly interesting picture of the interface between U.S. pressure and World Bank decisionmaking. The United States pressured the Bank not to lend to the Allende government after nationalization of Chile's copper mines. Despite the pressure, the Bank sent a mission to Santiago (having determined that Chile was in compliance with Bank rules requiring that for lending to resume after a nationalization, procedures for compensation had to be under way). Robert McNamara subsequently met with Allende to indicate that the Bank was prepared to make new loans contingent upon "" government commitments to reform the economy. But the Bank and the Allende regime could not come to terms on the conditions for a loan. Throughout the period of the Allende regime, Chile received no new loans.!20 Shortly after Allende's assassination in 1973 during a coup that brought General Pinochet's military junta to power, the Bank resumed lending, providing a fifteen- year credit for copper mine development. A retrospective internal Bank memoran- dum concluded that the Bank had made errors of both professional and tactical judgment in this sequence of decisions. It had failed to support the underlying social objectives of the Allende regime and therefore did not position itself to make the legitimate point that the economic costs of the government's program were unnecessarily high and could be reduced by proper economic management. Con- versely, in lending to the junta the Bank ignored the retreat from long-term social objectives and the high social costs of the economic reforms. Moreover, the memo- randum argued, the Bank made the mistake of not bringing the decision to suspend lending to Allende's government to the executive board so that it would be seen as a board action. Nowhere did the memorandum refer to pressure from the United States.!2! In an interview in 1991 McNamara said that U.S. pressure was not the cause of the Bank's decision to refuse to lend. Rather, he explained, the Bank simply could not justify lending under the economic conditions that prevailed,!22 Still, the sequence of decisions on Chile was clearly consistent with U.S. policy objectives. The suspension of lending in 1970-73 was cited in the 1982 U.S. Treasury report as a significant example of the successful exercise of U.S. influence 120. In its statement before the 1972 World Bank's annual meeting, the Chilean govern- ment protested that its rationalization policy was the reason for the country's having received no new loans during the twenty-two months of the Allende administration, despite having submitted elaborate project proposals. International Bank for Reconstruction and Develop- ment, Summary Proceedings of the 1972 Annual Meetings of the Boards of Governors (Washington, 1972), p. 55. 121. Confidential memorandum from Mahbub ul Haq to Robert McNamara, April 1976. 122. Jonathan Sanford, "The MDBs and the Suspension of Lending to Allende's Chile," CongreSSional Research Service, December 13,1974, supports McNamara's claim. U.S. RELATIONS WITH THE WORLD BANK 257 on the Bank. And although the Bank reached an agreement in principle on new lending in June 1973, the loan proposals were not formally considered by the board until after the September coup that brought General Pinochet to power. As a Bank white paper explained, preliminary reactions to the proposals by several executive directors "raised a serious question as to whether the proposals would command a favorable vote at that time. Hence, after consultation with the Government of Chile, the management postponed indefmitely the plaCing of this item on the agenda of the Executive Directors, and this is how matters stood at the time that the Allende government was deposed."123 Ironically, in the later years of the Pinochet regime the U.S. government asked the Bank to postpone board discussion of a structural adjustment loan to Chile to avoid congressional opposition on human rights grounds at a time when the ad- ministration was seeking support for Bank refunding. But in a letter to James Baker, the assistant secretary of the Treasury, on Oetober 29, 1986, Barber Conable rejected the U.S. request. The Bank's decision not to lend to Vietnam in the late 1970s was another instance in which strong U.S. pressure was exerted. Although McNamara said at the time and maintained in later interviews that the decision was made by the Bank on economic considerations, at least some of the staff servicing Asian countries felt otherwise. A memo to McNamara and a long "private note" written in August and September of 1979 by a senior Bank official for East Asia and the Pacinc region summarize the views of two economic missions to Vietnam. 124 The flrst mission in 1978 led to the beginnings of project preparation work on a modest scale. The level of funding earmarked for Vietnam was held by McNamara to $150 million, far below the $400 million the allocative norms would have sub- scribed to the country. The Bank's mission reported that economic conditions were not favorable, that economic management left much to be desired, but that there was no case for suspending the Bank's meager engagement there. Indeed, Shahid Husain, the head of the mission, reported in a memo to McNamara that it was the judgment of the mission that Vietnam's economic performance could not be rated lower than that of some other IDA borrowers in the region, including Bangladesh and Pakistan, and that experience on project implementation in Vietnam was actually better. Al- though in the wake of massive refugee flows Vietnam faced serious international criticism and it would therefore be inappropriate to take a project to the board, "there are reasonable prospects that in due course we should be able to build a meaningful dialogue on economic and development issues. So, while being respon- sive to the environment, we should try to keep our channels open to the Viet- 123. World Bank, "Chile and the World Bank," white paper, cited in Brown, United States and Politicization, p. 167. 124. "A Private Note on Internal Bank Deliberations on Vietnam," September 21, 1979; and confidential memorandum from Shahid Husain to Robert McNamara, August 31,1979. 258 U.S. RELATIONS WITH THE WORLD BANK namese."125 The mission's contention, in contrast to what McNamara said publicly in Newsweek, was that on substantive grounds there was no basis for stopping all lending to Vietnam. The Bank should wait until it could get sufficient support for lending from the board. Thus the staff in charge of the region did not support a suspension oflending on economic grounds; but whether McNamara was driven by strong V.S. and other donor pressure or his own determination remains open to debate. A more recent example in which the Bank's refusal to lend clearly coincided with V.S. policy is that of Nicaragua in the 1980s. The reason for the suspension of lending was the accumulation of arrears. However, in September 1984 the Nica- raguan government formally proposed a solution to its arrearages problem. The proposal encompassed three actions: a freeze until the end of 1984 on disburse- ments and repayments, preparation and appraisal by the World Bank of an economic adjustment program for presentation to the board before the end of June 1985, and a loan rescheduling or loan repayment in local currency. The third measure, the Nicaraguan government noted, was consistent with Article IV, section 4(c) of the Articles of Agreement, which provides, "if a member suffers from an acute ex- change stringency, so that the service of any loan contracted by that member or guaranteed by it or by one of its agencies cannot be provided in the stipulated manner, the member concerned may apply to the Bank for a relaxation of the conditions of payment." In the view of senior Bank staff, such actions would have entailed substantial danger for the Bank's "market image" and "shareholder rela- tions."126 Its response, which in Nicaragua's view showed "an absence of a construc- tive attitude on the part of the Bank," was to insist that the country settle its overdue payments in full and negotiate a stabilization program with the IMF.127 Only when those two conditions were met would the Bank be in a position to help with the preparation of a medium-term program. No concerted effort was made, however, to help the Sandinista regime meet these conditions, as was done, for example, in response to Zambia's arrearage problems later in the 1980s. Although one need not dispute the Bank's economic policy assessments of Allende's Chile, Vietnam, and Nicaragua under the Sandinistas, it is worth noting that equally harsh assessments could have been made, but were not, of Somoza's Nicaragua, Marcos's Philippines, and Mobutu's Zaire, regimes that were all impor- tant cold war allies of the V nited States. Instances in which the V nited States successfully influenced increases or more rapid lending to a particular country are even harder to pin down uneqUivocally because of the broad concurrence of V.S. geopolitical interests and Bank country 125. Husain, memorandum, August 31, 1979; and Susan Drake, "Vietnam's Troubles," Newsweek, August 20,1979. 126. Internal memorandum, December 21,1984 (confidential). 127. Cable from Joaquin Cuadra Chamorro, Nicaraguan minister of finance, to David Knox, December 19, 1984. U.S. RELATIONS WITH THE WORLD BANK 259 allocations. But examples exist in each of the Bank's decades. For instance, the United States influenced increased lending to Japan in the 1950s despite the Bank's reluctance because of the country's inadequate creditworthiness. 128 It is ironic that the United States pushed the Bank to finance steel projects in Japan, given that country's managed approach to industrialization and later U.S. opposition to lend- ing to the steel sector in many other countries. Two more recent examples of seemingly favorable treatment of countries impor- tant to the United States involve Bank decisions to release structural adjustment fmancing despite assessments by staff that conditions did not warrant lending. In 1988 the Bank prOvided the first tranch of a sectoral adjustment loan to the government of Argentina despite the fact that an IMF stabilization program had been held up because of differences between the Fund and the government, including differences over the size of the country's deficit. 129 Treasury and World Bank ofllcials have since said that the United States was interested in helping Argentine President Raul Alfonsin and had indicated to the Bank that it would support a decision to release funding to Argentina even in the absence of an IMF program. Despite opposition by some of its staff, the Bank released the funds. The United States, under a change of leadership at the Treasury, then reversed itself and openly criticized the Bank's actionY30 During the Persian Gulf crisis, Secretary of State James Baker offered Turkey support for increased Bank lending in appreciation for the country's assistance against Iraq. After Baker's visit, the World Bank released the second tranch of a sector adjustment loan that had previously been held up because of Turkey's failure to satisfY the Bank's loan conditions even though the IMF judged the country's macroeconomic performance unsatisfactory.l3l According to one study of World Bank policy-based lending, a large number of country cases reveal this same phenomenon-that although alliance with the United States does not earn a recipient country gentler loan conditions, it does yield "a more fOrgiving treatment of slippage on conditions."132 U.S. pressures on the Bank in regard to loans for the production of certain commodities intensified in the 1970s. In the Bank's early days the United States did not want it to lend directly to private companies nor act as a substitute for private lending. In tbe 1970s pressure was applied, some of it mandated by Congress, in an 128. "The Ironies That Built Japan, Inc.," Washington Post, July 18, 1993, p. H12. 129. See chapter 11 of this volume. 130. This sequence of events was confirmed in interviews, including Catherine Gwin, interview with Charles Dallara, New York, October 2, 1991, and is corroborated in Polak, op. cit. 131. Ibid. 132. Paul Mosley, Jane Harrigan, and John Toye, Aid and Power: The World Bank and Policy-Based Lending, vol. 1 (London: Routledge, 1991), p. 128. 260 U.S. RELATIOI\S WITH THE WORLD BANK attempt to prevent Bank support for increasing production of commodities that competed with those of producers in the United States. In most instances of congressionally mandated opposition to commodity loans-for palm oil or citrus products, for example-Bank management stood up to the United States and successfully gained executive board approval. This was the case with a loan for palm oil production to Papua New Guinea, which the United States tried to block in the late 1970s. But U.S. opposition was not without effect. U.S. legislation and U.S. position in the Bank were cast in terms of opposition to loans for commodities that were in surplus on the world market. The impact of this position was to make the Bank espeCially careful in its consideration of rates of return in these commodity areas. From the staff's point of view there was quite simply a higher burden of proof for products Singled out by the United States. l33 For certain other commodities, notably steel, mined products, oil, and gas, it was the U.S. administration even more than Congress that strongly opposed Bank lending. The Bank's decision in March 1987 to limit support for steel projects to prOViding technical assistance, thereby stopping loan requests from India and Pakistan, was the result, at least in part, of strong U.S. opposition over a number of years. In 1985 the United States had voted against an IFC equity investment in a steel project in Brazil and later opposed a Bank steel sector restructuring loan to Mexico (which was approved in 1988). The case of Mexico provides, however, an interesting example of conflicting American objectives and the nuances of U.S. opposition votes. The matter arose at a time when Bank and Mexico debt manage- ment and policy reform efforts were beginning to work well. For the Bank to retreat on a project that was well advanced would have seriously undermined the efforts. Besides, the United States had a keen interest in seeing a successful resolution to Mexico's debt crisis. It therefore voted against the loan, but it did not try to change the views of other members of the board, which it knew would support the loan. CongreSSional requirements were thus satisfied, although all parties were fully aware that the loan approval was never in doubt. The United States also voted against but did not oppose with much vehemence a steel sector loan to China at a time in the 1980s of warm U.S.-China relations. Yet in other cases where U.S. interests were not strong, opposition to steel sector lending was more forceful and projects were shelved. 134 According to former Bank Vice President Burke Knapp, U.S. opposition to steel production loans in the 1980s had as much to do with opposition to the Bank's lending to large state enterprises as to its lending for steel production per se. The United States had not objected to 133. Catherine Gwin, interview with Burke Knapp, Washington, D.C., September 25, 1992. 134. Internal Bank documents from the period show that Barber Conable rejected the recommendations of Ernest Stem that the Bank provide loans to assist steel sector restruc- turing in cases other than China and Mexico. Conable was presumably influenced by his knowledge of the strength of opposition on this issue in Congress and the administration. U.S. RELATIONS WITH THE WORLD BANK 261 earlier steel sector loans to Japan, where production was in the hands of private companies, but consistently opposed support for state-owned steel enterprises in developing countries as more ,rnd more producers came into the market. In mining, the United States argued against Bank lending both on grounds of oversupply in the world market and the availability of private finance for worthy investments. For instance, the United States blocked consideration of a request by a Brazilian joint venture mining company for an IFC loan that was intended to boost Brazil's export of iron ore. 135 It also opposed a major IFC investment in the Escondida copper project in Chile. Eseondida is one of the world's largest and richest copper ore bodies. U.S. copper producers were clearly concerned about the added competition and the potential for the new mine to drive low world copper prices even lower. However, the IFC estimated the impact of Escondida on copper prices to be "modest and tranSitory." And both Japan and Germany, which viewed Escondida as a stable long-term source of supply, were expected to provide the bulk of the loan financing in exchange for long-term service contracts. As a result, U.S. objections were not sustained and the investment went ahead. After the oil price shock of 1973-74 the United States supported increased Bank lending in the energy sector. Much of what the Bank undertook was then noncon- troversiaL However, lending for oil and gas exploration and development became a matter of serious dispute between the United States and the Bank, especially after the change from the Carter administration to the Reagan administration. In the opinion of Edward Fried, U.S. executive director at the Bank during part of the Carter years, a serious effort should have been made to inerease oil production and conserve use in developing countries because they were going to be big users as well as potential sources of supply. 136 The question was what the role of the Bank should be. From the U.S. point of view, it was a had idea for the Bank to spend money on oil drilling, but the institution could be influential in promoting exploration and development. Toward the end of the 1970s Sheikh Ahmed Zaki Yamani of Saudi Arabia proposed in a speech that the World Bank and oil surplus economies cooperate to boost energy sector development in the developing world. The idea was picked up by Fried and after discussion with the Bank put forward as a proposal for an affIliate that would provide a way of enlarging and con- centrating the Bank's work in the whole energy field. The proposal moved ahead until the Reagan administration withdrew U.S. support. The new administration not only considered the affiliate another window for increasing the lending of the Bank, which it opposed, but also argued that finanCing for oil and gas production should come from the private sector. The World Bank could foster policies that 135. Jonathan Friedland, "Inside Job at the World Bank," Sooth, no. 83 (September 1987), pp. 9-10. 136. Catherine Gwin, interview with Edward Fried, Washington, D.C., July 16,1992. 262 u.s. RELATIONS WITH THE WORLD BANK encouraged private sector investment, but it should not make loans to governments or state-owned oil and gas companies. 137 A U.S. note to World Bank directors explaining the new administration's opposition to the energy affiliate said that the United States would not approve development bank action that borrowed from private capital markets to make long-term loans to governments of developing countries for energy development. 138 FollOwing its defeat of the energy affiliate proposal, the United States continued to oppose the Bank's energy lending policy and speCific loan proposals not consis- tent with an emphasis on private sector financing and investment. A series of internal Bank memos reporting on conversations with the Treasury and the u.s. executive director in April and May 1984 make clear the nature and intensity of the dispute between the United States and the Bank (including both management and members of the board). In the conversations a Treasury official expressed concern over the Bank's "undue enthusiasm" for oil and gas lending that, he stated, could and should have been left to the private sector. Referring in one conversation to a specific Nigerian gas engineering loan as a scandal, he argued that Nigeria was a rich country and could easily secure the financing for itself. In response to the assessment that Nigeria could not get commercial bank financing at that time, he stated, "that was their own fault." They had "messed up" and could in due course restore their creditworthiness. Although a Bank representative made the point that the Bank was not like other lenders because it sought to improve the policy framework, establish appropriate prices, and improve production incentives, the Treasury official emphaSized that the United States would continue to oppose loans to national oil companies and loans where it deemed private financing to be attainable. 139 In subsequent Board discussions and votes the United States insisted that Bank lending not displace private equity and lending. To this end, it proposed two lending guidelines: there should be no Bank oil and gas lending to creditworthy countries and no Bank lending to established national oil companies. From the Bank's perspective this proposal discounted its technical contribution to the design and physical aspects of an investment or exploration program and the value of its policy advice. The inevitable conclusion, if the U.s. position prevailed, was that the Bank would then not lend at all "since we ourselves would not advance a case that we would be financing a hydrocarbon project simply to transfer resources."l40 Neither Bank management nor other member countries disagreed with the prin- ciple that the Bank's function should be residual and its lending not replace other financing available on reasonable terms; but there was considerable disagreement 137. Clyde H. Farnsworth, "U.S. Rejects Proposal to Form World Bank Energy Af- filiate," New York Tirnes, August 13, 1981, "Sunday Week in Review," p. 15. 138. World Bank internal memorandum, April 6, 1984. 139. Ibid.; and World Bank internal memorandum, May 9, 1984. 