Roads to Prosperity: Fixing Argentina’s Crooked Infrastructure

Nicolas Blog Post

Hello There by Flickr user mzagerp under an Attribution 2.0 Generic license.

By Nicolas Berlinski

The province of Jujuy, located in Argentina’s most northwestern corner, is heavily reliant on the cultivation of sugar cane and its exportation to the domestic Argentine market. Regardless, it takes 22 days to move that sugar to the national capital, Buenos Aires— the same amount of time it would take to move the sugar from Jujuy across the Atlantic to Hamburg, Germany.

Jujuy is no anomaly as poor transportation networks and connectivity have restricted long-term economic growth throughout Argentina for some time now. Subpar infrastructure has hampered the efficiency of Argentina’s supply chains and significantly increased the transportation costs of goods – Argentina’s shipping costs are twice the OECD average for example. Furthermore, the country ranked 81st out of 137 in the World Economic Forum’s 2017-2018 infrastructure index, mainly due to the lackluster quality of its roads, ports, and notably electricity supply (ranked 113th out of the 137 economies surveyed). Buenos Aires regularly faces summertime power blackouts as air conditioning in the city’s buildings strain the local power grids past their breaking point, shutting off traffic lights, office computers, and everything in between. Poor infrastructure is a threat to public health too as 22% of the country isn’t connected to public water networks and around 40% are not connected to sewage, making many Argentines, particularly children, vulnerable to parasites.

Considering the long distances between the country’s cities and resources, the energy needs of its largely urban population to function in daily life, and its economic status relative to most countries with similar infrastructure woes, Argentina’s long-term growth prospects largely rest on an infrastructure overhaul. There is little debate that Argentina must boost domestic investment in infrastructure from the insufficient current rates of 3% of GDP to 6% in order to match the needs of its society. President Mauricio Macri and his electoral coalition, Cambiemos, pledged to address the issue in his 2015 presidential campaign with the announcement of sweeping infrastructure plans across the country and the much-anticipated Plan Belgrano, an infrastructure plan for Argentina’s 10 Northern provinces. Marcos Peña, President Macri’s cabinet chief, described Plan Belgrano as “the most ambitious [infrastructure project] in Argentina’s history.”  Infrastructure projects were conceived without a specific budget. Instead, the Macri administration sought to facilitate contracts mostly through a range of Public Private Partnerships (PPPs) since Argentina has regained access to international capital markets following the resolution of a standoff between the country and holdout funds due to previous debt defaults and the elimination of harsh capital and import controls imposed by former president, Cristina Fernandez de Kirchner.

Unfortunately, like in so many other Latin American countries, Argentina’s infrastructure plans have struggled to live up to expectations and have an uncertain future, hindered by macroeconomic woes, a corruption scandal, and the possibility of a new president in October’s election. The lessons Argentina has learned thus far are demonstrating the challenges of financing infrastructure in the developing world. The importance of institutional strength and transparency, stable finances, and both the benefits and pitfalls of PPPs to build the infrastructure that the developing world needs have come to light in Argentina.

In 2018, the Argentine peso lost half of its value, its interest rates reached world highs, inflation creeped up on 50 percent, and the IMF had to grant Macri’s government a record-breaking $57.4 billion bailout, portending harsh austerity. The public purse is being gripped tight and private investors are obviously hesitant to engage in new projects. Fitch Solutions, a consultancy arm of Fitch Ratings, forecasts weak progress in 2019 for Argentina’s PPP infrastructure projects with multiple projects that were approved in 2018 struggling to attract investors.

Argentina was able to attract funding for 1325 km of road construction with the help of the Overseas Private Investment Corporation (OPIC) and China’s State Construction Engineering Corp-subsidiary China Construction America (CCA). However, another 2,028 km of road projects that were awarded in 2018 appear in jeopardy as private finance has become hard to find during these turbulent times. It is unlikely that the government will issue new PPP tenders for previously planned projects like a large-scale passenger tunneling project in Buenos Aires, the construction of a freight rail line between Neuquén and the port of Bahia Blanca, and another seven road corridors, among others. For now, the end of the construction slowdown is hardly in sight. Lending rates are unlikely to ease up soon as Argentina’s central bank battles to maintain tight monetary control.