140. World Bank internal memorandum, April 6, 1984. U.S. RELATIONS WITH THE WORLD BANK 263 on the proposed U.S. guidelines. As a compromise, new energy policy guidelines were formulated that provided clearer limits on Bank lending for oil and gas exploration and development but allowed loans to national oil companies, em- phaSized policy leverage, and held Bank financing to a minimum necessary to achieve policy impact. What then, is the eonclusion to be drawn about U.S. influence on speCific loan decisions? The reeord confirms that witb both management and the board, U.S. views have carried great weight on loan decisions. This is not the case when the United States is required by eongressional legislation to vote a speCific wayan designated categories of loans, because the United States acting alone can always be outvoted. But it is the case when the government has chosen to apply heavy pressure on the management and other members of the board in regard to a specific loan. Loans made despite strong opposition by the Bank's largest share- holder are the exception. However, U.S. pressure affecting the Bank's decision to make a loan to a speCific country or for a specific project is also the exception. The more pervasive influence is at the level of lending policy or in the details of a loan. ADMINISTRATION AND FINANCE. The United States has also applied strong pressure in matters of Bank administration and finance. Although instances of major disagreements between the United States and the Bank on matters of lending policy have been limited, at least before the 1980s, administrative matters have been a constant source of dispute. Four of them have been the focus of greatest attention and debate: the size of the Bank's administrative budget, in- creases in staff salaries and benefits, maintaining the value of Bank capital, and the evaluation and transparency of Bank activities. On all four the United States has had major influence. The United States has not been the only member country to express strong and eontinuous concern about the growth of the Bank's administrative budget (most of which has occurred since the late 1970s), but it has been one of the most vocal. Concern came to a head in June 1986 when the budget proposed by management was opposed by the United States, Japan, and France, with Germany and the United Kingdom abstaining. This vote of no confidence occurred two days before Barber Conable assumed office, which led him to ask Treasury Secretary Baker, who had prevailed on him to accept the preSidency, "what are you doing to me?"141 The outeome was a major reorganization carried out in the early months of his preSidency. Conable was told by the government that there was too much fat in the system. In consultation with him McNamara agreed that reorganization was needed. But, again aceording to Conable. the Bank had to put together such a rich personnel separation package that he lost the support of the U.S. government for the re- 141. John Lewis and Richard Webb, interview with Barber Conable, Washington, D.C., MayS, 1991. 264 U.S. RELATIONS WITH THE WORLD BANK organization. The Bank staff considered the reorganization disruptive and, more seriously, without clear purpose or apparent benefit to programs. Indeed, many inside and outside the Bank claimed at the time that the reorganization led to a serious mismatch between the new tasks the Bank was being pressured to take on (in environmental sensitivity, in eastern Europe and the former Soviet Union, and in private sector development) and the inadequate size and composition of the staff. Another problem, observers believed, was too little sector-specific technical expertise as a result of the reorganization. A reorganization in 1992, instigated not by the board but by Bank President Lewis T. Preston, responded to some of the {!oncerns raised by the Conable reorganization and to the fmdings of an internal evaluation, commissioned by Preston in 1991, on the Bank's portfolio manage- ment. 142 That evaluation, which documented a serious deterioration in the Bank's portfolio performance, challenged the Bank's management as well as its board to institute major operational changes that incorporate but go beyond the kind of changes the United States has been demanding for many years. The United States also criticized the high salaries of senior Bank staff as early as the 1960s. Salaries, it believed, should be compatible with U.S. civil service pay scales. But the issue did not become seriously divisive until the mid-1970s. It has since remained a point of tension, even though salary levels are now determined on the basis of a formula advanced by the United States. In 1976 the United States successfully achieved a reduction in proposed Bank salary increases, which it regarded as excessive. This was a time when salary increases for U.S. public officials were being held down as part of a deficit-reduc- tion, anti-inflation campaign. To win support for its position, the United States made a series of high-level representations to other member country governments. That same year, Congress linked the U.S. contribution to the Bank and IDA to the condition that the U.S. executive director not receive compensation in excess of that paid a U.S. government official at the level of assistant secretary. In response to the U.S. pressure, member governments agreed to form a Joint Committee on Compensation of the Bank and the Fund. The committee was made up of executive directors from each institution and outside experts and was charged with recommending principles and levels of compensation. The United States further proposed that the G-5 countries commission a separate but similar study by an independent management consulting firm. Based on the recommendation of the two studies, the Bank board agreed to a compensation framework in 1979. Underpinning the agreement was a formula proposed by the United States that would base future compensation levels and adjustments on compensation paid by "comparator organizations" in U.S. public and private sectors and similar organiza- tions in a few selected high-income member countries (which were taken into 142. Portfolio Management Task Force, Effective Implementation: Key to Development Impact (Washington: World Bank, 1992). U.S. RELATIONS WITH THE WORLD BANK 265 account to ensure that the Fund and Bank would remain competitive employers in the international as well as the U.S. market). FollOwing the adoption of its formula, the U.S. position was that the principles and mechanism were in place but ques- tions of interpretation remained that would require watching. 143 In subsequent years the United States made clear through high-level repre- sentations to other governments that its concerns about salaI)' levels had not yet been resolved. In April 1986 Treasury Secretary Baker sent a letter to all governors of the Bank stating that the work of the Joint Committee on Compensation "suggests that there are serious problems in the current compensation system." The letter continues that although it is "not possible at this stage to determine precisely how much Fund and Bank salaries and benefits are out of line, or exactly what changes in the compensation system are needed," he urged governments to join the United States "in supporting a delay in any salary increase until ... a revised compensation system has been installed."144 In July 1989 Assistant Secre- taI)' of the Treasury Charles Dallara, in a letter to Barber Conable, strongly opposed management's recommendations on a revised system. The recommenda- tions of the Fund and Bank management, Dallara said, were at odds in important respects with Joint Committee recommendations that the United States supported but that were "already a compromise among all participants in the Committee." Dallara concluded, Because the compensation issue has not been resolved satisfactOrily, I fear that it could undermine our efforts to obtain funding from the Congress for both the Bank and IMF. For our part, we cannot and will not defend the new "system," which in our view does not represent a system, but rather a disparate and unwieldy collection of JCC and staff inspired elements. Both managements were fullya'ware of our concerns before their proposals were adopted, so I can assume you are confident of your ability to explain and defend the decisions taken and their implications. l45 Thus after a decade and a half of contention, compensation remains a serious source of controversy. The United States is insistent on holding down excessive salaries and perks; others counter that the effect of U.S. pressure is to undermine the Bank's ability to attract high-quality staff from other countries. The role of the dollar in the valuation of Bank capital is another matter on which the United States and the Bank (including all other members of the board) have been in dispute for many years. Although valuation is not a matter of major Significance for the operations of the Bank, the U.S. refusal to abandon what is 143. See National Advisory Council on International Monetary and Financial Policies, Annual Report, Fiscal Year 1981 (Washington, 1981), pp. 41-42. 144. Letter from Secretary of the Treasury James A. Baker to each of the governors of the Bank, April 25, 1986. 145. Letter from Assistant Secretary of the Treasury Charles H. Dallara to Barber Conable, July 10, 1989. 266 U,S, RELATIONS WITH THE WORLD BANK perceived as special treatment has posed financial difficulties for the Bank and antagonized other member countries. In effect, by insisting on maintaining the value of Bank capital in terms of a fixed rate of exchange between special drav.ring rights (SORs) and the dollar, the United States has kept itselfin the unique position among member countries of having to assume no exchange risk in its capital contributions to the Bank. The valuation of Bank capital became an issue between the United States and the Bank when the second amendment of the Articles of Agreement of the IMF, which created the SOR, came into force. The Bank's Articles had stipulated that the standard of value for Bank capital was the U.S. dollar "of the weight and fitness in effect on July], ] 944." This weight and fitness referred to the amount of gold for which one dollar could freely be exchanged. The Bretton Woods exchange system set the value of every other currency in terms of the dollar, which, as long as a fixed dollar price of gold prevailed, meant that every other currency also had a fixed gold value. But once the dollar was delinked from the price of gold, the executive directors of the Bank were faced with having to decide whether the successor to the ]944 gold dollar should be the SOH or the current U.S. dollar (at a rate of exchange of 1.20635, the last par value of the dollar), and whether the question should be decided through the executive directors' powers of interpretation of the Articles of Agreement or through an amendment to them. The opinion of the Bank's general counsel, and the preference of all member countries except the United States, was that the SOH should be substituted for the 1944 gold dollar on the basis of the directors' powers. The United States argued, and still argues, that a change would require an amendment because it would impose a different, flexible obligation on member governments. As a result, the United States and other countries would have to pass legislation whenever their currencies depreciated to fulfill obligations to maintain value on paid-in capital. And the United States opposed such an amendment for the same reason-that a change in SOH valuation would require legislative authorizations and appropriations for each maintenance-of-value pay- ment the United States might be obliged to make. For the United States the problem is more political than financial. The likely effect on the U.S. budget (positive or negative) would be minuscule. However, to accept a new maintenance-of-value obligation in the Bank would be to accept (as all other countries have had to do) an open-ended obligation to make such pay- ments as would be reqUired should the dollar decline against an agreed standard of value. No a priori ceiling could be set on such an obligation. Therefore, to fulfill it would require open-ended authorization and periodic appropriation legislation, which successive administrations have argued would be politically impractical even though financially trivial. The unequal treatment that has resulted from the U.S. refusal to accept a maintenance-of-value obligation is a source of irritation among member countries. It has also posed financial headaches for the Bank from time to time. In the fall of U.S. RELATIONS WITH THE WORLD BANK 267 1987 a considerable depreciation in the U.S. dollar caused a decrease in the Bank's headroom-the difference between the amount of loans outstanding and the Bank's legal lending limit-from $18.2 billion at the end of September to $8 billion at the end of December. 146 The problem was exacerbated because negotiations for a general capital increase for the Bank had been blocked for several years by the United States. To avoid a temporary suspension of disbursements on all outstand- ing loans and a loss of credit standing in the markets, the Bank discussed the possibility of a special bridging operation with central banks. The aim would have been to cover further substantial dollar depreciation before Bank receipt of new subSCriptions under a capital increase (not agreed to until the late 1980s). But the need for such an agreement was averted. Over the years the United States has also persistently tried to strengthen Bank audit and evaluation procedures and has pressured the Bank to make more infor- mation on its activities available to the public. Serious U.S. attention to audit and evaluation procedures began in Congress in the late 1960s. In June 1970 a bill authorizing the next installment ofIDA funding proposed a GAO audit of the Bank. In September, Robert Mc~amara issued an administrative circular within the Bank, noting that since 1968 budgetary and financial controls had been strengthened by creation of the Programming and Budgeting Department, establishment of the Audit Committee of the executive directors, and strengthening the Office of Internal Auditor. In addition, the circular called for establishing an Operations Evaluation Unit whose task would be "to review past lending operations with the central objective of establishing whether the actual benefits of the completed projects are in accordance with those expected at the time of appraisal and, in the case of divergence, the reason."147 In mid-1971 this unit was converted into the Operations Evaluation Department. But for several years thereafter the United States urged independence from management of both the audit and evaluation operations. The OED, it argued, should be closely related to, if not directly under, the board. In 1973 a GAO report once again recommended independent evaluations of Bank operations and activities. Legislation was proposed that would require the U.S. government to seek establishment of an independent evaluation unit in the World Bank (as Congress had previously mandated in 1967 for the International Development Bank) that would separate the postproject review system from the regular project implementation process. This step was taken by the Bank in July. The OED, along with the Internal Auditing Department, was made a separate department under a vice president who had no other direct operational respon- sibilities. But the matter did not end there. 146. At that time, each 1 percent depreciation of the dollar vis-a-vis other G- 7 currencies eroded the Bank's headroom by $800 million. 147. Robert S. McNamara, administrative circular, September 2,1970, p. 1. 268 U.S. RELATIONS WITH THE WORLD BANK In December 1973, legislation was approved requiring that the United States actively seek to establish an independent review and evaluation system under the Bank's governing body. The law also required that a statement of auditing and reporting standards be prepared by the U.S. comptroller-general to assist the Bank's board in devising terms of referenee for an independent review system. The comptroller-general's statement, released in June 1974, proposed that the findings and related recommendations of the OED be reported to the Bank board. In response, MeNamara proposed that the OED be formally linked to the board as well as to the president and that the head of the department be selected by the executive directors from a list of names put forward by the president. But the United States eontinued to urge even greater independence. It sought and achieved the establishment of the OED as a department that reported to the board. In addition, the staffing and design of the work program was to be the responsibility of the director-general of the OED, subject to review and approval of the board on wbicb tbe preSident, as chair, would have a Significant rolc. After that, McNamara lost interest in the operations of the OED. And for a time it was inSignificant and not a source of much intemalleaming. Although the United States takes credit (as in the 1982 Treasury assessment) for fostering stronger audit and evaluation proce- dures, one might wonder how serious it ever was about project evaluation and impact and whether the poor record on project implementation, documented in the Bank-initiated 1992 Wapenhans report, would have occurred if the United States had reached a compromise with McNamara in the mid-1970s and addressed the issue of impact consistently. 148 Since the early 1970s the United States has also pressured the Bank to make more of its analysiS available to the public. Congress first focused on the idea largely out of frustration with the Treasury's lack of Hill eonsultation on Bank policy issues, Although the Treasury supported Congress's efforts to institute stricter audit and evaluation procedures, it did not endorse demands for greater disclosure of Bank country papers and loan documentation, claiming that greater transparency would undermine Bank operations. Both Treasury and Bank management took the position that it was up to the borrower government to decide what documents to release. With little movement on the issue having occurred, greater transparency was again pushed aggreSSively in the late 1980s and early 1990s by environmental nongovernmental organizations outraged by their inability to get documentation on Bank activities deemed environmentally detrimental. The Bank is now devising a ehange in praetice, but the new procedures are certain to remain a matter of congressional scrutiny in the early years of implementation. Overall, U.S. influenee in the Bank in matters of administration, lending, and development policy appears to have had a mix of strongly favorable and seriously 148. Portfolio Management Task Force, "Effective Implementation: Key to Develop- ment Impact," World Bank, September 1992. U.S. RELATIONS WITH THE WORLD BANK 269 detrimental effects. On the positive side, the United States has used its influence to broaden the Bank's base of donor support; it has encouraged expansion of develop- ment focus and scope of lending; and it has achieved improvements in procedures of accountability and transparency of Bank operations. On the negative side, however, the constant U.S. pursuit of narrow objectives, driven more by short-term foreign policy aims or domestic political imperatives than by concern for the effectiveness of Bank operations, has taken an inordinate amount of the time of the Bank's high-level management and has undermined staff morale. U.S. reluctance and delay in meeting its funding commitments have obliged senior management to devote large amounts of time in replenishment negotiations and in securing bridging arrangements. U.S. pressure has also obliged the Bank to wage a constant fight for its au- tonomy. As a result, its leadership and staff have "developed a 'protective shell' of beliefs and practices" that, while insulating the Bank from U.S. pressures, has hindered its effective functioning. 149 It has spent far too much time, attention, and caution in developing loan proposals and has given inadequate consideration to potential risks and alternative approaches. At the same time, the United States along with other countries has pushed the Bank, especially in recent years, into more and more areas of activity without adequate assessment of existing institu- tional strengths and weaknesses and without sufficient questioning of how far the institutional capabilities could be stretched. This has caused a serious deterioration in the quality of the Bank's operations. The matter of loan quality has now been starkly illuminated by the Wapenhans report, and any discussion of the sources of the problem would be incomplete without attention to the role played by the members of the board, including the United States. ISO Furthermore, the history of the World Bank shows that the choice of its presi- dent is crucial to the life of the institution. The past three appointments have not been strong. Even McNamara's dynamic tenure could not have been anticipated- at least there was nothing to suggest that he would be a leading development figure or that he was appOinted with that in mind. The United States more than any other member country can be held accountable for the leadership the Bank has enjoyed from its birth to its approaching half-century mark. Finally, and perhaps most seriously for the future of the Bank, the combination in the 1980s of U.S. policy inconsistencies, increased assertiveness on selected issues, and dwindling support has strained relations between the United States and other member countries. There is a growing sense among them that the United States has been overplaying its hand and causing unnecessary politicization and 149. William Ascher, "The World Bank and U.S. Control," in Margaret Karns and Karen Mingst, eds., The United States and Multilateral Institutions (Boston: Unwin Hyman, 1990), p.1l6. 150. Portfolio Management Task Force, "Effective Implementation." 270 U.S. RELATIONS WITH THE WORLD BANK polarization of the Bank board. This resentment has been aggravated by the increase in the 1980s of congressional micromanagement of U.S. participation in the Bank. Generally, the United States has been more successful in advancing particular issues when it has worked to build consensus than when it has been mandated by Congress to vote a particular way. One result of the growing resent- ment is that Japan and the major donors of Europe are focusing more on other institutions in which they exercise greater control: the European Community's development fund, the newly launched European Bank for Reconstruction and Development, and the Asian Development Bank. Yet any weakening of the World Bank would seem to run counter to the interests of the United States, which have generally been well served by Bank policies and operations and at a remarkably low cost. A Tally of Costs and Benefits Over the past half century the United States has not only contributed to but has Significantly benefited from the activities of the World Bank. The most comprehen- sive assessment to date of the costs and benefits of participation in the Bank was the 1982 Treasury report, which concluded unequivocally that the World Bank and the other multilateral development banks had been effective instruments of U.S. objectives. Referring speCifically to the Bank, the report stated: On the whole, the poliCies and programs of the World Bank Group have been consistent with U.S. interests. This is particularly true in terms of general country allocation questions and sensitive policy issues. The international character of the World Bank, its corporate structure, the strength of the management team, and the Bank's weighted voting structure have ensured broad consi~tency between its policies and practices and the long term economic and political objectives of the United States. 