Argentina’s high public debt is another hurdle – it’s back on the rise after it peaked during the country’s 2003 sovereign debt crisis. PPPs seem to be Argentina’s only option. On the one hand, publicly financing large projects at this moment in time seems impossible considering the country’s historic current account deficits and the conditions of the IMF bailout. Likewise, the country’s infrastructure needs are as immediate as the job of balancing the books.

Unfortunately, as President Macri is beginning to learn, PPP agreements aren’t a panacea. They still require assets from the government and are costly when something inevitably goes wrong. Although PPP agreements and their liabilities can be written off the books, project costs must be paid off to the private sector down the line and extra costs end up on the government books eventually. All may seem fine today, but Argentina is taking on potential debt, whether or not it’s on the books, as an infrastructure project of this scale is bound to have complications along the way that will need government financial intervention. To ignore this fact would be foolish, especially considering the country’s fiscal history and knack for volatility.

Whether Argentina will be able to tackle the costs that will likely appear down the line is unclear to say the least. Argentines have been consuming at high rates and saving very little. National domestic savings and investment have tumbled since 2008 and the country faces a deeper current accounts deficit than ever before. Gross savings in the country as a share of GDP in 2017 were 13.5%, among the lowest in Latin America, let alone the rest of the world where developing countries like India, Indonesia, the Philippines, and Thailand have saving rates between 30-40%. Argentina’s infrastructure needs are immediate but so are its fiscal issues.

With little available investment capital, high public debt, and a challenging investor environment, it is no wonder that infrastructure projects have moved along at a fraction of the pace President Macri’s campaign seemed to promise.

As if Argentina’s economic situation wasn’t complicated enough for infrastructure development, a wave of corruption allegations leveraged on the Kirchner administration have rocked the boat and fueled distrust of PPP agreements. The Lava Jato investigations which revealed continent-wide political graft by Brazilian construction conglomerate, Odebrecht, in public works projects led to around $35 million in bribes being paid to Argentine government officials. These investigations also prompted the publication of journals documenting bribery by many Argentine firms of government officials between 2005 and 2015, which has led to drawn out court dealings, political infighting, and skepticism about ongoing public works projects. Owners of some of the country’s largest construction firms have been implicated, including President Macri’s cousin and ally, Angelo Calcaterra, the former owner of construction company, Iecsa, which has been recently accused of receiving unfair preferential treatment on the “Ruta Nacional 8” project, linking Buenos Aires to the provinces of Santa Fe, Cordoba, and San Luis.

Fitch Solutions argue that public wariness and skepticism as a result of the scandals, have made elected officials hesitant of pushing PPP infrastructure too hard, exacerbating the challenges caused by the macroeconomic situation in the country. President Macri’s administration is currently trying to strengthen laws and regulations so that only individuals that are involved in corruption are penalized while companies must simply pay fines in order to avoid cancelling already awarded projects and to avoid blanket bans on PPPs. “The government is adopting regulations to save the companies, while executives and shareholders face the consequences of their actions,” Marcelo Etchebarne, country head for consultancy DLA Piper Argentina, said.

Corruption is an institutional blight to infrastructure development and has made infrastructure projects in Argentina costlier and more inefficient for as long as it has permeated the country’s public institutions. When unfair competition for government contracts arises through corruption and bribery for government officials, the public good is compromised by personal gain. A recent study by researchers at the University College of London and Central European University sought to quantify the average cost of corruption by looking at a large dataset of public procurement announcements from 2009 to 2014 of 27 European Union countries. The researchers measured corruption with an index of a country’s corruption risk and estimated that a one unit increase in the corruption index, equivalent to the difference between Hungary and Sweden, was associated with a 35% increase in road costs when controlling for other factors.

A final cause for concern for the future of Argentina’s infrastructure efforts, is the possibility of a new president being elected in this year’s election. President Macri’s approval ratings have been low and volatile amidst the economic crisis of 2018 and haven’t cracked the 40 percent mark in a while. The nightmare scenario for President Macri would be former president Kirchner, or a similar firebrand candidate, winning the presidency. That could mean a re-implementation of the capital controls that Kirchner put in place prior to 2015, once again constricting Argentina’s access to foreign capital and investments for infrastructure.