151 Referring to all the multilateral development banks together, it noted that they had been "most effective in contributing to the achievement of our global economic and financial objectives and thereby also helping us in our long term politicallstrategic interests." They were less effective instruments, however, for achieving short-term policy objectives, where identification of the assistance with the United States was important and, it emphaSized, there was "room for improvement in terms of encouraging more effective economic policy reform in individual [less developed countries]. "152 One of the main ways U.S. interests have been served is by Bank lending-far beyond an amount the United States was willing to provide bilaterally-to 151. Department of the Treasury, United States Participation in Multilateral Develop- ment Banks, p. 59. 152. Ibid., p. 4. U,S, RELATIONS WITH THE WORLD BANK 271 countries of strategic or economic importance to the United States. Indeed, as has been frequently noted in executive branch testimony before Congress in defense of World Bank funding requests and reiterated in the Treasury assessment, most Bank lending has gone to those countries. The point is made, for example, in a letter from President Reagan to Robert Michel, the Republican leader in the House, urging support for the 1988 general capital increase: "The Bank commits the vast majority of its funds in support of specific investment projects in the middle income developing nations. These are mostly nations (such as the Philippines, Egypt, Pakistan, Turkey, Morocco. Tunisia, Mexico. Argentina, Indonesia and Brazil) that are strategically and economically important to the United States,"l53 Bank lending has also served broad U.S. economic interests in the building of a free. open, and stable international economic system. According to the Treasury assessment, "by promoting economic and social development in the Third vVorld, fostering market-oriented economic poliCies, and preserving a reputation for im- partiality and competence, the MD Bs encourage developing countries to par- ticipate more fully in an international system based on liberalized trade and capital flows .... This means expanding opportunities for U.S. export~, investment, and finance." In addition, the ability of the multilateral banks to design and implement high-quality development loans has contributed to a more efficient process of development assistance. Their "capability to administer programs productively and efficiently ensures cost effectiveness and can maximize the use of scarce develop- ment resources."154 The United States has achieved these benefits for a remarkably low financial expenditure. Two points are relevant here. First, U.S. investment in the Bank and its contributions to IDA have been highly leveraged. In the case of the Bank the United States had paid in $1,857,100,000 of the $218,209,900,000 provided in loans as of mid-1992. In the case ofIDA it has contributed a relatively larger share of the funds over the years, and the leveraging effect has been less but by no means inSignificant. As of mid-1992 it had contributed $18,081,500,000 of the total $71,065,000,000Ient.155 Second, the net effect of the World Bank Group on the U.S. balance of pay- ments has been positive (table 6-4). One reason is that the United States has received substantial procurement benefits: World Bank procurements have totaled $26,060,700,000. In addition, interest payments to U.S. bondholders living in the United States have been $20,169,700,000 and administrative expenses incurred in U.S. dollars in the United States, $10,948,700,000. These amounts have been the major factors contributing to a total net balance of payments effect (in real tern1s) 153. Letter from President Ronald Reagan to Representative Robert Michel, June 10, 1988, p. 1. 154. Department of the Treasury, United States Participation in Multilateral Develop- ment Banks, pp. 48, 52. 155. World Bank data. Table 6-4. World Bank and International Development Association Operations and U.S. Balance of Payments, Cumulative, 1946-91 Millions of constant 1990 dollars World Bank Current account Procurement of goodsft 26,060.7 Interest to bondholders b 20,169.7 Interest to loan holders 626.5 Administrative expenses including issuance cost of bondsc 10,948.7 CurrenL), swap activity -4,357.4 Investment income 16,916.7 Balance on current account 36,531.4 Capital account Assets U.S payment of 1 percent subSCription 66.4 U.S. payment of9 percent subscription .597.3 U.S. paymcnts d 126.0 Local currency releasesc 1,071.2 Net bond sales f 13,623.4 Net loan sales -696.9 Total assets 14,787.4 liabilities Investments with matnrities over one year 20,645.3 Investments with maturities of one year or less -UO.2 Total liabilities 20,535.1 Balance of capital account 5,747.7 Net change 42,279.1 IDA Current account Procurement of goodsg 5,112.3 Administrative expenses 4,612.6 Investment incomeh -642.4 Balance on current acount 9,082.8 Capital account Assets Subscriptions and contributionsi 18,634.4 Total assets 18,634.4 Liabilities Investments with maturities over one year 104.9 Investments with maturities of one year or less U7.8 Total liabilities -12.9 Balance of capital account -18,647.3 Net Sourme: World Bank Treasury Department. a. Includes procurements speCifically identified as originating in the United States and the same proportion of procurement not identifiable by countrv of origin. b. Interest payments to U.S. bondhofders living in the United States. c. Administrative expenses incurred in U.S, dollars in the United States, including the issuance cost of bonds. d. Capital subSCription paid by the United States, e. Capital subSCription in 18 percent national currencies released in U.S. dollars and nsed for loan disbursements. f. Bonds sold for delayed delivery are included in the year in which settlement is made, g. Includes procurements specifically identified as originating in the United States and the same proportion of procurement not identifiable by country of origin. h. For years from inception through June 30, 1964, the ratio ofaverage of US. investments to average total investments was applied to total investment income, For flscall965 and subsequent years, the amount shown is the actual amount as computed for the statement "Statistical Summary of Funds Received by Source." i. Excludes notes not encashed. U.S. RELATIONS WITH THE WORLD BANK 273 of $42,279,000,000, which more than compensates for the net negative effect of support for IDA of some $9,564,500,000. Obviously, U.S. contributions to the Bank entail an opportunity cost, but taking into account the political and economic iuterests served, the conclusion about U.S.-World Bank relations is one of shared benefit. Conclusion A number of broad observations can be drawn from this review of the history of the U.S. relations with the World Bank from 1945 to the early 1990s. More than any other country, the United States has shaped and directed the institutional evolution, poliCies, and activities of the World Bank. And for the most part, U.S. participation has supported the iustitution's rise to prominence in de- velopment cooperation. The United States has applied pressure both to stop and to encourage particular loan agreements, but the greater influence has been at the level of policy and institutional evolution and growth. Much, though not all, of what the United States has promoted has helped foster constructive changes iu the Bank, includiug the increase in agriculture and poverty-oriented lending, the increasing concentration of IDA lending on the poorest countries, the introduc- tion, after some reluctance, of structural adjustment lending, and the recent atten- tion to environmental sustainability and transparency of transactions. Although U.S. support for the World Bank has shown some ups and downs, it has been more stable than other elements of U.S. economic assistance. This stability has largely been due to the value to the United States of the leveraging effect of contributions to the Bank, perceptions of the Bank's relative effectiveness as a provider of both development finanCing and policy advice, and the view held by most administrations and members of Congress that the Bank contributes to the broad interest of the United States in a growing and open world economy. With the exception of Reagan's first administration, all administrations since the Bank's founding have advaneed these views and, with only few exceptions, leading Repub- licans and Democrats in Congress have concurred. Criticisms of the \'\TorId Bank from various voices in the United States have, however, greatly intensified since the mid-1970s. These opinions have come from all points on the politieal spectrum, including churches and other NGOs, the traditional bulwarks of support for development assistance. In part the criticism reflects the increased prominence of the Bank in development and the closer scrutiny it receives. In part it reflects changing ideas about development, not all of which suit Bank lending operations as eaSily as the earhcr preoccupations with infrastructure development. And in part the criticism reflects the loss of a clear sense of purpose and direction in U.S. development pohcy, for which the Bank is but one instrument. 274 U,S, RELATIONS WITH THE WORLD BANK U.S. policy toward the World Bank has always reflected an underlying am- bivalence toward both development assistance and multilateral cooperation. Recog- nizing the long-term benefits of the relatively efficient and relatively depoliticized development financing the Bank offers, the United States has also looked upon it as an instrument of foreign policy that was expected to be responsive to short-term U.S. positions. As a result, U.S. policy toward the Bank and the positions it has taken within the Bank have been erratic, often reflecting more the ebb and flow of U.S. politics and foreign policy than a coherent view of the Bank's development financing and a steadfast concern for the effectiveness of its operations. Two features of the policy process have strongly influenced the character ofU .S. World Bank policy. On the one hand the dominant role of the Treasury has limited the development content of U.S. policy and participation in the Bank On the other hand Congress and, indirectly, NGOs have been instrumental in designing U.S. Bank policy. This involvement has influenced Treasury's dominant role, keeping development concerns in sharper focus in the formation of U.S. policy than might otherwise have been the case. But Congress has also been a conduit for par- ticularistic views on Bank lending and has been responsible for the proliferation of restrictions and demands on the Bank that have been unilaterally promoted by the United States. Debates in Congress have also led to frequent failures on the part of the United States to deliver its share of negotiated replenishments within an internationally agreed time frame and have forced other countries to make up for temporary u.s. shortfalls to avoid a break in IDA lending. Both kinds of actions have eroded U.S. influence on the board of the Bank and on the Bank's efficiency. Finally, the United States has also pressed successfully for ever greater burden sharing by other developed country members of the Bank But it has resisted the power sharing that ought to go along with their growing financial contributions. If the United States wants to see the Bank continue to function and evolve in ways consistent with U.S. interests, it will have to dedicate effective personnel to its Bank policy positions (including the position of U.S. executive director), arrive at an understanding with Congress on the major priorities of U.S. policy toward the Bank, structure development policy expertise into its Bank policymaking process, and engage actively vvith other member countries in consensus building. It must shed the ideolOgical strictures of the past decade of U.S. Bank policy and develop with other countries, notably Japan, the policy guidance for and oversight of the challenging new era of the World Bank's second half century. SEVEN Japan and the World Barlk Toyoo Gyohten JAPAl\i'S POSTWAR "miracle" was the result of many factors, including abundant and diligent human resources, the socioeconomic structure inherited from before the war, export drives, and government industrial poliCies. These are the self-help , efforts on which the philosophy of today's Japanese development assistance is based. In addition, Japan relied on external assistance until the early 1960s, mainly from the United States and the World Bank. Indeed, during the early 1960s the size of Japan's loan outstanding from the Bank was second only to India's, but the Bank believed it was safe to lend to Japan. In the thirteen years that Japan borrowed from the Bank, the loans brought many things, including new and rebuilt physical infrastructure and knowledge of software and technolOgies. Because of its rapid economic growth, Japan graduated from borrowing from the Bank in 1966. In 1971, as the Bank's funding in the Tokyo market increased, Japan became a net creditor to it. In 1990, repayment was completed and Japan genuinely graduated from the Bank. The first part of the World Bank-Japan relationship is thus a history of graduation. The most recent relationship is based on increasing interaction. Since the late 1970s Japan's pOSitions at international financial institutions (IFIs) have become important because of its increasing economic presence. It became the second- largest shareholder (the United States is the largest) at the Bank in 1984. Financial contributions have been made and positions taken, but Japan's human and intellec- tual contributions to these institutions are still somewhat delayed. Now, tbe country is more than ever expected to play an important role in the IFIs, among them the World Bank. 275 276 JAPAN AND THE WORLD BANK The objectives of this chapter are threefold. First, it tells the history of the World Bank and Japan, a story of graduation, emphasizing the experiences of individual projects and their implications. Second, the section titled "The Asian Perspective" reviews the recent discussions between the World Bank and Japan on how to understand economic development with respect to experiences in East Asia. The third section contemplates the present and future perspectives of the World Bank and Japan and gives some comments on both. Overview of the World Bank-Japan Relationship From 1945 until 1952 Japan was occupied by the Allied powers. Throughout the country defeatism prevailed. Economic hardship overshadowed future prospects. Postwar inflation occurred because of money-financed wartime expenditures and was followed by a sharp decline in production, mainly in iron and coal. Fearing total destruction of the economy, the government introduced the Priority Produc- tion System (PPS), which allocated resources heavily to priority sectors. As a result, industrial output climbed to more than 70 percent of its prewar level. l But the PPS created credit-line expansion financed by the Bank of Japan as well as fiscal expansion through increased government subsidies and not only exacerbated infla- tion but also introduced huge distortions into the economy. In 1949, to alleviate the situation, Joseph Dodge, an economic advisor to the Allied powers, imposed fiscal and monetary austerity. Under the Dodge stabilization policy, a single exchange rate of $1 = ¥360, to be maintained until 1971, replaced the multiple exchange rates and prepared the ground for Japan's comeback in the world economy. Although the deflationary effects of the stabilization policy were so acute that the number of bankruptcies skyrocketed and unemployment increased, it is certain that the policy initiated the normalization of the economy. In the early 1950s the Korean War brought windfall gains to the Japanese economy through increased consumer demand and export opportunities and paved the way to the rapid growth that followed. As the economy started to normalize, it became increaSingly clear that infrastructure was the main bottleneck for further reconstruction and development. In this regard, it is worth noting that Japan had an advanced economy even before the war: it experienced takeoff from 1878 to 1900. 2 Thus the initial stages of the postwar economic evolution can be seen as recon- struction rather than new development. Although domestic savings were relatively high compared with that in to day's less developed countries, they were insufficient 1. Fusae Ota, Hiroya Tanikawa, and Tasuke Otani, Russia's Economic Reform and Japan s Industrial Policy (Tokyo: Research Institute of International Trade and Industry, Ministry of International Trade and Industry [MITI/RI], 1992). 2. Walt W. Rostow, The Stages of Economic Growth: A Non-Communist Manifesto (Cambridge University Press, 1960). JAPAN AND THE WORLD BANK 277 to accommodate the huge demand. Thus Japan started seeking possible sources of capital abroad. 3 In response to the emergence of communist regimes in Asia as well as a surge of leftists in Japan, the United States granted a large sum of aid, mainly the Govern- ment and Relief in Occupied Areas (GARl OA) and the Economic Rehabilitation in Occupied Areas (EROA) assistance to Japan in parallel with the Marshall Plan in Europe. The GARIOA and EROA supported vital imports of food and materials for industrial production, some $2.1 billion worth from 1946 to 1952.4 The U.S. government's intention was to reduce assistance to Japan gradually and to achieve balance of payments equilibrium by about 1952. When the assistance was actually terminated in 1952, the Japanese economy was bolstered by the Korean War and the balance of payments situation was improved. Through his stabilization policy, Dodge introduced a counterpart fund system under which revenues in local cur- rency from resales of aid-financed import goods were kept in a government fund, separate from fiscal budget. These were used to improve infrastructure and pro- vided part of the original capital of the Japan Development Bank:5 On the political front the supreme commander of the Allied powers was transcen- dent and controlled almost all government activities, including diplomatic under- takings. The peace treaty Signed in San Francisco became effective on April 28, 1952, which meant that Japan was restored to full sovereignty in the international community. Against this background, the Japanese government started negotia- tions to join the Bretton Woods institutions. Japan and the Bretton Woo@ Institutions Although economic assistance from the United States was terminated in 1952, the shortage of capital in Japan was obvious, and it appears that the U.S. govern- ment intended to switch sources of economic assistance from its own budget to the World Bank to lessen the burden on Ameriean taxpayers. But assistance to \Vest Germany was continued by the newly established U.S. Economic Assistance Agen- cy (ECA), and World Bank lending was never granted to West Germany. It is arguable that the NATO framework made Americans more attached to Germany than to Japan, which worked in West Germany's favor. Given the termination of aid, Japanese authorities were eager to join the Bretton Woods institutions as a key step toward international recognition, even though the 3. Because of the shortage of domestic savings, the introduction of foreign capital was given policy priority by the Yoshida cabinet. 4. According to Ministry of Finance, Showa Zaisei Shi: Shusen kara Knwa made, voL 3 [The History of Fiscal Policies in the Showa Period: From Surrender to the Peace Treaty] (Tokyo: Toyo Keizai Shimpo-sha, 1976), p. 272. Total U.S. overseas assistance from 1945 to 1958 was $72 billion. 5. Based on such experience, Overseas Economic Cooperation Fund (OECF) program loans require borrowing countries to establish counterpart funds. 278 JAPAN AND THE WORLD BANK 6 peace treaty was yet to be signed. In April 1950 Minister of Finance Hayato Ikeda visited Washington and expressed the Japanese government's informal intention to join the International Monetary Fund (IMF).7 The Fund welcomed the statement and requested the government to provide data on Japan's balance of payments, fiscal budget, inflation, and so forth. The newspapers applauded the intention as a Significant step toward Japan's return to the international community. Japanese officials examined the pros and cons of membership in the Bretton Woods institutions. The benefits included the psycholOgical effects on the Japanese of asserting the country's international standing, the increased credibility of the yen, credits from the IMF, loans from the World Bank, and the pump-priming effects of promoting private financial inflows through increased creditworthiness. The costs and burden of joining included the discontinuation of foreign exchange controls, IMF approval before altering exchange rates, and that the benefits of membership might not be large-that is, credits and loans from the institutions might not be available immediately. Through such considerations, government officials concluded that while direct benefits might not be immediately tangible, at least the psycholOgical and diplo- matic implication that Japan had taken a Significant step was important. They assumed that benefits from World Bank loans would be more direct and substantial than those of the IMF credits, although they did not have a clear plan of how much to borrow or to what sector or project to allocate the loans. 8 Diet Discussions and Public Response Soon after the peace treaty had become effective, the Japanese government began formal consideration of the Bretton Woods issues. In May 1952 the Diet started discussion on the IMF-World Bank Articles of Agreement and associated domestic legislation. The government's explanations on the necessity for member- ship were that direct benefits might not be immediate and tangible, but they would bring increased creditworthiness and thus give the country access to foreign capi- tal. Legislators asked Hayato Ikeda how much the country might be able to borrow 6. Italy joined the International Monetary Fund before it resumed international sovereignty, and Japanese authorities saw that as a precedent. However, after examining the pros and cons it was concluded that membership in the Bretton Woods institutions was not of urgent concern. 7. At the time, Japan was occupied, and such international deals had to be endorsed by the Allied powers to become effective. Indeed, the supreme commander of the Allies, General Douglas MacArthur, did not approve the official request for membership in the IMF and the World Bank. Finally the request was made on August 9, 1952, after the departure of General MacArthur. 8. They were preoccupied by the problem of how to pay the IMF quota and the World Bank subSCription, because they believed that Japan's gold and foreign currency reserves were insufficient. JAPA~ A~D THE WORLD BANK 279 from the Bank. The finance minister did not give exact figures but again stressed the importance of creditworthiness that membership in the Bretton Woods institu- tions would bring. There was also a question of whether the government had a specific borrOwing plan. An official answered that although there were no concrete plans, infrastructure, especially hydroelectric power development, was expected to be the major beneficiary of the Bank loans. Legislation approving membership passed both the lower and upper houses of the Diet by mid-June, and the Japanese ambassador in Washington Signed the Articles of Agreement on August 13, 1952.9 Japan had become the fifty-second member of the IMF and the Bank. It was the ninth largest shareholder, and was raised to eighth and then seventh by capital increases in 1959 and 1965. The Japanese public welcomed IMF and Bank membership, which was remark- able considering that there was substantial anti-American feeling and the Bretton 'Woods institutions were regarded as American agents.l0 But it is important to remember that Japan achieved the membership well hefore joining the United Nations in 1956. This fact symbolizes the Significance of the event as a step toward full-fledged partiCipation in the international community and future economic power. After the seventh IMF and Bank annual meeting, though it was the first for Japan, an election was held for the IMF-World Bank Board of Governors and Japan was elected one of the executive directorsY It was to represent the con- stituency of Japan, Thailand, Burma, and Ceylon (S ri Lanka) .12 The World Bank Mission to Japan In July 1952 Eugene Black, president of the World Bank, indicated that the first Bank mission to Japan would be sent once the country became a member. The purpose of the mission was not to appraise individual projects but to identifY 9. West Germany joined the IMF and the Bank the next day. 10. Newspapers reported the signing with headlines such as "Japan Returns to the International Economic Community: It joins the IMF and the World Bank." See "Kokusai keizai shakai ni fukki: Tsuuka kekin, Sekai ginko e seishiki " Asahi Shimbun, August 14, 19.52, p. 1. Anti-American resentment, mainly caused by harsh u.s. economic policy toward Japan and reinforced by leftist influence, was widely felt among Japanese during and immediately after the Dodge stabilization period. 11. In the process of membership negotiations, the Japanese government insisted that the IMF quota as well as Bank subSCription be $300 million to $350 million rather than the $250 million indicated for member countries of the IMF, because the amount should be "appropriate to Japan's international standing." An official of the Ministry of Finance has written, "'We were quite disappointed to know how the world saw Japan after the defeat." Shichiro Murai, "Kokusai Tsuuka Kikin ni Kamei Surumade" [The Way to IMF Member- ship], Gaikoku Kowase, vol. 57 (1952), pp. 1-4. In the same spirit, Japanese officials thought that Japan deserved seats on the boards of the IMF and the Bank. 12. Nepal, Singapore, Laos, and Malaysia joined the constituency later. 280 JAPAN AND THE WORLD BANK Japan's general economic condition as well as potential projects for Bank financing. Before the mission, a Bank staff member suggested that the mission's priority would be potential projects rather than a general economic survey because basic data were readily available. 13 Such a reversal was unusual for a first mission to a new recipient country: in other developing countries, where basic soft infrastructure was lacking, the first mission would spend much of its time and resources to collect and process basic data. The government had held a number of vice ministerial meetings to discuss the projects proposed to the Bank, and on October 18, 1952, it published a report, "Projects for Which Loans from the International Bank for Reconstruction and Development Are Desired." The report included seven projects that were ex- pected to cost about $900 million. 14 When the proposals were disclosed, an ardent petition was issued by the Japan Electric Machinery Manufacturers Association, headed by Taizo Ishizaka, demanding that the loans for power development not be used to import foreign generators. IS The reasons the association gave were that Japanese manufacturers had enough capability to meet domestic demand and were now seeking export opportunities; they were making efforts to upgrade their products through licensing from foreign firms; and imported generators would not only damage domestic manufacturers, but also affect the international reputation of Japanese products, thus impeding export possibilities. It is not clear how or whether the government and the Bank reacted at the time, but at least the petition shows that Japanese manufacturers were determined to achieve self-reliance and intended to expand exports. 16 The mission arrived in Tokyo in October and stayed until January 1953. Robert Gamer, vice president of the Bank, joined the mission in December and par- ticipated in a great many sessions with government officials, prefectural officials, and private sector entrepreneurs. During these road shows, some prefectural governors and entrepreneurs requested Bank loans for projects not listed on the government proposals. This was a reflection of the high expectations they had for the loans, but such unorganized lobbying as well as excessive geisha entertainment 13. IMF staff had been involved in making laws on foreign exchange control before Japan became a member of the IMF. 14. The projects were hydroelectric power development, highway construction, elec- trification of the Japan National Railway, industrial port construction, development of a new air transport system, modernization of the iron and steel industry, and coal shaft develop- ment. Some of these proposals were later funded by the Bank and some were not. Govern- ment of Japan, "Projects for Which Loans from the International Bank for Reconstruction and Development Are Desired" (Tokyo, October 18, 1952). 15. Ishizaka was president of Tokyo Shibaura Denki (Toshiba). In 1952 he was elected president of Keidanren, the most powerful business lobby in Japan. 16. When the hydroelectriC power project was financed by the Bank, it was done with a so-called impact loan, which did not exclude local cost finanCing. However, it is difficult to establish a relationship between this fact and the petition. JAPAN AND THE WORLD BANK 281 17 seemed to have initated the Bank officials. Upon his departure, Garner held a news briefing at which he expressed his stern views on the Japanese economy and the state of affairs in the country.lR First, he said, the government was trying to borrow more than Japan could afford, and therefore the proposed projects should be very carefully scrutinized. Second, he said that officials should have a more concrete plan of how they wanted to develop the economy. Third, he pOinted out that because its balance of payments situation was still unstable, Japan should try to capture export markets in Southeast Asia. Bank assistance to Southeast Asian countries would then be a roundabout but effective way to assist Japanese economic development. He was even reported as saying that before it would deserve Bank loans, Japan needed Scottish chartered accountants to rectifY what he saw as a messy state of affairs. In Washington, Garner reported the results of the mission to the World Bank Board. Again he expressed skepticism about Japan's borrowing capability. He added that he had suggested to Prime Minister Yoshida that a government body for coordinating an overall borrOwing plan be established, and he understood that the prime minister mentioned the suggestion in the Diet. Although such a coordinating entity was not established, coordination among the ministries was strengthened and no similar complaints were heard from the Bank again. The First Loan: Thennal Power Plants In November 1952 the Kansai Electric Power Company made a request for an exporter's credit to the Export-Import Bank of Washington to import two 66,000- kW steam generators from an American manufacturer. 19 Groundwork for the credit had bcen commissioned in autumn 1952 by Kansai Electric and the Japan Development Bank as the on-lender to the company. The Eximbank's response was favorable, and the Japanese government listed the project on the national power development program in March 1953. The listing was followed by the approval of the project by the bank's board in May. However, in June 1953 the U.S. Congress passed legislation that reduced the terms of reference of the Eximbank to short- term credits only and switched longer-term financing to the "World Bank. 20 17. It was said that Ministry of Finance officials had tried to arrange a geisha entertainment, allegedly at Gamer's request. Reports went on to say, however, that Minister of Finance Tadaharu Mukai rejected the idea because he thought it was inappropriate for a country asking for assistance from the Bank to indulge in such extravagance. I do not know whether the story is true. 18. Press statement issued by Robert L. Gamer, vice preSident, Interuational Bank for Reconstruction and Development, Tokyo, December 19, 1952. 19. Similar arrangements were being made by the Chubu Electric Power Company and the Kyushu Electric Po\\'Cr Company. Eventually, all three projects were financed by the first loan. 20. There was a struggle between World Bank President Eugene Black and Eximbank Chairman Herbert Gaston. Black tried to persuade the Japanese ambassador in Washington 282 JAPAN AND THE WORLD BANK Following the change in U.S. policy, the Japanese government reluctantly sub- mitted an application for a Bank loan in June 1953. 21 The Bank proposed conditions to the loan, mainly: -Three beneficiary power companies should raise their power supply prices to strengthen their financial positions. Therefore, it was recommended that the govern- ment commit itself to a prompt increase in power supply prices. -The proposed five-year power development plan was too ambitious and needed to be scrutinized further. Moreover, it was recommended that the govern- ment commit itself to improve debt-equity ratios of the power companies. -Along with power development, reducing system losses was also important and effective. So the government should commit itself to efforts to reduce the losses. In principle the government accepted the conditions, but the proposal to raise power prices triggered considerable debate among Japanese bureaucrats and poli- ticians. It was astonishing to the Japanese that the World Bank should demand such a sensitive alteration in policy: keeping power prices low was regarded as a fun- damental benefit for much of the Japanese population. As a compromise the government agreed that it would approve price increases "with reasonable prompt- ness." This episode has a significance beyond surface events: through negotiations, Japanese officials had learned that the Bank was not a mere moneylender but an institution that cared very much for the details and outcomes of its projects. Another issue was guarantee conditions. In the beginning the government considered that as a government agency the Japan Development Bank did not need official guarantees. However, the World Bank insisted that a government guarantee was required even if the JOB was the borrower and on-lender to the power companies, and that this condition was to be customary for all other loans. Finally, the government had to accept the Bank's argument, and three types of draft agreements were prepared-a World Bank-Japanese government guarantee agreement, a Bank-JOB loan agreement, and project agreements between the Bank and power companies. 22 Yet another problem was the negative pledge clause. The Bank demanded that its position as creditor to Japan should be no less favorable than that of other that the financing for the steam power generator should come from the World Bank rather than Eximbank. He implied that the amount of the already proposed loans for hydroelectric power development ($120 million) would be reduced should Japan get finanCing from the Eximbank for the steam power generator. For competition in lending to Japan in general, see Edward S. Mason and Robert E. Asher, The World Bank Since Bretton Woods (Brook- ings, 1973), pp. 500-01. 21. The proposed terms of Eximbank loans were more favorable than those of the World Bank. Moreover, the Japanese government's intention was to fmance hydroelectriC develop- ment with a World Bank impact loan. The World Bank loan for the steam power projects was a tied loan-that is, the proceeds of the loan were for imports of specific items. 22. The government needed special legislation to enable it to enter into the guarantee arrangement. JAPAN AND THE WORLD BANK 283 creditors. This meant that even assets of the Bank ofJapan could be collateralized for loans from the World Bank. The Japanese government opposed the condition, but the Bank, being skeptical about Japan's borrowing capacity, took a stem stance, and at last the government had to accept the condition. Whcn the agreement was disclosed in September 1953, Japanese media assailed the government's negotia- tion position as "traitorous" and "an act of shame." However disputable, these conditions were fmally settled, and officials were looking forward to signing the agreements. But just before they were to be signed, there was a snag: negative pledge clauses were found in loan agreements between the power companies and Japanese commercial banks. This reawakened the dis- pute, and the signing was postponed. The World Bank demanded that all the loan agreements with the commercial banks be translated into English and submitted for its scrutiny. It further demanded that the loan agreements be altered so as not to compromise its position as the superior creditor. These done, it still delayed the signing. But at last, on October 15, 1953, the first loan agreement for $40.2 million between the Bank and the JOB, the guarantee agreement between the Bank and the Japanese government, and the project agreements between the Bank and the power companies were Signed in Washington. In these early negotiations there were Significant culture shocks experienced by both the Bank and Japanese officials. To the Japanese the conditions stipulated in the agreements seemed much too detailed and exhaustive of the possible scenarios. Such a contractual form was quite foreign to a society in which implicit long-term confidence among parties had been of the utmost importance and strict legal contracts were rare. By the same token, it could be argued that during the negotia- tions, Bank officials were unusually alert and suspicious. Supposedly this was the result of the skepticism the Gamer mission had brought back. As dealings between Japan and the Bank deepened, however, such cultural gaps were narrowed and the Bank came to regard Japan as a model borrower. The Era of Rapid Growth From 1955 to 1966, the year of the last World Bank loan, Japan borrowed thirty times for a total of more than $800 million. The loans were used to develop basic industries, power, roads and railways, and agriculture. The follOwing are some experiences of the Bank loans during this period of rapid growth. IRON AND STEEL SECTOR. The World Bank's skeptiCism about Japan's ability to repay its debts perSisted, and the second Bank loan was made two years after the first. When the Priority Production System ended in 1949, it was clear that Japan's iron and steel industry could not compete internationally. The first modernization plan was carried out from 1950 to 1954, financed mainly by domestic resources. After 1954 a second plan totaling ¥120,OOO million (about $330 million) for further modernization was outlined. However, to keep the country's budget balanced, 284 JAPAN AND THE WORLD BANK domestic finance was restricted. So the government of Japan sought Bank loans to cany out the plan. Along with other modernization programs the plan was ex- plained to a Bank mission, headed by Russel Dorr, that visited Japan in October 1953. The mission's objective was threefold: to identifY and discuss Japan's macro- economic and sectoral policies, to examine the Bank's overall lending plan for Japan, and to conclude legalities involving the first loan. The mission pointed out that the government needed prudent macroeconomic policies to curb inflationary pressure and sincere efforts to promote exports, especially to Southeast Asia. It concluded that agriculture, iron and steel, and coal mining would be the focus of the Bank's interest. As for the government's request for so-called impact loans, the mission's answer was that such loans were exceptional and should not be applied to Japan. 23 Following the mission, Bank President Eugene Black, still doubtful of Japan's borrowing capacity, sent a letter in July 1954 to Minister of Finance Sankuro Ogasawara stating that it was understood that the borrowing Japan could afford would be $100 million a year. The mission identified agriculture, iron and steel, and coal milling as priority sectors for Bank financing. The Bank was willing to finance the proposed hydroelectric project if technical aspects were worked out satisfactorily.24 Appraisal work was carried out, and the loan agreement for the modernization project of Yawata Iron and Steel Co., Ltd., was signed in October 1955. The agreement included a condition allOwing loans to strengthen the financial position of the company, which was novel both to Yawata and the Japan Development Bank. The Yawata loan was the inception of Bank financing in the manufacturing sector. Following the loan, the Bank financed a package of four industrial projects for a total of $8.1 million in Japanese fiscal year 1955. The loan covered the iron and steel, automobile, and shipbuilding industries. The notable feature of this package was that the Bank did not demand agreements with individual companies, which added flexibility to project implementation. In 1956 the Japanese government's economic white paper stated, "the postwar economic rush is over," Signaling that the Japanese economy had entered another stage of stable growth. In December 1956 a loan agreement for modernization and expansion of the Kawasaki Steel Chiba factory was signed. Two years of painful efforts had finally been rewarded. When the project was first announced, there was considerable criticism of it. The plan envisaged the first integrated steel mill in Japan, with an annual capacity of 500,000 tons of crude steel, 10 percent of the nation's production at the time. 23. The government's perception was that the local cost part rather than foreign currency portion of the project was underfunded; as a result, officials wanted to introduce untied impact loans. Impact loans were defined as exceptional in article IV, sections 3(b) and (c) of the Articles of Agreement. 24. Nihon Kaihatsu Cinko, Kokusai Fukkou Kaihatsu Cinko Karyoku Shakkan [The IBRD Loan for Steam Power Plants] (Tokyo: Japan Development Bank, 1955), p. 321. JAPAN AND THE WORLD BANK 285 The project was regarded as too risky. It ran contrary to the government's policy of sealing down investment in the sector. The Bank loan would not cover all of the cost, and the associated demand for enormous local matching funds would crowd out borrowing by other industries. Any expected cost reductions in the price of iron were doubtful because of the large interest payments and depreciation costs. Finally, the market for sheet steel would stumble as a result of the increased capacity. However, Kawasaki, determined to introduce a Bank loan, convinced both the government and the Bank that growing demand for sheet steel and export possibilities could be gained by cost reductions. 25 Along with other steel manufacturers, Kawasaki got two more Bank loans. 26 But having been assured of Japan's creditworthiness and ability to borrow from the private sector, the Bank set conditions for these loans, such as strengthening the companies' financial positions. Moreover, in the 1960s the Bank extended loans only when a joint market-based offering, that is, bond finance, was made. In summary, the Bank's main contributions to the Japanese iron and steel sector were enabling the introduction of new processes and reminding companies of the impor- tance of a healthy financial position. POWER DEVELOPMENT. Although the first World Bank loan to Japan was to develop thermal power generation, the power companies, haVing experienced what they considered needlessly tedious procedures associated with the loans, became increasingly reluctant to borrow from the Bank and turned to the Export-Import Bank. 27 In view of such circumstances, President Black visited Japan in May 1957. Upon arrival, he issued a statement in which he indicated that impact loans could be provided to Japan and that the terms were flexible, subject to the condition of the national economy and the types of projects. Black held a meeting with Finance Minister Hayato Ikeda, and they basically agreed that the Bank loans were to be used for power development, road construction, and industry, especially the iron and steel sector, and the terms of the loans were to be flexible. Both parties were keen to see economic development in Southeast Asia. During his visit, Black saw the realities of the Japanese economy and altered his earlier view of Japan's 25. Kawasaki applied for the loan as early as May 1954. However, the Bank pOinted out the company's financial weakness and demanded that it show improvements in this regard. To meet the Bank's demand, Kawasaki suspended dividend payments for one and a half years and increased intemal reserves. It also scaled back a part of the project in line with the Bank's recommendation. 26. The second loan for the Kawasaki project, signed on January 29, 1958, was the first impact loan to Japan. 27. By this time, Eximbank had resumed its provision of long-term fmancing. In Novem- ber 1960 a staff member of the World Bank told the Japan Development Bank that if power companies tried to introduee Eximbank loans tied to Ameriean products, it would be difficult for World Bank staff to persuade the board to approve impact loans to Japan. Nihon Kaihatsu Cinko, Nihon Kaihatsu Cinko Juu-nen-Shi [Ten Years of JOB] (Tokyo: Japan Development Bank, 1963), p. 327. 286 JAPAN AND THE WORLD BANK borrowing capacity.28 After his visit, Bank operations in Japan became more active than ever. Consequently, a rush on loans ensued: eight projects totaling $174 mil- lion, including power projects, were approved by the Bank in just thirteen months. Following the Black mission, the Bank financed six power development projects, five of them hydroelectric. The most notable was the Kurobe No.4 (258,000-kW) project, for which the Bank granted an impact loan of $37 million. Kurobe Valley is located in the middle of a mountainous area, and power development had been considered since the early 1900s. Before the war five middle-size power stations were built, but their output was not enough to accommodate postwar increases in demand. In September 1957 the Japanese government applied for impact loans, including the one for Kurobe No.4. When appraisal work had been finished and loan negotiations were ready to wind up, Japanese newspapers reported that the power companies were to be reorganized. 