Argentina’s stuttering efforts to improve infrastructure resemble similar narratives throughout the world and Latin America, where public and private infrastructure investment is lower than every other region in the world except Sub-Saharan Africa and the share of paved roads is lower than anywhere else. Argentina is emphasizing important lessons of infrastructure development. On the one hand, the balance book must be in check. Stability is the key to an investor’s heart and, with a global financing gap for infrastructure projects, private investors will be key. A country’s institutions must be fortified to weather the temptations of bribery too, and they must be staffed by public servants who have the public good in mind. In the face of high public debts, harsh investment environments, widespread graft, and political uncertainty, many developing country’s infrastructure ambitions are falling short of reality.

So where does the country go from here? Any serious discussion about infrastructure in the country must revolve around normalizing the country’s fiscal troubles. Obviously, that is part of Argentina’s larger economic picture. Macroeconomic policy needs to be directed both towards short-term sustainability while also addressing the immediate needs of Argentines, especially the most vulnerable. When the books are in order, then large-scale infrastructure projects will be easier to manage, and investors will be more willing to engage in Public Private Partnerships.

Tackling corruption is another challenge that can be addressed in the immediate future. Laws that demand greater transparency regarding the bidding and approval process of PPPs will help but the broader issue at play is restoring the justice system that has become highly politicized and ineffectual – only 2% of the indictments filed by state attorneys in the past decade have resulted in concrete penalties. Moreover, PPPs require private investment and private investment yearns for stability and rule of law. Tackling political graft will ease the concerns of investors in the short run, at least slightly, reduce costs of infrastructure development, and improve the final product.

Longer paved roads, vast railways, and modern airports can provide a structural boost to Argentina’s economy to provide for long-term growth while providing plentiful employment. In order to achieve this though, the economic ship must be steadied, and corrupt leaders from the public and private sector banished from power.

 

 

Developing Countries Should Invest in Prisoners, Not Prisons

Prisons

Prison fence by Flick user Brad.K under an Attribution 2.0 Generic license.

By Carmen Garcia Gallego

Prisons are an essential element of a functioning justice system, but detention facilities often focus on punishing rather than rehabilitating convicts. This can lead to high rates of recidivism and be so expensive that issues with overcapacity, inadequate health services, and violence seem almost inevitable. There are 10 million people incarcerated worldwide, and overcrowding in prisons is an issue in 120 countries. These issues are particularly prevalent in developing countries like Brazil and Indonesia, which have large prison populations and insufficient means to maintain them.

Amidst these challenges, new models of detention focused on convict rehabilitation, vocational training, and greater inmate freedom have been successfully developed. New ideas on prison reform are essential to address the overwhelming issues that strain prison systems worldwide, and increased attention on mass incarceration presents a great opportunity for reform. Now is the time to look at existing prison models and enact change in a way that can both improve inmates’ well-being and advance countries’ development priorities in a cost-effective and sustainable manner.

The APAC Prison Model in Brazil

Brazil has the third-highest prison population in the world, behind the United States and China, with over 690,000 prisoners. Prisons are a big issue in Brazil, where overcrowding, security, violence, and poor conditions are regularly featured on news headlines. In the first week of 2017, almost 100 people were killed in gang-related violence in prisons in Manaus and Roraima. In the same week, 184 inmates escaped. Yet Brazilian prisons are also making the headlines for a different reason: treating some convicts humanely.

The Association for the Protection and Assistance to Convicts (APAC) opened its first prison in Brazil in 1972 and now runs 50 facilities. APAC is overseen by the faith-based non-profit Brazilian Fraternity of Assistance to the Convicted (FBAC). Unlike public and private prisons, APAC prisons give inmates – called recuperandos, “recovering people” – freedom, work, and study opportunities. Prisoners hold the key to their own cells, wash their own clothes, cook their own meals, study, and attend group therapy sessions. There are currently 3,500 recuperandos in APAC facilities, roughly 0.5 percent of the entire Brazilian prison population. To be incarcerated at an APAC facility, inmates must first pass through the national penitentiary system and show remorse, willingness to work and study, and commitment to the APAC philosophy. If they pass and meet certain requirements – for example, they must not be serving a lifelong sentence and they must have family living in the solicited region – they may be transferred by a judge to an APAC prison.