29 This news made the Bank doubtful of the government's policy integrity as well as the viability of the project because reorganization appeared to make power companies financially even weaker through the merger of efficient companies with less efficient ones. So the Bank once more raised the question of the pricing of power. For clarification it demanded a letter from the Ministry for International Trade and Industry (MITI) stating that the government did not intend to merge power companies and that necessary actions to improve the financial positions of the power companies would be taken. This demand ignited fierce debates among politicians and bureaucrats, and the matter was brought before the cabinet. After two months of debate, the cabinet approved the MITI letter, although it had watered down the commitment to price increases. Thus even after five years of dealings, the government was still quite uncomfortable with Bank demands that involved touchy political matters. The loan agreement for the Kurobe project was signed on June 13, 1958, and "the dam project of the century" entered into full-fledged construction. The construction took seven years and introduced frontier technologies, which were employed later by other Bank-financed projects such as motorways and the bullet train. MOTORWAY PROJECTS. Plans for a motorway in the industrial belt stretching from Tokyo through Nagoya to Osaka had been on the table since the 1930s. Because of the war and postwar turbulence, the plan had been postponed, but as the economy grew, it became clear that the motorway was badly needed. In 1956 a team of American consultants headed by Ralph J. Watkins came to Japan and carried out extensive survey work on the state of the roads and issued a report, "Kobe-Nagoya Expressway Survey for the Ministry of Construction." The con- clusion of the report states concisely, "The roads of Japan are incredibly bad. No 28. In 1956 the annual growth rate of CDP was 6.4 percent and of manufacturing output 23.1 percent. See Shigeo Ohara, Nempyo de miru Nihon keizai no ashi doTi, 2d ed. [The History of Japan with a ChronolOgical Table] (Tokyo: Zaikei Shyouhou-sha, 1994), pp. 56-57. 29. After the war the national power company had been divided into nine companies. JAPAN AND THE WORLD BANK 287 other industrial nation has so completely neglected its highway system." And it adds that neglect of the system "is imposing a heavy cost burden on the Japanese economy."30 The Nihon Doro Kodan (Japan Highway Public Corporation) re- viewed the recommendations of tbe Watkins report and published its own report, which formed the foundation of the Bank appraisal work that followed. From the beginning the Nihon Doro Kodan contemplated bond financing for the project, but because of the poor performance of American toll road projects, the market for road construction bonds was unpromising. But the World Bank, follOwing the Black mission, indicated that it was willing to extend impact loans, and the Japanese government made a request in September 1957. A Bank fact- finding mission came to Japan in February 1958 and recommended that the Doro Kodan employ foreign consultants. The company requested its German counter- part to nominate an appropriate expert for the project. Xaner Dorsch, a veteran engineer of the German autobahn, visited Japan and gave detailed recommenda- tions on the design of the motorway. His recommendation included application of clothoid curve designing, which had become an international standard but had yet to be introduced in Japan. 31 Because of the "complete neglect," the basic know-how of motorway construc- tion was lacking in Japan, and construction companies had to rely heavily on foreign consultants. But Japanese road engineers mastered new technologies qUickly by working closely with the consultants. 32 The concept and importance of inde- pendent consultants was new to Japan, where in-house engineers dealt with tech- nical matters, which limited technical spillover as well as objective evaluation of technolOgies. Through their experiences with consultants, in-house engineers in road construction, plant engineering, power, telecommunications, and other in- dustries started to become indcpendent, and some have now achieved internation- al reputations. On March 17, 1960, almost four years after the Watkins report, the $40 million first loan for the Doro Kodan project was approved by the Bank. Five more loans, including the last Bank loan to Japan, followed, covering the cost of most of the motorway between Tokyo and Kobe. Although the loans to the Doro Kodan were impact loans, certain portions of the construction work were open to international competitive bidding. In the third loan an American construction company submitted the cheapest bid and was awarded 30. Kobe-Nagoya Expressway Survey Team, "Kobe-Nagoya Expressway Survey for the Ministry of Construction," August 1956, p. 14. 31. A clothoid is a curve such that the rate of changes in the direction of a car driving at constant speed is fixed; the driver need only tum the wheel at a constant speed. World Bank Tokyo Office, Segin shakkan kaisou [Memoir of the World Bank Loans to Japan] (Tokyo, 1991a), p. 69. 32. Xaner Dorsch and Paul Sonderegger, an American soil specialist, visited Japan every year until 1964. A group of engineers who worked closely~ith Dorsch called themselves the "Dorsch School." Nihon Doro Kodan, Sekai ginko shakkan keii, vol. 1 [The World Bank Loan] (Tokyo, 1969). 288 JAPAN AND THE WORLD BANK the contract. 33 This was the first foreign company to win a contract in a Bank project in Japan, and the Bank was pleased to know that international competitive bidding had proven effective. However, because the company could not establish cooperative relationships with local subcontractors and engineers, the progress of its work was slow and it finally canceled the contract. According to Doro Kodan records, there appeared to be two main reasons for the cancellation. First, because of an economic boom at the time, good local civil engineers were attracted by larger construction companies. Second, there had been a keiretsu relationship among Japanese contractors and subcontractors, and it was very difficult for a foreign company to get acceptance. In March 1961 Burke Knapp, vice president of the Bank, had a meeting with the finance minister and indicated that the proposed second loan to the Doro Kodan would be the Bank's last public sector loan to Japan. Loans to the private sector would also be gradually reduced. This was the first suggestion of Japan's graduation from World Bank loans. 34 At the Bank board, the matter of graduation was raised by developing countries whenever loans to Japan were discussed. On such oc- casions Japan claimed that although industrialization had progressed, the government was experiencing shortages of capital to improve the long-standing inadequacy of basic infrastructure. Officials also asserted that Japan was increasing its assistance to developing countries through International Development Association contribu- tions as well as bilateral assistance. 35 THE BULLET TRAIN. Today, the 500-kilometer trip from Tokyo to Osaka takes only two and one-half hours by Shinkansen bullet train. At the foot of the Shinkan- sen platform in Tokyo station there is a plaque with the inscription, "This railway was accomplished by the wisdom and toil of the nation." Indeed, as was the Tokyo-Kobe motorway, the bullet train was a long-standing project. It was first suggested to the Bank by Minister of Finance Eisaku Sato at the Bank-IMF annual meeting in 1958. Examination of the project and ofJapan National Railways (JNR), the prospective borrower, started soon after. In the initial stages the Bank was 33. According to a Bank official, this company was not a first-rate one in the United States, and the Bank was rather surprised to learn that it had been selected. Nihon Doro Kodan, Sekai ginko shakkan keii, vol. 3, p. 139. 34. Following Knapp's statement, Eugene Black also suggested Japan's graduation at a Bank board meeting, although he added he was prepared to consider additional loans if economic conditions changed. Consequently, Doro Kodan became pessimistic about addi- tionalloans from the Bank and sought to sell a bond issue in the U.S. market to finance the remaining part of the Tokyo-Kobe project. See the section "Graduation from the Bank Loans: What Japan Gained" later in this chapter. 35. Japan was an original member and the sixth largest contributor to IDA. Japanese bilateral assistance has its roots in 1950s and 1960s reparation payments to Asian countries that it formerly occupied. Japan's first attempt at development assistance was its participa- tion in the Colombo Plan in 1954. The first yen loan to a developing country was made to India in 1958 by the Export-Import Bank of Japan. The Overseas Economic Cooperation Fund, which deals with yen soft loans, was established in 1961. JAPAN AND THE WORLD BANK 289 cautious because the concepts presented by the Japanese government and the JNR appeared "experimental" and "glamorous."36 Bank staff insisted that, as a poliCY, the Bank could not extend loans for projects that included experimental elements. Their impression was that although a maximum speed of 150 kilometers per hour on international narrow gauge was acceptable, 250 kilometers per hour on standard gauge was too fast. The JNR explained that 250 kilometers per hour was an approximate figure decided politically and that new technologies employed for the project were already satisfactorily tested. 37 The Bank remained ullconvinced, but at least it was satisfied with the financial viability of the project and the financial health of the JNR.38 The economic impact of the project was understood to be an overall efficiency gain: speeding up passenger transport would allow additional cargo capacity on the existing parallelline.39 Finally the Bank agreed to send an appraisal mission, which visited Japan in May 1960. For a month it carried out detailed examinations fOCUSing on everything from the management strncture of the JNR to the project's design and its implementa- tion schedule. Its findings were favorable, and in May 1961 an agreement for an $80 million loan was Signed by Bank President Black and Chairman Shinji Sogou of the JNR. The loan \vas an impact loan, but like those for motorway projects, it included a portion open to international competitive bidding. Although some foreign com- panies were prequalified, they finally withdrew their bids. Land acquisition, imple- mented Simultaneously with constrnction work, was one of the most difficult elements of the project and took nearly five years to complete. The Shinkansen bullet train started commercial operations on October 1, 1964, ten days before the opening ceremony of the OlympiC games in Tokyo. It is ironic that although the bullet train itself was quite profitable, the JNR fell into deficit in 1964. Its financial position worsened, and finally it was liquidated and divided into six regional companies. 36. The proposal was to construct a railway with a maximum speed of 250 kilometers per hour, thus enabling a one-day return trip between the two metropolitan areas. The plan also envisaged introdUcing international standard-gauge tracks (the Japanese standard was inter- national narrow gauge). 37. These technolOgies included seamless superlong rails, a new type of rail bed, elec- tricity supply, specially designed trains, and an automatic train control system. Most had been developed domestically. Nihon Kokukyuu Tetsudou [japan National Railways], Nihon kokuyuu tetsudou hyaku-nen-shi, vol. 12 [Centenary of JNRl (Tokyo: Dainihon Insatsu, 1973). 38. The Bank demanded that train fares be increased enough to secure the financial health of the JNR. The fare increase was carried out, although it was politically very difficult. This episode suggests how badly the government needed the Bank loan. 39. There was a tricky part in this explanation. In the initial plan, cargo transport was included in the projcct, and it appears that the JNR took this line with the Bank. Ministry of Finance, "Okura-shou no rekishi tokoro dokoro" [A History of the Ministry of Finance], Finance, January 1994, p. 84. 290 JAPAN AND THE WORLD BANK Graduation from the Bank Loans: What Japan Gained As mentioned earlier, the first time Japan's graduation from World Bank loans was officially suggested was in 1961 by Knapp and Black. For a time no loans to Japan were approved by the board after the second motorway project in 1961. FollOwing their announced intentions, the Japanese government expanded bond financing in the private market. 40 However, in 1963 the interest equalization tax introduced by the U.S. government made Japan's bond issues in the New York market difficult to sell. In view of the situation, Minister of Finance Kakuei Tanaka met Bank President George Woods at the 1963 World Bank-IMF annual meeting in Washington and persuaded him to extend $300 million over three years. The first of the new loans, for the third motorway project, was approved by the board in September 1963 and six more in the next two years. At every Board meeting, however, it was suggested that Japan had developed enough to graduate from Bank loans. Indeed, it joined the Organization for Economic Cooperation and Development (OECD) in 1964 and also became an IMF Article 8 country that year. The Olympic games and the Bank-IMF annual meeting were held in Tokyo in 1964, thus exhibiting Japan's economic power. At the annual meeting, Prime Minister Ikeda concluded his statement by saying, "My country, let me say, is prepared to contribute even more positively than before to international cooperative endeavors."41 When George Woods visited Japan in October 1965, he told Minister of Finance Takeo Fukuda that the Bank-Japan relationship should go back to the 1961 status, meaning a loan to continue work on the Tokyo-Kobe motorway would be the last Bank lending operation in Japan. He said that the lending had been continued on condition that the Japanese government make every effort to raise the maximum amount possible in private markets, and Japan had become able to raise enough funds for its needs. Although Fukuda argued that there were limits to the financing available in private markets and Japan needed Bank loans, which would also endorse its creditworthiness, Woods's stance was adamant. 42 Following the meet- ing, Japanese government officials were informally prepared to give up further loans from the Bank and were mainly concerned with limiting the psycholOgical damage to the Japanese economy. The last loan for the Tokyo-Kobe motorway was approved by the board on July 29, 1966, and Japan graduated from thirteen years of Bank lending. The Asian Development Bank, in which Japan and the United States were the largest share- 40. The first foreign currency bond was issued in the New York market in 1959 for a hydroelectric project. This was part of a parallel loan from the Bank. 41. Hayatci Ikeda, "Address by the Prime Minister of Japan," Summary Proceedings, Annual Meeting 1964 (Washington: International Monetary Fund, 1964), p. 4. 42. Ministry of Finance officials had examined a possible buy-back operation of Japan's debt to the Bank, thus raising the ceilings on the fresh loans to Japan. However, the idea was finally abandoned and was not presented to Woods. JAPAN AND THE WORLD BANK 291 holders and the president was Japanese, had its inaugural meeting in Tokyo, gathering representatives from more than thirty countries. Thus, as former prime minister Ikeda had declared, Japan embarked on its way to becoming the world's largest provider of economic assistance to developing countries. The thirty-one Bank loans to Japan totaled $857 million net of cancellations. What did the loans bring to the nation? Quantitatively, the share of borrowing from the Bank amounted to 18.7 percent of total borrowing from 1959 to 1964; borrow- ingfrom the United States amounted to 67.4 percent of total borrowing in the same period. Borrowing from the Bank was thus helpful but quantitatively not decisive. However, the qualitative impact of the Bank loans appears to be more important. New construction technologies were brought in, developed, and learned \vith the Bank projects, as in the Kurohe No. 4 and motorway projects. The Bank's loan conditions had a side effect akin to technology transfer. The Bank often imposed conditions of financial soundness on executing agencies and had them change their pricing policies. Such actions provoked debates and friction among the Japanese, but it is undeniable that they realized the importance of the conditions and made efforts to improve the financial positions of steel and other companies. For their part, the Bank staff learned that the Japanese way of doing business was different from the American or European way. Initially, the disparity caused some difficulties, but as dealings became more common, Bank oftlcials established a cordial relationship \vith their Japanese counterparts. In the later stages, Bank oftlcials learned a mixed approach to dealing with the Japanese: sometimes they used coercive methods; in other cases they nurtured. vVhen Japanese officials faced coercive demands, they, though superfiCially annoyed, sometimes explOited the demands as external leverage (gaiatsu) to launch difficult policy alterations. On July 16, 1990, the Doro Kodan repaid the last of its debt obligation, and Japan genUinely graduated from a Bank borrower to a large shareholder. Becoming the Second-Largest Shareholder Once they were eonvinced that there would be no further loans from the Bank, Japanese government oftlcials started to seek genuine graduation from the Bank- that is, for Japan to become a net creditor to the Bank. Initially, a debt buyback operation, such that credits to Japan on the Bank balance sheet would be reduced, was eonsidered. However, the Bank rejected the idea on the grounds that it needed to keep creditworthy borrowers like Japan on its balance sheet to maintain its AAA status. 43 So the Japanese government decided to participate in the Bank's horrow- ing operations, thus becoming a net creditor to it. In 1969 the Bank of Japan 43. During the 19805 when the debt erisis in Latin Ameriea cast a pall over American bond markets, a Bank finanCing officer suecessfully convinced some West Coast security houses to buy Bank bonds by pointing out that the Bank had a good portfoliO, including loans to Japan and European cmmtries. 292 JAPAN AND THE WORLD BANK purchased $162.5 million of Bank loans in prepayment of Bank loans to Japan. The Bank's first borrowing in Japan was in 1970 when two issues of serial bonds of ¥36 billion each ($100 million) were sold to the Bank ofJapan. In 1971 the Bank of Japan purchased two more issues of serial bonds (¥36 billion). These purchases totaled more than $500 million, which exceeded the $450 million of Japanese debt outstanding to the Bank. Hence, Japan became a net creditor to the Bank only five years after the last loan. In addition, as a result of the 1970 general capital increase, which lifted it from the seventh largest shareholder to the fifth, Japan obtained an appointed seat on the board of executive directors in 1971, thus increasing its influence on Bank operations. TOKYO OFFICE: HARBINGER IN THE TOKYO MARKET. When Japan joined the OEeD, commitments were made to liberalize the country's current account and to achieve greater capital mobility. Liberalization measures were announced in June 1966, and Japan gradually opened its capital markets. Following these actions, the Bank opened its office in Tokyo in November 1970. The objectives of the Tokyo office were liaison with the Japanese government, assisting Bank borrOwing opera- tions in Japan, public relations, and recruitment of Japanese nationals to work in the Bank. However, borrowing operations were emphasized, and the office has been reporting to the Office of the Vice President (Treasurer) ever since. Aritoshi Soejima was appointed director of the office on the recommendation of the Minis- try of Finance: such an arrangement has continued to this day. This was because Robert McNamara, then Bank preSident, was convinced of the future prospects of the Tokyo market. The first Bank samurai bond (a nonresident yen bond issued in Tokyo) of ¥ll billion ($30.6 million) was issued in the Tokyo market on June 30, 1971. 44 Thereafter, the Bank enhanced its samurai bond operations until 1986, except for the period from 1973 to 1977 when an interest rate surge made issuing bonds difficult. In 1984, after U.S.-Japan talks, liberalization of the Japanese capital markets and the internationalization of the yen were announced. The Bank, having issued a modest amount of Euroyen bonds, promptly reacted to the announce- ment, and the number of Euroyen bond issues greatly increased. In view of such developments, the Bank introduced a Euro-linked Daimyo bond (a ¥40 billion, or $286.7 million, nonresident yen bond issued in Tokyo and settled in the Euro- market) in 1987, thus enabling more efficient borrowing operations. In 1985 the Bank introduced the first Shogun bond (a nonresident foreign currency bond issued in Tokyo) in the Tokyo market. As a result of less favorable conditions in the Tokyo market because of heavy regulation and unique business customs, only six Shogun bonds were issued by the Bank before 1989. This raised a question about the unique characteristics of the Tokyo market. Since 1991 the Bank has shifted its 44. The very first samurai bond, for ¥6 billion ($16.7 million), was issued by the Asian Development Bank in November 1970. JAPAN AND THE WORLD BANK 293 yen borrowing program to global yen bonds, which was another of its innovations, and the efficiency of the borrowing operations was further improved through full integration of the Tokyo, New York, and Euromarkets. The Bank has been a harbinger in the yen capital markets. In each operation the Tokyo office has functioned as liaison with the government of Japan and with the Tokyo capital market community. Its relationship with the Ministry of Finance has been especially important: it would have been difficult to persuade the ministry to permit snch innovative funding methods had the director been sent from Bank headquarters and unfamiliar with Japanese business customs and with the ins and outs of government functions. THE SELECTED CAPITAL INCREASE OF 1984. In the early 1970s Japan recorded a huge balance of payments surplus annually and, in the wake of foreign pressure that arose from trade imbalances, reduction of its trade surplus became an impor- tant policy matter. Moreover, the 1973 oil shock, which hampered the Japanese economy, revealed the importance of multilateral aid as a means of economic diplomacy. Consequently, in 1977 the government announced that Japan would double its overseas direct aid in five years; in 1978 a revised target was announced as the first medium-term aid goal-a doubling of aid by 1980. The first target was more than achieved, and since then, in line with its increasing economic power, Japan has announced five medium-term targets.4.5 In addition, the first surplus recycling scheme, which included non-aid resources, was announced in 1986, followed by the second and the third, and developed into the Fund for Develop- ment Initiative, announced in 1993. 46 These initiatives contributed to mitigating developing countries' debt problems in the 1980s. Although the amount of economic assistance expanded rapidly, the lack of a co- herent philosophy about it caused criticisms that the aid was faceless. So in 1992 the concept of Japan's eG'Onomic assistance was stated as the Overseas Development Aid Charter and was authenticated by the cabinet. This delay in conceptualization does not mean that Japan's assistance before the charter lacked coherence, but it comes from the very nature of the Japanese: they are too practical to conceptualize their deed. Against this background, Japan increased contributions through the international financial institutions, among them the Bank group. The contributions were spurred by political as well as economic reasons. In view of the country's increasing impor- 45. Those are the second (doubling overseas direct aid from 1981 to 1985, which fell short of the target); the third (more than $40 billion from 1986 to 1992, which was achieved in 1987); the fourth (doubling aid from 1988 to 1992, which was nearly achieved); and the fifth ($70 billion to $75 billion from 1993 to 1997), which was announced in 1993. 46. These were the first (1986; $10 billion contributions to the IMF, subSCriptions to multilateral development banks, participation in the banks' borrOwing programs, and estab- lishment of the Japan Special Fund in the Bank); the second (1987; $20 billion in five years); and the third (1989; $65 billion from 1987 to 1992). All have been achieved. The Fund for Development Initiative is expected to provide $70 billion of untied aid funds and $50 billion of non-aid funds. 294 JAPAN AND THE WORLD BANK tance in the global economy (japan's GNP had become second only to that of the United States in 1968), public opinion demanded that Japan's position at the fmancial institutions be in line with its international economic standing. 47 Japan is an Original member of the International Finance Corporation (IFC) and the Inter- national Development Association ( IDA), and its original rankings were the seventh and sixth largest contributor, respectively. During the IDA 5 negotiations (1975-77), Japan first demanded that its shares at IDA and the International Bank for Reconstruction and Development (IBRD) be harmonized. Its cumulative contribution to IDA was proportionally twice as much as its subscription to IBRD capital. However, Japan's claim was not heard by other countries. The Bank, basically welcoming Japan's intention to increase its shareholding at the IBRD, proposed a selective capital increase that would have raised the count!)' to the equivalent of the German position. 48 After debates among major shareholders, it was decided that a simultaneous selective capital increase, which would keep France in a slightly higher position than Japan, be proposed. Finally as a compromise, Japan got 4,000 unallocated shares while France received 1,900, and Japan, Germany, and France were almost equally placed. However, Japan still remained the fifth largest shareholder of the IBRD. Concurrently, a general capital increase was put on the table as early as 1977 by Bank President McNamara, and discussions were held. The capital increase was needed because of a predicted shortage of capital and was deemed urgent. Therefore, no fundamental reshuffiing of share ranking was discussed. Finally, it was concluded in 1980 by a proportional increase of capital from post-1979 selective capital increase shareholding: Japan again remained the fifth. In 1983 at the IMF's eighth general quota review, Japan was allocated 10 per- cent of the selective quota increase, which meant that its position at the IBRD would be automatically raised by an associated selective capital increase. Although there were again extensive discussions among other shareholders, they led to a conclusion favorable to Japan. Therefore the 1984 selective capital increase finally raised Japan to the pOSition of second largest shareholder of the IBRD. At the same time, IDA 7 replenishment was being discussed, and Japan's contribution to IDA was increased conSiderably. There are several factors behind this sto!), of Japan's "getting the right place." First, Japan's persistent trade surplus and the emerging debt problems of develop- ing countries placed international pressure on the country to increase its contribu- tion to poorer countries. Second, the United States, suffering from a huge fiscal 47. In 1977 the Diet, upon passing laws related to the IDA 5 replenishment, resolved that Japan's "de facto economic power" be reflected in the coming IMF fifth general review of quota. Japan's position at the IMF was fifth after IMF 5, as it was at the International Bank for Reconstruction and Development. Such resolutions had been customary until Japan became the second largest shareholder of the Bank. 48. At the same time, IDA 6 replenishment was under discussion. JAPAN AND THE WORLD BANK 295 deficit, was unable to maintain the traditional high burden sharing, especially in IDA. As long as its dominant position was unaffected, it had every reason to support Japan's increasing contribution to the Bank as a whole. Third, the other industrial countries had problems similar to those of the United States, and the impossibility of increasing their contributions overcame political pressure to main- tain their positions. Fourth, by enhancing contributions to IDA, Japan was able to obtain enthusiastic support from developing countries. Japan as Second-Largest Shareholder THE JAPAN SPECIAL FUND AND THE POLICY AND HUMAN RESOURCES DEVELOPMENT FUND, In the context of surplus recycling, Japan established the Japan Special Fund along with a scholarship fund and a consultant trust fund with the Bank in 1987. The JSF was counted as part of the surplus recycling scheme, and the initial endowment was ¥30 billion of untied grants in three years. The purpose of the JSF was to help the Bank prepare projects and at the same time to alleviate the financial burden on developing countries that was associated with preparation. In view of urgent needs for human resource development and sound economic policies in developing countries, an announcement was made at the 1990 World Bank-IMF annual meeting by Ryutaro Hashimoto, Japanese minister of fmance, that these funds were to be added to and integrated into the Policy and Human Resources Development (PHRD) Fund. 49 The PHRD includes teclmical assistance grants that include funds for environmen- tal protection activities, women-in-development activities, and private sector develop- ment activities, thus fOCUSing on the crosscutting issues. The fund also includes training grants through the Economic Development Institute, a training wing of the Bank; a consultant trust fund; and a scholarship fund. The initial PHRD endowment was ¥14.2 billion in 1990, and the amount has been expanding in line with the increasing demand for such technical assistance, notably assistance to former plarmed economies. The main feature of the PHRD is that, although the endowment is a Japanese grant fund, its procurement is basically lmtied and management of the fund is completely delegated to the Bank. Compared \vith other bilateral grant funds with the Bank, which are normally tied to donor countries and their use controlled by donor discretion, the amount of the PHRD is far bigger and more flexible. Therefore, according to a recent survey by the Bank, task managers responded that the PHRD is by far the best means available for project preparation. Indeed, it appears that there are internal competi- tions to capture the lion's share of the fund. As a result, its geographical distribution is more or less in line with the Bank's operations. With the traditional UN Development Program (UNDP) funding for project preparation declining, the PHRD is now the main source for Bank project prepara- 49. World Bank, Cofinancing Services, "Policy and Human Resources Development Fund: Japanese Grant Facility: Operational Review" (1993). 296 JAPAN AND THE WORLD BANK tion and welcomed in and outside the Bank. Some might argue that the fund is a means for Japan to influence the Bank beyond the eountry's voting power there. 50 The argument is intriguing, but it does not capture the true nature of the PHRD. The management of the PHRD is largely delegated to the Bank, and the government of Japan's say is limited to the overall ceiling of the grant and, if any, its inclination toward project preparation rather than implementation support, thus leaving the geographical distribution and choice of individual projeets to the Bank. This is the key reason for the PHRD's wide appreciation among the Bank's managers. COFINANCING OPERATIONS. Japan was one of the original members of the Consultative Group meetings when the Aid-India consortium launched them in 19.58, but cofinancing with the Bank rapidly increased during the late 19705 along with the successive overseas direet aid targets and surplus reeycling initiatives. Japan's eofinancing in fiscal years 1984 to 1993 was $16.4 billion, or 46 ..5 percent of the Bank's total cofinancing operations. Japan is by far the largest eofinaneier, followed by Germany, whose share remains 7 percent. There are several reasons why Japan's cofinancing effort increased. First, having made various commitments, Japan needed to increase its financial contributions to developing countries, Second, Japan did not have enough institutional capacity for project formulation because of a lack of expertise in aid-providing agencies as well as a scarcity of internationally qualified consultants. Third, because of this deficien- cy, Japan needed certain know-how from the Bank: indeed Japan's aid agencies have assimilated the Bank's procedures and organizational struchlre. During the 19805, cofinancing with the Bank was distributed to almost all the world's regions. In the wake of debt problems, cofinancing of structural adjustment lending increased. In the 19905, as the Japanese government and its aid agencies have accumulated extensive experience in Southeast Asia, they have obtained their own capaeity for project formulation; thus cofinaneing operations in Southeast Asia are on the decline. Also, the share of adjustment lending in eofinancing is decreas- ing, reflecting the declining needs for balance of payments finance in many coun- tries. However, in regions with which Japan is not familiar, sllch as Latin America, Africa, and to a lesser degree South Asia, aid agencies are still learning and need the Bank's expertise. So in 1993, the idea of the Accelerated Cofinancing Facilities was proposed. An ACF is intended to streamline procedures associated with co financing, thus drawing on the Bank's expertise as much as pOSSible. Through such a faCility, the Japanese government and its aid agencies are expected to acquire more know-how. It appears that some vvithin the Bank are not satisfied with increased cofinanc- ing operations, as can he seen from the so-called Wapenhans report. 51 The report 50. See, for example, Edward J. Lincoln,japan's New Global Role (Brookings, 1993). 51. World Bank, "Effective Implementation: Key to Development Impact," Portfolio Management Task Force Report (''The Wapenhans Report") (Washington, September 1992), R92-195. JAPAN AND THE WORLD BANK 297 implies that cofinancing increases the probability of poor project performance through complicated procedures associated with the financing, although on average the report appreciates cofinancing as a critical means of filling funding gaps. Criticisms aim mainly at tied cofinancing, which entails extra loan conditions and special rules on procurement. However, this was not the case for Japan; its cofinancing loans are all untied. Indeed, a task force on cofinancing gave a positive assessment of Japan's cofinancing operations with the Bank. Yct most of thc opera- tions work in one way: the Bank prepares the projects and Japan follows. Thus it is now all the more desirable that the Bank-Japan relationship centered on cofinanc- ing be raised to an equal partnership. The Asian Perspective Japan's Experience Japan's economic development is often called a miracle, but economic develop- ment is a historical product and by no means a miraculous phenomenon. For Japan the miracle hypotheSiS focuses on postwar development. However, the postwar period does not tell the whole story. From the Meiji Restoration in 1868 until World War II, Japan acquired most of what constitutes the foundation of a modem SOciety-legal system, bureaucracy, military system, banking system, and so on. In the early stages, basic knowledge was acquired from foreign experts employed by the government. Learning was fast, and soon the government initiated state-led economic development ·with a slogan, "progress toward wealth and might": this period can genUinely be called the state development phase. At the same time, a universal education system was introduced; this broadened the human resource base, which also contributed to postwar development. After the tum of the century, industrialization, mainly by financial cliques, gained momentum, and Japan was equipped with most of the heavy industries, bolstered by imported natural resour- (.'Cs from Asia. A bank-centered financial system, along with the postal savings system, evolved and mobilized funds for industrialization. In view of the lack of human resources and basic economic frameworks in todays developing countries, lessons from Japan's prewar experience have no less relevance to the developing countries than its postwar experience. These experiences are the broadening of the human resource base, technology transfer and acquisition through learning by dOing, and the bank--centered financial system. In looking into postwar development, the important pOint is that those bases were inherited from before the \var. Although they were conSiderably damaged by World War II, the fundamentals for rapid growth were already there. A., such, it is recommended that much greater attention be paid to, and lessons be drawn from, Japan's prewar experience. japan's postwar development is well known and described in various publica- tions, including The East Asian Miracle by the World Bank, and need not be 298 JAPAN AND THE WORLD BANK 52 repeated here. The main features of postwar development arc maintenance of a stable macroeconomy, except for the periods after the oil shocks; the role played by the Fiscal Investment and Loan Program (FILP); export development; bank- oriented flnance; and good corporate governance and management. Most of these points are elaborated on in The East Asian Miracle, but somc are discussed below. The Way to The East Asian Miracle Study In 1989 the government of Japan received a request from a member of the Association of Southeast Asian Nations for an Overseas Economic Cooperation Fund loan from the ASEAN-Japan Development Fund (AJDF). The fund was founded in 1987 as part of the surplus recycling plan and was intended to provide concessional resources to foster private sectors in ASEAN countries. It has two components: one is for intra-ASEAN projects and the other for concessional two-step loans (on-lending) to small- and medium-scale industries that support export manufacturing in ASEAN countries. This type of loan had been extended to various Asian countries based on the Japanese perception that to support prospec- tive private sectors it was necessary for the second-step loans to be concessional, provided tbe target has been identifled and targeting has worked. This was a belief derived from Japan's own experience through FILP. The World Bank, however, insisted that interest rates be on the market-clearing level because preferential rates would distort fmancial markets and harm economic development. Such a pcrccption is obviously based on a neoclassical view of financial markets. The Bank's neoclassical perception has its origin in Ronald McKinnon's work and is as follows. 53 Many developing countries adopted policies of flnancial repression under which the government kept interest rates artificially low. As a result, credit rationing was unavoidable, and savings were further dis- couraged because of negative real interest rates. Credit rationing, however, tended to result in misallocation of resources due to imperfect information and institution- al wealmess: after all, money is fungible and targeting would not work. Thus McKinnon's (and the Bank's) prescription for developing countries was to liberalize the flnancial market so as to attain market-determined interest rates that would "correct" the misallocation of resources. As far as the particular OECF loan was concerned, a compromise was reached. However, the issue did not end \vith just a compromise: both the Bank and OECF staffs were aware that the difference was fundamental. The Bank's attitude was based on rigorous economic theories and its experiences in Latin America and 52. See World Bank, The East Asian Miracle: Economic Growth and Public Policy (Oxford University Press, 1993); Ryutaro Komiya, Masahiro Okuno, and Kotaro Suzumura, Industrial Policy ofJapan (Academic 1988). 53. Ronald L McKinnon, Money and Capital in Economic Development (Brookings, 1973). JAPAN AND THE WORLD BANK 299 Africa, where most such schemes had failed. The OECF's ideas relied more on experiences in Japan and in other Asian countries, where many successful cases had been obseIVed. Both parties shared the view that developing countries had a lot of market malfunctioning and failures. But as for the remedies, their views differed. The Bank, having experienced ample eXoo'1mples of failed attempts of government inteIVentions (some of them had been advised and supported by the Bank during the 1950s and 1960s) and their aftermaths, concluded that the market failures were much less costly than "government failures," thus more or less rejecting govern- ment inteIVentions. 54 The Bank's position was that, where appropriate, subsidies should be proVided out of fiscal budgets rather than in the form of subsidized interest rates so as to maintain the transparency and directness of the subsidies. Japanese officials, priding themselves on their successful economic policies, believed that the extensive market failures in developing countries justified govern- ment inteIVentions; and as long as targeting worked, such subsidized loans were an effective means to foster economic development. 55 They argued that economic theory did not say that fiscal subsidies were preferable to subsidized interest rates. Moreover, they claimed that subsidized interest rates did not encourage corruption and misallocation of resources, although such tendencies did exist in certain sectors of the economy. They concluded that as long as there was no theoretical reason to deny subsidized interest rates, the problems raised by the Bank could be controlled through adequate supervision by the recipient countries and tlle donors. FollOwing these discussions, the OECF issued an occasional paper, the first in its thirty-year history, discussing not only the two-step loans but also the Bank's approach to structural adjustment.56 The fad that the organization issued its first occasional paper after thirty years, whereas the Bank had issued numerous discus- sion papers and working papers, reflects the difference in working styles between the OECF (or tl1e Japanese government) and the Bank. 57 The Bank is paper oriented or reasoning oriented, while the Japanese are more experience oriented. 58 The OECF paper raises several points on the need for investment promotion, infant industry protection and export promotion, financial market policy, and a slower privati7Altion process. The main points of the paper are as follows: 54. See, for example, Anne O. Krueger, "Government Failures in Development," Journal of Economic Perspectives, vol. 4, no. 3 (summer 1991), pp. 9-23; World Bank, World Development Report (Washington, 1991). 55. See Isao Kubota, "The Case for Two Step Loans," paper prepared for the World Bank-Overseas Economic Cooperation Fund biannual consultation meeting, May 1991. 56. Overseas Economic Cooperation Fund, "Issues Related to the World Bank's Ap- proach to Structural Adjustment: Proposal from a Major Partner," OEeF Research Quarter- ly, no. 73 (1991), pp. 4-18. 57. The OECF so far has issued just a few occasional papers. 58. This might be a bit of an exaggeration. The Japanese government and its affiliated institutions are increasingly voicing their views on economic policies in the fonn of papers. See note 50, for example. 300 JAPAN AND THE WORLD BANK 1. Streamlining procedures and liberaliZing markets may not be sufficient to induce continuous waves of investment. In such cases, investment promotion aiming directly at prospective industries is required. 2. The costs associated with hasty trade liberalization are large. Rapid liberali- zation tends to result in static comparative advantage, which does not reflect dynamic aspects of economic development. Thus due attention should be paid to the liberalization process and some infant industries need time-bound protection from international competition. At the same time, efforts to promote prospective export sectors are necessary. 3. The financial markets in developing countries are incomplete and the Signal- ing function of interest rates does not work. Also, due to various market failures, market mechanism has its limitations and does not necessarily bring the optimal allocation of resources. 4. Although needs for privatization are understandable, the Bank's rather uni- versal approach is not sufficient: situations are different among countries and a more country- and situation-specific approach should be sought. Moreover, priva- tization through foreign participation is politically not always sustainable, though it could be efficient. 5. Japanese fiscal and monetary poliCies in the postwar era may be worthy of consideration. These are centered on preferential tax treatment and development finance institutions lending. The paper, although offering nothing new theoretically, was reported as the government's rebuttal to the Bank's approach and attracted considerable atten- tion. 59 However, the Japanese in principle understood the importance of market- based development and by no means intended to supplant the market-oriented views held by the Bank: they just pointed out the limits of the textbook approach to development. In 1991 the Bank issued the World Development Report subtitled The Chal- lenge of Development in which a "market-friendly approach" was proposed. The approach, although based on the neoclassical framework, acknowledges some areas such as education, health, and other basic human needs in which government has comparative advantage and is encouraged to act aggreSSively. At the same time, the report endorses the neoclassical pereeption that government should not be the main actor in manufacturing and certain service sectors where the private sector has the advantage. Many development practitioners appreCiated the approach as a step forward from the textbook approach, but some were not satisfied and the government-versus-market debates continued. 