Transfer can be extremely beneficial to inmates. One inmate, who was serving a sentence for drug trafficking, was transferred to an APAC prison after four months in a conventional correctional facility. Now, she is the head of a prison council and works to reduce her 8-year sentence. Inmates can receive drug rehabilitation courses in partnership with local universities on how to prevent drug use, and they are taught that they are co-responsible for their own recovery. Another recuperando was given jail time for theft and, upon entry into the APAC system, took a training course on civil construction and landed a job in the field after serving his sentence. Prisoners do not escape, partly because a failed escape attempt will land them back in a conventional prison, but also because being in an APAC facility gives inmates a sense of community and responsibility. This is reflected in impressive recidivism rates: 7 to 20 percent of APAC prisoners go back to jail at some point, well below the national average of 70 percent.

APAC prisons have not only benefited inmates; they have also helped Brazil save money, manage overcapacity, and fill skills gaps. Maintaining a prisoner in an APAC facility costs one third of maintaining one in a state prison: the Brazilian state pays 3000 reais (nearly $800) on average per prisoner in a state prison versus 950 reais (around $250) for an APAC recuperando. The enormous difference is due to the lack of paid prison guards and weapons and the costs saved by allowing prisoners to farm, cook, clean facilities, and perform maintenance tasks as needed.

If, hypothetically, half of Brazil’s 690,000 prisoners were transferred from a federal prison to an APAC facility, Brazil could save nearly 1.5 billion reais (over $400 million) and invest this money in education, health, or infrastructure. These investments are much more likely to create jobs and better provide for the people, which will decrease incentives to commit crimes in the first place. Providing vocational training at APAC facilities can also help inmates find quality job opportunities after serving their sentences and help fill some of the skills gap in Brazil’s workforce. For example, tourism will create 1.5 million jobs in Brazil by 2027 – jobs that will require language and hospitality skills. Agriculture makes up 45 percent of all Brazilian exports, and changing technologies will require workers with more technical skills to work in agriculture. Training recuperandos in the tourism and agriculture sectors can help meet future demand and complement existing APAC programs that train inmates to be car mechanics, painters, and security officers, among others.

Bringing the APAC Model to Indonesia

19 countries in the Americas, Europe, and Asia have APAC-like prisons. They are notably absent from Indonesia, a country which could benefit tremendously from the model. Indonesia’s prison population has nearly quadrupled since 2000, making it the seventh largest in the world today, with roughly 248,000 prisoners. The prison system in Indonesia faces challenges of overcrowding, escapes, riots, and understaffing like that of Brazil. Corrupt prison staff provide drugs, outings, and phones to wealthy convicts. Prisons are at 198% of capacity, making it difficult for prison guards to monitor communications to counter the important issue of radicalization. In 2016, for example, a radicalized ex-convict launched a suicide bomb attack in Jakarta. He had been influenced by an Islamist cleric in prison who, while incarcerated, was able to publish his allegiance to the Islamic State on Facebook.

Implementing the APAC model in Indonesia would help address some of these issues. Receiving education and skills training at APAC prisons could discourage inmates from becoming radicalized and help them find jobs after serving their sentences. Levels of labor productivity are exceptionally low in Indonesia, and almost one-third of the workforce is in a position of vulnerable employment. Indonesia ranks low in terms of technological readiness and has made efforts to increase its economic competitiveness, but technological advances threaten to thwart economic growth. Addressing some of these issues will require a more productive, skilled workforce and placing a greater emphasis on the manufacturing and high value services sectors. Providing prisoners with technical and vocational training can help fill some of these skills gaps, and it can ensure that convicts are prepared for the jobs of the future when they are reintegrated into society.

With regards to improving inmates’ well-being, the rehabilitation and education aspect of the APAC model could greatly aid the drug crisis in Indonesian prisons. One of the major reasons for Indonesia’s large prison population is that the country criminalizes narcotics use with a three-year sentence. Over 80 percent of Indonesian inmates are in jail due to narcotics-related charges. The drug problem continues within jails; prisoners contract HIV within cells and, in 2013, even a meth lab was found inside Indonesia’s biggest prison, Cipinang. Transferring some of these addicted inmates to APAC-like facilities and offering them rehabilitation and education could help alleviate their addictions, reduce HIV mortality rates, and decrease prison overcrowding.