59. For comments from British academics and policymakers, see Kazumi Goto, Nemure- ru paatonaa no chiteki 1I1e"",ame: Kouzou Chousei ni kansuru OECF ronbun ni yoserareta Eikoku karano messeiji a chushin to shite [The Intellectual Awakening of a Sleeping Partner: Some Comments from the U.K. on OECF's View of Structural Adjustment}, OECF Re- search Quarterly, no. 76 (1993), pp. 151-83. JAPAN AND THE WORLD BANK 301 These debates were strongly influenced by trends in economic literature. During the late 1970s and early 1980s, a new "classical" revolution occurred that almost supplanted Keynesian-oriented views. The new classicists believed in laissez faire and through rigorous mathematical deduction showed that any government attempts to alter an economy would be nullified by superrational, farSighted economic agents. The thesis was attractive for policymakers who had experienced huge fiscal and external imbalances as a result of the oil shocks, and the new classicists preVailed, particularly in the United States. The Japanese, especially government officials, though somewhat attracted by the thesis, in prin- ciple remained under Keynesian influence because the thesis seemed too abstract and incompatible with reality. They also doubted the value of complete laissez faire. 60 Since the early 1980s, new Keynesians have emerged, empha~izing the impor- tance of market failures such as coordination failures and increasing returns to scale in explaining the real economy. Now in the 1990s the two parties coexist: the new classicists have made their model~ more sophisticated, and the new Keynes- ians have broadened their areas of analysis. Against such a background, the Bank's inclination toward the neoclassical view may be partly due to the fact that most Bank economists were trained in or influenced by the new classical dominance during the 1970s and 19805. Indeed, during the 19505 and 1960s, when tlle Keynesian view prevailed, the Bank sup- ported state-led projects in many countries. Or, the inclination could be explained in another way: as a borrower from the international financial markets, where laissez faire has been sacrosanct, the Bank needs to satisfY the institutional inves- tors who buy its bonds by maintaining an AAA rating. East Asian Miracle Study Such was the prelude to the East Asian Miracle study. At the Bank-IMF annual meeting in 1991, Yasushi Mieno, governor of the Bank of Japan and World Bank alternate governor for Japan, said, "Experience[sl in Asia have shown that although development strategies require a healthy respect for market mechanisms, the role of the government cannot be forgotten. I would like to see the World Bank and the IMF take the lead in a wide-ranging study that would define the theoretical 60. The Ministry of International Trade and Industry published policy recommendations in 1992 for Russia's economic refonn based on Japan's postwar experience. The paper argued that Russia should apply gradualism, not "shock therapy," and recommended an industrial policy similar to Japan's PPS and selective interventions. The papers were taken up by various media including the Financial Times, July 20, 1992, and the Far Eastern Economic Review, August 13, 1992. However, such policy measures should not be applied in view of Russia's political situation-too many opportunists and a weak central government. 302 JAPAN AND THE WORLD BANK underpinnings of this approach and clarity the areas in which it can be successfully applied to other parts of the globe."61 It is true that the Japanese government encouraged the Bank to conduct a study of the experiences of East Asian countries in view of their successful economic development and economic policies. But it appears that it was Lawrence Summers, then vice president for policy, research, and external affairs at the Bank, who initiated the study. The study was officially launched in the spring of 1992 when the study team headed by John Page was formed. The Japanese government did not intervene in the research or the writing of the report, except for asking the Bank to ensure that the draft report should be commented on by Asian researchers and former government officials, a rare occurrence in Bank studies. The researchers were mainly American-trained Asian economists. The Japan Development Bank participated in the study and prepared a report on japan's policy-based finance. As drafts came up for review, considerable discussion was induced among Bank staff on the report's evaluation of the role of government policies in economic growth. Some of the staff were not satisfied with the approval of active government intervention, and the discussions in the report seemed to have been somewhat watered down. Finally, the report was released at the IMF -Bank annual meeting in 1993, and attracted much media attention. The major findings are: -The East Asian countries have been unusually successful in sharing the benefits of growth, while achieving a remarkable record of economic growth. -It is confirmed that "getting fundamentals right," including stable macro- economic management, investment in people, establishment of secure financial systems, and unbiased agricultural policies, was imperative for sustained economic growth. -The East Asian countries applied selective policy measures, including in- dustrial policies, directed credit schemes, and e""port promotion, of which export promotion particularly seems to have contributed to the economic growth in those countries. -As for applicability of those experiences to today's developing countries, "getting fundamentals right" can be applied in any country \vithout reservation, and selective intervention policies are generally not recommendable to the developing countries where institutional capacity is not sufficient. However, the scope for export promotion remains substantial even in today's international economic emironment. It would be fair to say that the report's conclusion is a subtle mixture (and compromise) of the neoclassical and interventionist views. It could also be said to be inconclusive and equivocal. Indeed, when the report was made public, some critics argued that the Bank had finally admitted that interventionist policies 61. Yasushi Mieno, "Statement by the Alternate Governor of the Bank and Fund for Japan," Summanj Proceedings, Forty-Sixth Annual Meeting of the Board of Governors, 1991 (Washington: International Monetary Fund, 1991), p. 67. JAPAN AND THE WORLD BANK 303 worked while others observed that the Bank's neoclassical stance did not change at alL The media highlighted the East Asian Miracle affair as a dispute between the Bank and Japanese experts. However, such an obseIVation does not do justice to the Japanese government. The government's critique of the Bank's view, if any, was intended to contribute to improving development policies; it was not intended to become part of academic disputes. In this regard, it is all the more welcome that the report attracted much attention and that a lot of discussion has been induced around the globe. These discussions in and out of the Bank should further deepen the study's influence, which would add more choices to development policy measures. In this connection, it is worthwhile to raise some points that were not well articulated in the report. First, links between the East Asian countries should be studied more fully in view of the recent horizontal division of labor among countries through direct investment and other means. This division of labor was first raised by Kaname Akamatsu as the "flying geese theory" in the 1930s and has now been analyzed in more rigorous frameworks. 62 Second, the microstructures of manage- ment and corporate governance in the East Asian countries should be more thoroughly explored, although they may not be separable from the cultural back- ground. It seems that the Japanese style of management, under which staff mem- bers work together in a large room, facilitates close coordination and information sharing, thus aVOiding possible coordination failures. 53 Finally, the applicability of East Asian lessons to other developing countries should be carefully examined in light of the socioeconomic situations in the countries concerned. Comparison u;ith the Asian Development Bank The Asian Development Bank was established in 1966. The regional develop- ment banks, that is, the Inter-American Development Bank (1960) and the African Development Bank (1964), were already in existence. The idea of creating a similar institution in Asia had popped up at various forums in Asia. In Japan, as early as 1963, a group of private experts chaired by Takeshi Watanabe, who later became the first preSident of the AD B, produced a rough outline of the new regional bank. According to the outline, the bank should be capitalized with $3 billion, of which the United States and Japan would subscribe 30 percent each. Membership would be extended to nonregional industrial countries with the aim of explOiting a wider resource base. The bank's headquarters were planned to be set up in Tokyo. In 1964 at the UN Economic Commission for Asia and the Far East (ECAFE) meeting in Manila, a motion was adopted to convene the Experts Meeting for the 62. Kanarne Akamatsu, "Shinkoku Kogyokoku no Sangyou Hatten," Uedo Teijiro Hakushi Kinen Ronbunshu, vol. 4 (July 1937); Gene M. Grossman and Elhanan Helpman, Innovation and Growth in the Gwbal Economy (MIT Press, 1991). 63. Masahiko Aoki, Information, Incentives, and Bargaining in the Japanese Economy (Cambridge University Press, 1988). 304 JAPAN AND THE WORLD BANK Establishment of the Asian Development Bank. The most controversial issue discussed at the meeting was whether to invite non-Asian developed countries to join the bank. Representatives of developing Asian countries expressed a strong preference for limiting the membership to Asian countries, follOwing the formula adopted by the African Development Bank. In the end, however, the Japanese argument in favor of non-Asian membership prevailed. At the ECAFE meeting in New Zealand in March 1965, an intergovernmental conference was established to finalize the plan. In the early stages the United States remained noncommittaL Eugene Black, former president of the World Bank, was most instrumental in persuading the U.S. government of the importance of membership in the bank. The United States decided to join the ADB with an equal share with Japan of 20 percent of total capital. The inaugural meeting of the bank was held in Tokyo in 1966. The bank's headquarters were established in Manila, and Takeshi Watanabe, fornler executive director of the World Bank and senior officer of the Japanese Ministry of Finance was elected the first president. In many respects Watanabe molded the corporate philosophy and corporate culture of the Asian Development bank. During his preSidency Watanabe insisted on two principles. The first was that the organization was a bank and not an aid-giving agency. His first job as president was to visit major international capital markets and creditor governments with the aim of convincing them of the bank's sound operational policy. In spite of strong political pressure from wishful develop- ing members, the bank took more than a year to make its first loan. The second principle Watanabe insisted on was that the bank's role should be similar to that of a family doctor: it should be fully familiar with the condition of each member of the family, and it should be ready to rush to the patient to provide first aid. Since the Asian Development Bank is a modest institution, a patient in critical condition who requires a big operation needs to be transferred to a big hospital-the World Bank. Watanabe's gospel has been inherited by the five Japanese presidents who succeeded him. The organization has managed to maintain its status as the soundest regional bank. It has also preserved certain regional characteristics such as its strong emphaSiS on agricultural development and the improvement of public infrastructure. It cannot be denied that its activity as the family doctor contributed to nurturing the developmental dynamism in the region that was unleashed in the 19808. The economic situation in East Asia has changed dramatically over the past two decades. The achievement of self-sufficiency in food production is no longer a major economic issue in the region. And a wave of privatization has been spreading. Large amounts of foreign private capital have flown into the region in various forms. As a result, the Asian Development Bank's role needs to be adapted accordingly. The bank was the fIrst international institution in which Japan shared equal leadership wi.th the United States. Accordingly, the U.S.-Japan relationship has JAPAN AND THE WORLD BANK 305 been the critical factor in the management of the bank. On the whole, the two largest shareholders have succeeded iu working together productively. There have been times when their views on the bank's operational strategy and the issue of capital replenishment have differed, but the rifts have been ironed out before they paralyzed the bank's operations. The United States has supported the continued Japanese presidency and refrained from making overt demonstrations of power. Japan has also made the utmost effort to reach a compromise with U.S. positions and has not dared to fonn a regional alliance to resist the nonregional influence. From the very inception of the bank, it has been obvious that U.S.-Japan coopera- tion was truly vital to the successful development of the institution. Fortunately, all parties concerned seem to be fully aware of the situation. The relation between the Asian Development Bank and the World Bank has also been a c-'Ooperative one, although with certain elements of healthy competi- tion. Around the time of the establishment of the Asian Development Bank in 1966, President Watanabe paid his respects to George Woods, president of the World Bank, in Woods's office in Washington and asked if the World Bank could spare a few experienced staff members to train the new recruits at the ADB. Woods turned down the request, reminding Watanabe that they were competitors. The idea of creating a relationship of "family doctor versus big hospital" between the ADB and the World Bank did not materialize due probably to the rapid growth of the former. However, the two institutions have learned from experience how best to cooperate. They have sometimes joined in cofinancing schemes and sometimes agreed to a division oflabor. In response to the rapidly changing global economy, particularly in the Asia-Pacific region, both the World Bank and the ADB have had to redefine their roles, and the relation between them will be an inseparable item to be addressed in the process of redefinition. For Japan the Asian Development Bank is certainly a special institution. Japan was actively involved in its creation and has prOvided the largest share of the institution's human and financial resources. There is no question that Japan con- siders itself the most responsible shareholder for the successful management of the bank. However, it is not correct to argue that Japan controls the bank as if it were Japan's own. Other creditor members, particularly the United States and the European countries, have not hesitated to oppose policies proposed by the presi- dent or the Japanese government. Although there have been accusations that Japan is domineering and self-interested, they have not gained the support of the majority of other members. The fact that the institution is viewed as the most successful regional bank speaks for itself that members as a whole support the way it is run. Japan's position in the World Bank is quite different. There Japan does not consider itself the most responsible shareholder. Its request for a larger share of the voting rights and a greater role in management is motivated by three considera- tions. The first is that Japan's role as one of the largest providers of global aid should be better reflected in its role in the Bank. Second, Japan's overall financial con- 306 JAPA~ AND THE WORLD BANK tribution to the Bank should be better matched by its voting share. Third, Japan can and should contribute more to the activities of the World Bank with the benefit of the knowledge and experience it has gained in the developmental effort at home and in East Asia. n should not be forgotten that Japan has always been a country where a greater contribution to multilateral development banks was unanimously supported by the government, by taspayers, and by all political parties. Advice to the Bank The Future World Bank: Diversification of Means The Bretton Woods institutions have passed their first fifty years, and the global economic and political environment has changed. The Bank, as the leading pro- vider of funds, has contributed greatly to economic development, and that role should not change in years to come. However, in view of changes taking place, the role should be modified. Looking at the post-cold war world, one finds some successful economies, mainly in Asia, where private funds are flOwing in, economies in transition that will need continuous support from the international financial institutions for the fore- seeable future, and impoverished and stagnant countries, especially in Africa, where there is even greater and probably insatiable demand for development finance. All these exist in the context of an increasingly tight fiscal position for all industrialized countries that will make the expansion of development assistance more difficult. The Bank has reacted to thesc situations, and in reeent years it seems to be switching its regional distribution of resour<..'es from Asia and to a degree from Latin America to the economies in transition and to Africa. It would be an over- statement to say that someday the Bank will become the Bank for Africa and Economies in Transition, but the need is there and the Bank should serve it. Still, there remains a huge demand for Bank involvement in Asia as well as in Latin America, although the forms of involvement should be different from the ones in Africa or the economies in transition. Privatization, a movement to which the Bank has contributed much, has become popular in Asia and Latin America. However, these countries are yet to be able to attract enough private funds on their own. The rationale for continuous Bank support to Asia and Latin America is there: given the increasing importance of the private sectors in those regions, the Bank can and should playa catalytic role. In this regard, it need.. to reconsider its means to assist the private sector. So far, it has been inclined to lend to the public sector, which poses a mismatch with such needs. Several options, not mutually exclusive, have been proposed. Some argue that the IBRD should transfer a much larger share of its net income to the IFC and JAPAN AND THE WORLD BANK 307 IDA. Bank (not IFC) lending to the private sector without sovereign guarantee has also been suggested. Although these suggestions merit serious examination, they bear certain risks of damaging the Bank's financial position through reduced re- serve funds and increased risks, thus affecting its AAA investment rating, which should be preserved as an international asset. Compared with these options, the guarantee function of the Bank is less likely to affect its financial position while the pump-priming effects of the function are very great. The guarantee function, which is clearly stipulated in the Articles of Agree- ment, had been put somewhat on the sidelines until the late 1980s: the Bank had had the B-Ioan scheme whose guarantee ratio was just 25 percent. In 1989 the Expanded Cofinancing Operations (ECO) program was introduced to replace the B-Ioans as a three-year trial operation. A review of the ECO in 1992 confirmed its effectiveness and made the follOwing modifications: the ECO can be applied to purely private sector operations (previously it needed to be accompanied with Bank loans to public sector-affiliated projects), and when appropriate, the guaran- tee ratio can be raised to 100 percent (previously 50 percent). This modification further reinforced the ECO program, which is expected to be enhanced even more. The Bank's role as the organizer and coordinator of the Consultative Group meet- ings is also fmancially important. As the most experienced development organization, the Bank can analyze and discuss economies of the developing countries in an authoritative way, thereby assuring the bilateral and multilateral donors of the economic situations and financial need" of these countries. The Bank's analysis usually forms the basis of the discussions at the Consultative Group because in many cases the Bank has established a monopoly position in this field. Bilateral donors, in the wake of their weakening fiscal pOSitions, increasingly necd to scrntinize their aid strategies and allocations. Given this background, the Bank's high-quality economic analysis and policy recommendations are much sought after. Bank reports serve as a useful yardstick and can influence bilateral donors' decisionmaking. Therefore, the Con- sultative Group's meetings, along with associated Bank analysiS, are an area in which the Bank should further strengthen its capability of analyzing economies and formulat- ing policy recommendations from an objective viewpoint. In so doing the Bank should be cautious not to be too authoritative: this is the point at which the checks and balances between the Bank and other donors should work. Thus, the guarantee function being an example, the Bank needs to diversify its financial means to meet varying needs. Certainly, where appropriate, it needs to provide traditional IBRD-IDA loans and credits, which will remain the main vehicle of finance. Especially in poorer countries, IDA credits are still much in demand, and support from donor countries is needed. In terms of coordination, the Consultative Group meetings remain critical. In addition, the growing development agenda calls for more extensive technical assis- tance from the Bank as complementary to mainly financial activities. Therefore, 308 JAPAN AND THE WORLD BANK the Bank must be flexible in adjusting to these changing needs for its financial and development know-how. The Bank Group as a whole should reconsider its optimal synergetic role, taking into account the comparative advantage of each sub- organization. Development Policies and the Bank Post-cold war developments and the increasing attention to the health of the environment have raised a renewed and long agenda for development. The Bank is more than ever expected to act aggressively to achieve development goals that include sustainable development, poverty reduction, private sector development, environmental conservation, transition from planned to market economies, and democracy and good governance. The importance of these objectives is beyond doubt, and now they are accompanied by the concept of sustainable