Education and rehabilitation benefit both inmates and the state, and Indonesia stands to gain from other aspects of the APAC model as well. First, Indonesia could save a large sum of money and address the problem of overcapacity by reallocating prison guards. In 2015, there were only 15,000 prison guards in the entire federal prison system and they earned an average $300 a month. Low pay and understaffing can lead to corruption, escapes, drug use, and radicalization, among others, so this issue must be promptly addressed. Since APAC prisons require little to no guards, transferring prisoners to APAC facilities would allow federal prison personnel to pay better attention to remaining convicts. They could receive higher pay and more staff could be hired with the amount saved.

Second, Indonesia could save money on maintaining the prisoners themselves. The Indonesian government spends 15,000 rupiah (about $1 dollar) per prisoner per day – which translates to $90 billion per year. If APAC facilities in Indonesia had similar cost structures to those in Brazil (i.e. if the cost of maintaining a prisoner in an APAC facility were one-third the cost of maintaining one in a federal prison), and if just 20 percent of the prison population were transferred to APAC facilities, over $12 million could be saved per year. If APAC facilities yielded lower recidivism rates, overall cost savings could increase yearly. These funds could be reinvested in education, social reform, health, or rehabilitation programs for drug offenders. However, it is unclear whether the same cost savings would apply – further analysis should be conducted on this matter.

Lastly, the Indonesian Ministry of Justice and Human Rights announced that 49 prisons, 13 detention centers, and 62 rehabilitations centers would be constructed in 2015. In 2016, plans for a new high-security prison and four other new prisons were also announced. It is unclear how much progress has been made on these initiatives, but it signals that Indonesia is paying attention to prison-related issues and is aware of the need for reform. This presents a great opportunity to promote the APAC model and install it in detention and rehabilitation centers. These centers could be built instead of high-security facilities and conventional prisons, cutting construction costs and transferring non-violent prisoners to detention centers, thereby addressing the issue of overcapacity, and maintaining dangerous convicts in conventional and high-security prisons.

Broader Implications and Recommendations for Prison Reform

The APAC system could be implemented in both developed and developing countries, beyond Brazil to countries like Indonesia. However, the model’s success in Brazil does not guarantee that it will be equally successful elsewhere. Even in Brazil, local involvement and political will are necessary to open APAC prisons, and efforts to open new facilities have been thwarted in the past due to financial issues, overcrowding, and corruption. Nevertheless, there are APAC prisons in 19 countries and those that are running are thriving, suggesting that the model can be replicated in different contexts. Countries interested in this model must first consider social, economic, and political factors, strengths and weaknesses of current penitentiary systems, and skills and workforce needs. The amount of money saved, the number of prisoners held, and the types of education and rehabilitation offered at the facilities would vary from country to country. Further study on potential impact should be conducted to ensure that the APAC system is viable and beneficial in the long run, in Indonesia or in any other country.

It is worth noting that, in Brazil, APAC only hosts a small fraction of the whole prison population. Even if the program were extended, not all prisoners would be eligible for transfer. Inmates in high-level security facilities, violent persons, and repeat offenders are unlikely to be given the keys to their own cells. However, APAC facilities can host vulnerable populations, non-violent and low-severity offenders, and prisoners awaiting trial worldwide. Therefore, the APAC solution is not a one size fits all: it may only benefit a subset of the prison population, but it should still be considered as part of prison reform due to the tremendous development opportunities it presents.

In sum, reforming prisons should be a development priority. Introducing more humane, cost-effective prison systems can save countries millions of dollars to reinvest in line with development priorities, decrease recidivism rates, and reintegrate ex-convicts into the workforce in ways that reduce skills gaps and advance countries’ economic interests.

 

 

BUILDing a Better Economic Future Requires People, not just Infrastructure

By Alicia Phillips Mandaville and Kristin Lord

 

Last month, heads of state from around the world gathered in New York City for the UN General Assembly to discuss, among other topics, global development goals. This year, there was no shortage of whiplash for both policy makers and American citizens who prioritize the United States’ engagement in the world: just after President Trump’s General Assembly address caused hand-wringing in New York, a momentous global development event unfolded in Washington DC with the bi-partisan passage and White House support of the BUILD act, which establishes a new U.S. International Development Finance Corporation (USIDFC).