development, which was fully endorsed by the Earth Summit in Rio de Janeiro in 1992. The Bank has been working to adapt itself to the new environment and needs to continue doing so. As for the environment, the Bank established a new Vice PreSidency for En- vironmentally Sustainable Development in 1993. The office is expected to formu- late Bank strategies for the environment and to disseminate the best practices. The importance of dissemination outside the Bank is well recognized. At the same time, it is recommended that the vice preSidency actively carry out training and dissemi- nation inside the Bank; otherwise the regions may pay insufficient attention to such crosscutting matters. Lewis Preston, president of the Bank, put poverty reduction as its central objective, an action that has gained broad consensus. Indeed, except for a few countries in Asia, poverty in developing countries is worsening. But no panacea has been found, and even the East Asian Miracle study, while applauding the region's success in shared growth based on right fundamental policies, was unable to providc a quick remedy for other developing countries. Against this background, the Bank is reinforcing its poverty-targeted operations, such as health, primary education, social safety nets, and urban infrastructure. In the wake of the collapse of planned economies and the lingering problems of overgrown public sectors in developing countries, the Bank also emphasizes private sector development. Indeed the private sector has been and 'hill remain the primary participant in the free market economy, and efforts to foster its health are needed more than ever. In this respect the Bank has established the Vice Presiden- cy for Finance and Private Sector Development, which is expected to function in much the same way as the one for environmentally sustainable development. Thus various efforts have been made, and the Bank should continue to review its policy priorities and direction. Poverty reduction, environmental conservation, and private sector development are not unchangeable creeds. They are subject to JAPAN AKD THE WORLD BAKK 309 continuous review and modification. For example, assisting the private sector alone does not bring fruitful results: the private sector and the government should go hand in hand. There remains ample room for the government to prepare a fa- vorable environment for fostering the private sector, as can be seen from the East Asian Miracle study: this can be done only by the government. So there is still considerable scope for the Bank to support governments by advising on effective public sector management, appropriate regulatory frameworks, and human re- source development that facilitate emerging entrepreneurship. The Bank also needs to review its policies on poverty reduction. Although redUcing poverty is imperative and targeting an impoverished population is most effective, if policies go to extremes, they may not help the overall economy of a poor country catch up with the economies of industrial countries, allOwing global inequality to persist. Exc"Cssive targeting on the poor may also trigger resentment from well-off populations, which would make poverty reduction politically unsus- tainable. The same may apply to environmental conservation, although in this instance win-win policies do not apply in the long run. Thus the problems are not straightforward, and the Bank must act flexibly in tackling them. Along with these relatively new priorities, the Bank needs to continue to support infrastructure projects, not only in poor countries but also in middle-income countries where there is still a lot of demand. In some middle-income countries the lack of infrastructure has become a major barrier for further development, and the imbalances between metropolitan and rural areas are being exacerbated. To rectify the imbalances the Bank needs to playa catal}tic role, such as using its guarantee function to attract private sector funds in the case of middle-income countries and providing traditional IBRD and IDA fmancing for poorer countries. Given the fact that the private sector capital flows to middle-income countries in the forn1 of direct and portfolio investments are e},:panding, the Expanded Cofinancing Opera- tions program, which provides "partial Bank guarantees to support borrowers in gaining access to &)'I1dicated bank loans and international capital markets," is best suited to infrastructure needs. 54 The ECO program, launched in 1989 to replace the previous B-Ioan scheme, has so far provided guarantees to one project each in Hungary, India, Pakistan, and Jamaica; several others are being considered. In view of its flexibility and ability to mobilize relatively large sums of private capital flows compared with the traditional IBRD loans, the ECO has added a new dimension to Bank operations and is expected to be improved. Human resource development is another important function. Rapid accumula- tion of human resources has been one of the key factors of East Asia's success. There are two components in human resource development. First, a broad human resource base is of the utmost importance. Japan's postwar success in manufactllr- 64. On capital flows to middle-income countries see, for example, World Bank, World Debt Tables: 1993-94, vol. 1 (Washington, 1993), p. 72. 310 JAPAN AND THE WORLD BANK ing owes much to the availability of relatively cheap, abundant, and educated labor, which enabled companies to adapt to new technolOgies and achieve rapid produc- tivity growth. Much attention has been paid to higher education in developing countries, the effects of which have barely trickled down to vast undereducated populations and have led to brain drain overseas (including to the Bank). This does not help developing countries achieve their development goals, especially poverty reduction. The Bank has been and must continue to playa leading role in this regard, including education, population control, health, nutrition, and women in development. Second, while basic education will lift up the human resource base, human resource development within government is also crucial. At the very least, govern- ment needs to prepare an environment in which private entrepreneurship can flourish, but in most developing countries the governments are not up to such performance: they are simply incapable or they lack good governance. The need for the government to function properly is emphaSized in the East Asian Miracle study and elsewhere, and the Bank has been contributing to good governance by provid- ing technical assistance associated with structural adjustment operations and through policy dialogues with borrOwing countries. But such assistance tends to be neglected once a country graduates from structural adjustment operations because of an improved balance of payments position. It is in this way that huge structural impediments within the government are left intact. To avoid this outcome, the Bank needs to improve its technical assistance to borrower governments, including ones that no longer need structural adjustment lending. Structural adjustment has been questioned by the Japanese. From a different point of view, Tony Killick of the Overseas Development Institute in London points out that although the policy thrust of the adjustment programs is generally sound, there is little evidence of strong program results in low-income countries. 65 Killick contends that this is in part because conditionality has a modest capability for achieving improved economic policies, and international financial institutions have similar constraints of their own, such as limited knowledge of a country and mismatch of time horizons between the adjusting countries and the institutions. He concludes that imposed policy change rarely works and emphaSizes the importance of policy ownership of developing countries. His points seem complementary to the Japanese critique. Tbe Bank and borrowing countries, in the process of adjust- ment operations, need to pay more attention to policy ownership, which should be the central element of much needed self-help efforts by the developing countries. The Bank has been the intellectual leader in development matters. It is certainly important that it continue to develop new ideas and directions in development policies. Collection and dissemination of the best practices is no less important. 65. Tony Killick, "Improving the Effectiveness of Financial Assistance for Policy Re- form," paper prepared for the 47th meeting of the Development Committee, Overseas Development Institute, London, September 27, 1993. JAPAN AND THE WORLD BANK 311 The East Asian experience suggests that each country owes much to learning and adopting good practices from elsewhere in the region. Although it is arguable that the East Asian interaction was possible only because of similar cultural and histori- cal backgrounds of the countries in the region, the region's experience gives many lessons that can be adopted by countries in other regions. The Bank is endowed with abundant experience, both successes and failures, and must construct de- velopment policies and strategies based on such unique assets in combination with its innovative research work. In so dOing, the Bank and policymakers in developing countries need to be patient: learning by doing, which facilitates policy ownership of developing countries, takes time, usually more than a generation. The Bank as Bureaucratic Organization The Bank as an organization has many faces: its well-known highly qualified staff (often with doctorates), its bureaucracy and inflexibility, and its secrecy, just to mention a few. In any case, as an organization the Bank has not only strengths but also weaknesses. In this section, I would like to raise some questions on the institution's organization. WISE MEWS COMPLACENCY? The Bank and the IMF staff members are highly qualified: most of the profeSSional staff, especially economists, hold doc- torates or master's degrees from top-ranked universities. Such an intellectual environment enables the Bank to bridge the distance between academics and practitioners: the Bank is the intellectual leader in the field of development. Indeed, it has initiated a lot of new ideas and practices such as structural adjustment frameworks, outward-oriented poliCies, win-win policies of environmental protection, and so on, as can be seen from the annual \Vorld Development Reports and other Bank publications. Most bilateral and multilateral aid agencies have assimilated its policies and procedures. The Bank also chairs Consultative Group meetings for which it prepares policy framework and country papers in collaboration with the IMF and borrower governments. But this intellectual environment or institutional culture seems to have some drawbacks, although it is beyond doubt that the Bank's output on average is of high quality and it is expected to display intellectual leadership. The dominance of economists in the institution may make it too sensitive to the trends of mainstream economic literature, espeCially in the United States. The problem is that the trends are likely to be driven by socioeconomic changes in the industrial countries, whereas the situations in developing countries remain unchanged. Also, economists tend to pursue sophisticated models that may have little relevance for the real world. This may create gaps between development practice and the policy preScriptions the Bank has established as a virtual monopoly in developing countries. Moreover, the dominance of economists entails the danger of making the Bank's policy recommendations misleading to developing countries, whose situation needs 312 JAPAN AND THE WORLD BANK a more interdisciplinary approach and a mix of skills: economists with scant ex- perience in government and business administration may not be the people best suited to making recommendations to governments in developing countries. The post-cold war developments and the situations in these countries have raised multifaceted challenges, including economies in transition, poverty targeting, en- vironmental protection, good governance, and ownership of development policies. These issues are not separable from wider social and political situations in the countries. In this respect, the practitioners most needed are interdisciplinary rather than individuals with specialized doctorates. Thus it is recommended that the Bank seriously reconsider the appropriateness of its staffs mix of skills. The Bank should also seek ways to cooperate more effectively with other organizations to draw upon their expertise. AN OVERGROWN ORGANIZATION? With more than 6,000 permanent staff members, the Bank is a large institution by any standard. Given the expanding operations and constant need for quality improvement, the amount of associated work justifies the number to some extent. However, some argue that the Bank is overgrown. For example, the loan commitment per staff member at the OECF (\vith about 320 staff members in 1994) is three times that of the Bank. Although this does not mean that the OECF is more efficient than the Bank nor that the quality of OECF loans is comparable with those of the Bank, this fact may partly confirm the critics' view. 56 It could be argued that the Bank has embraced too many roles. For example, some of the Bank's functions overlap with those of other international finan- cial institutions, especially the IMF, and redefinition of demarcations may con- clude that some of the Bank's roles, for example, macroeconomic analysis and some regional initiatives, could be given to the IMF and regional development banks, which have comparative advantages in these fields. Some suggest that the IMF and the Bank will eventually merge. 67 It is certainly true that there are many overlapping responsibilities at the two institutions, and they need much closer coordination. But merging seems farfetched. The roles of the IMF and the Bank are in principle different, though some elements such as transition issues overlap: one deals with macroeconomic matters, while the other special- izes in developmental issues. Merging them into a mega-institution may do more harm than good: it will bring mega-bureaucracy and cannot be cost effective. 66. I have by no means intended to say that the OECF's performance is superior to the Bank's. The request system of the Japanese ODA means that the OECF does not to have to prepare its own projects, whereas the Bank is involved in the project preparation from the initial stages. Likewise, the depth of project appraisal and economic and sector work of the OECF could be said to be less than that of the Bank. 67. "Sisters in the Wood: A Survey of the IMF and the World Bank," FA::onomist, October 12, 1991, p. ~8. JAPAN AND THE WORLD BANK 313 The size of the Bank also means difficulties in maintaining institutional identity, thus making it a bureaucratic machine. For example, it is widely observed that tasks of officers are divided in a piecemeal fashion, whieh often leaves an impression that the Bank is not working as an organization but as a collection of individuals. Of course, highly specific skills and expertise are often needed, and as long as piece- meal decisions are made, such an organization is most effective. However, such an organization makes interdepartmental coordination difficult and thus creating an institutional identity difficult. As a result, different parts of the institution tend to act in different ways. More important, when the Bank faces drastic changes in the external environment, readjustment can only be initiated by top management, an institutional weakness; such centralization of management was the trademark of the centrally controlled economies, which have collapsed. Compartmentalization of day-to-day business and centralization of decision- making have other drawbacks. Because lower entities of the institutions are highly specialized, they tend to pay much less attention to overall administrative issues, portfolio management, and managerial discipline. Although I would not argue for a fundamental reshuffling, I would like to see the Bank make efforts to modify and streamline its business conduct. This is also important to improve the Bank's reputation. It might be worthwhile to reconsider the career path of the young profeSSionals who constitute the mainstream of the Bank staff. Before they are promoted to managers, they experience only narrow fields of the operation. This means that they tend to climb narrowly defined ladders in Washington, thus facilitating or- ganizational inflexibility, which is not compatible with the interdiSciplinary de- mands of the Bank's constituent countries. As a remedy, it is recommended that these staff members, especially when they are junior, be posted to field offices in developing countries and acquire experiences in the realities of development. To avoid organizational inflexibility and to bring in fresh management perspectives, the Bank should also appoint more outsiders to managerial posts. BAI\K INITIATIVES FOR IMPROVEMENT: CONTINUOUS MOMEI\TUM NEEDED. Although I have raised a number of criticisms, I by no means wish to denounce the Bank as a white elephant. As a former civil servant, I know the complexity associated with the reorganization of large institutions, and so I do appreciate recent Bank initiatives for improving development effectiveness and organizational transparency as a courageous step forward. As a preferred creditor as well as the leader in the development field, the Bank needs to maintain its reputation and the good performance of its portfolio. The Bank itself is quite aware of the needs, and the Wapenhans report, which was initiated by Lewis Preston, pointed out various problems. 58 The report attracted much attention, and was followed by an action plan to improve Bank-borrower 68. World Bank, "Effective Implementation: Key to Development Impact." 314 JAPAN AND THE WORLD BANK dialogue, development policy ownership of borrowers, participation of affected people, project design, supervision of ongoing projects, operations evaluation, and internal changes. The scope of the plan is thus wide, and if fully implemented it will immensely improve the effectiveness of Bank operations. The Bank is facing an increasing number of criticisms from nongovernmental organizations. Although there are legitimate criticisms, there could also be un- substantiated or misleading statements. It is understandable that the Bank, as an organization, needs to protect itself from unnecessary and sometimes misleading allegations by misunderstanding and misinformation. This led the Bank to adopt a hroad information disclosure policy, and an inspection panel system, which are ex- pected to inerease the organization's transparency and accountability, though informa- tion disclosure should be carefully operated in order not to violate borrOwing countries' sovereignty and cofinancers' need to safeguard their own interests. In the face of pressures from nongovernmental organizations, the Bank's share- holder governments are inereasingly cautious about portfolio performance. Al- though there are further criticisms that those efforts are not sufficient, changes takc time and they should be implemented step by step. The shareholders thus need to provide full moral support to the Bank's initiatives while remaining vigilant on the progress of implementation. ""'hen necessary, they should whip the Bank to expcditc the progress, and thcy are duly expected to do so. Furthermore, the shareholders ean contribute to the improvement of portfolio performance by, for example, insisting on allocating a larger share of the budget to operation evaluation. Advice to Japan Having raised a number of demanding pOints about the Bank, it is fair to pose some to Japan. Human Contributions Japanese representation on the staff of the Bank is far from being in line with its finaneial contributions. 69 The share of Japanese staff at the Bank was 1.8 percent in fiscal year 1994 and 2.1 percent among profeSSional staff.1° Japan's financial con- tributions are far larger: its share of the Bmlk is more than 6 percent, for exmnple, and 69. This section owes much to Hirono and Stern's comment to Ryokichi Hirono, "japan's Leadership Role in the Multilateral Development Institutions," in Safiqul Islam, ed., Yen for Development: Japanese Foreign Aid and the Politics of Burden-Sharing (Washington: Coun- cilon Foreign Relations, 1991), pp. 171-81. See also Masaki Shiratori, Sekai Cinko Cumpu: Tojyoukoku enjyo to Nihon no yakuwari [The World Bank Group1(Tokyo; Kokusai Kaihatsu Journal-sha, 1993); Ministry of Finance, Kokusai Kin-yuu Kikan ni okem Nihon-jin Shokuin no Katsudou Sokushin ni Tsuite [On Promotion ofJ apanese Staff Members at International Financial Institutions] (Tokyo, 1987). 70. Figures are for the World Bank Group, including IBRD, IFe, and MICA. Profes- sional staff includes higher-level staff in grades 18-30. JAPAN AND THE WORLD BANK 315 contributions to IDA make up more than 17 percent of the organization's budget. Japan is determined to enhance its human contributions to the international com- munity and the Bank is not an exception. Although the Japanese government has been trying to contribute intellectually to the Bank's policy formulation, its in- fluence is naturally limited as long as the Japanese staff representation remains so low (the management and staff playa central role at the Bank). The problem is well recognized and it has become customary for the Diet, when Bank capital increases are brought up, to pass a resolution demanding an increase in the number of Japanese on the staff. There are several causes of the low representation: language barriers, the lack of job security compared with Japanese industry'S practice of lifelong employment, and the increasingly unattractive Bank pay because of the appreciating yen. In addition, there seems to be a mismatch of the qualifications required by the Bank and the ones Japanese candidates can offer. The Bank usually demands post- graduate degrees and work experience in specialized fields. Although there are a number of Japanese experienced in various fields, they usually do not hold graduate degrees because Japanese companies, where most of the candidates gain work experience, normally recruit recent graduates and prOvide in-house training. There are many interrelated factors, and the difference in working styles is one: as noted earlier, the Bank is paper oriented whereas Japan is far more experience oriented. The difference is difficult to overcome, and no qUick remedy can be found. However, if we change our viewpoint, such a differenee could be a source of benefit both to the Bank and to Japan: they can learn good practices from each other. So there is a compelling need to create a critical mass of Japanese staff in the Bank to transfer Japanese practical know-how. vVhat, then, can the government ofJapan and the Bank do? First, the government should proVide incentives for potential candidates to work at the Bank. The govern- ment needs to create an atmosphere that working with the Bank is