 

Designed to enable infrastructure investments in emerging and developing economies, this new DFI can create new market opportunities for Americans and economic growth for our partners. But to fully reap the potential, we must ensure fresh, actionable thinking about the fundamental relationship between human capital and infrastructure in long-term economic growth. Based on prior experience with the Millennium Challenge Corporation (MCC) and the discussions around the USIDFC so far, this may not happen without an explicit and intentional focus early on.

 

Investing in infrastructure is important. It directly impacts economic growth and signifies progress to all who observe it. As anyone who has traveled to major urban centers or economic hubs knows, infrastructure is the nerve system through which an economy operates. Whether highways, sanitation, or telecoms, infrastructure enables transactions and information to move at the speed needed for a modern economy.  And, despite the noise and the dynamism, if you have ever stood in the middle of a busy industrial port anywhere in the world, there is something quietly reassuring about the resonant buzz of that operation. It is as if you can feel the growth happening around you.

 

But if there is one lesson that economists and humanity have learned over and over, it is that the economic growth equation fails in the absence of human contribution; no matter how well it is equipped, an economy without dynamic human resources is a recipe for stagnation. Development organizations know this: the historic, multilateral, “if you build it they will come” model of public goods provision led to roads-to-nowhere and was roundly critiqued by academics and development technocrats alike early in the 21st century. This was in part what led the US to stand up the MCC as an effort to put resources in those countries already investing in human capital and sound governance, and therefore was able to provide an environment in which investments in public infrastructure could have maximum impact. It is also why World Bank President Jim Kim’s efforts to focus on human capital so revolutionary.

 

The BUILD Act, and the USIDFC it creates, is built on this and other hard-learned lessons of development. But it emerges at a point in time when nearly everything we know about the nature of dynamic human contributions to an economy are in question. The global labor market is changing, and with the rise of automated systems, artificial intelligence, and employment platforms, so are our expectations about the very role of humans in a labor market. Common wisdom is that the jobs of the future in all economies will center around complex, creative, and interpersonal skills – but no one quite knows what it will take to get there. 

 

Looking at this uncertainty, it could be easy for a newly minted USIDFC (and other US levers of economic development) to cause the US to focus exclusively on the physical capital side of investment. That would be a mistake. To succeed, the USIDFC will need to apply one of the most complicated and least glamorous lessons of the MCC: investing in both the human and physical side of economic growth. Without that, it will fail to leverage this obvious moment for American economic leadership in a dynamic sector, and neglect opportunities both at home and abroad. To put it more pithily, US foreign assistance needs to invest in people as well as in stuff. 

 

What does this mean? The USIDFC needs to make a tangible commitment to rigorously designing and evaluating the human capital side of its investments. It may require new research and creativity to assess the evolving effect of secondary and higher education transitions, or the role of informal education, apprenticeships, or other employment focused interventions at the young adult and adult level. But to be successful over time, the DFC’s economic assessments must articulate their assumptions about the role of people in making economies work, and impact evaluations of that work should create the same type of robust experiments that MCC depended on to explore investment returns in agriculture, transport, and power sectors. That may also mean pulling other foreign assistance agencies as well as private sector and philanthropic partners in to make complementary investments in human capacity that align with their own mandates.

 

We know there are a tremendous number of ways for individuals to actively participate in an economy, and that this participation is necessary for growth as well as for political and social stability. Genuinely evaluating the ways US investments and foreign assistance support this crucial participation will invariably lead us to some positive conclusions and some painful realizations – that is the nature of robust impact assessment. But we all see the future of work changing. It would be inexcusable for the development community to believe that has no implication for the way we work too.  

 

Alicia Phillips Mandaville is Vice President of IREX, and a non-resident Senior Associate for the CSIS Project on Prosperity and Development. Kristin Lord is President and CEO of IREX, a global development and education nonprofit celebrating its 50th year.

Secretary Carlucci valued American Soft Power and Allies

Frank Carlucci2

Secretary of Defense Frank C. Carlucci transfers the rein of command of US Central Command from General George B. Crist (USMC) to General H. Norman Schwarzkopf (USA) on January 11, 1988

By Daniel F. Runde and Christopher Metzger

Legacy of Service

Former Secretary of Defense Frank Carlucci passed away last month. There is a generation who do not know his exemplary legacy of public service. For all those who remember him, Secretary Carlucci is best known for his later career as National Security Adviser and Secretary of Defense under President Reagan.  He is less known for his very important contributions to using American soft power to increase freedom and create deeper ties with allies while serving in Portugal; it is this part of his legacy that deserves more attention.

Before serving as a political appointee, Secretary Carlucci was a career ambassador and foreign service officer service in Africa and Latin America starting in the 1950s. But he really made a major contribution when he was ambassador to Portugal from 1975-1978. Secretary Carlucci was sent to Portugal during a period of utter chaos. From 1932 to 1968, António de Oliveira Salazar had ruled Portugal as a dictator, suppressing political freedom and establishing the Estado Novo (“New State”). Shortly after Salazar suffered a stroke and was replaced, 300 officers called the Armed Forces Movement and led by Francisco da Costa Gomes successfully completed a coup in what would be later be called the Revolution of the Carnations. By 1975, the Portuguese Communist party and other Marxist-Leninist groups had won virtual control of the government, and it seemed that all of the Lusophone and Ibero American countries in South America and Africa would fall to communism as well.

File:Frank Carlucci official portrait.JPEG

Official Portrait of Secretary of Defense Frank Carlucci on November 1, 1987

To this day, Secretary Carlucci is very highly regarded in Portugal for his leadership during the “Portuguese Revolution” of 1975-1976. Ambassador Secretary Carlucci famously remained in the country even after Otelo Sariva de Carvalho, a leading leftist member of the military, said they could “not assure his safety.” Leveraging USAID and other forms of American soft power, Secretary Carlucci was a key figure in Portugal’s democratization and ultimate election of its first Prime Minister, Mario Soares. According to an interview with Amb Carlucci by the Gerald Ford Foundation, “if Portugal hadn’t gone democratic, it’s really questionable whether Spain would’ve. And Spain set the pace for Latin America.”

Secretary Carlucci was also instrumental in the negotiations over the Azores islands in the Atlantic Ocean. The United States had stationed a fleet of planes at the Lajes field in the Azores islands since World War II. After the war was over, Portugal and the U.S. reached an agreement that granted the U.S. the right to use the Azores, while the Portuguese government retained ownership of the land and infrastructure. Our basing rights on these islands, near Northern Africa, have only grown in importance over the years.

Another part of Mr. Carlucci’s legacy in Portugal was his involvement with the Luso-American Foundation that continues to build ties between the U.S. and Portugal and the growing Lusophone (i.e. Portuguese speaking) world. At a time when the U.S. is considering how to maintain ties with countries that used to receive foreign assistance, the Luso-American Foundation is an example that deserves study and replication.

President Reagan named Mr. Carlucci national security advisor in 1986 and, just a year later, appointed him Secretary of Defense.  Though he is remembered primarily for these last two positions, it is the far-reaching impact of his time in Portugal that cements his legacy as a pivotal figure in the history of American foreign policy.

Daniel F. Runde is a Senior Vice President, holds the William A. Schreyer Chair in Global Analysis, and directs the Project on Prosperity and Development at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Christopher Metzger is the program coordinator for the CSIS Project on Prosperity and Development. 

 

Photo 1: National Archives/CCO
Photo 2: Ron Hall/CC0

The United States Needs a Stronger World Bank

By Pamela Cox

The World Bank, the leading multilateral institution whose mission is to fight poverty and boost economic development, is seeking a capital increase to continue its lending operations.  The capital increase request has generated debate in Washington D.C. about the World Bank’s future role in international development. Some advocate that the World Bank continue its current role as lender to poor and middle-income countries, but with a set of reforms to reflect twenty-first century realities. Others advocate that the World Bank shift its focus to only the poorest and fragile states. Yet others want to refocus the World Bank into a new type of financing institution for global public goods. Despite the differing views, the U.S. and other shareholders should continue supporting the work of the World Bank, while the World Bank needs to adapt its role to the changing world, building on its strengths.

In its 74-year history, the World Bank has changed its model several times, to respond to shareholders’ demands and global trends. Founded originally as the International Bank for Reconstruction and Development (IBRD) to finance post war reconstruction in Europe, the World Bank made is first loan to France in 1947. But as the Marshall Plan ramped up, the World Bank quickly shifted to financing projects in lower and middle-income countries constrained by access to capital. Recognizing the importance of promoting private sector-led development in these countries, the International Finance Corporation (IFC) was established in 1956 to do both debt and equity lending. As former colonies became independent but lacked credit worthiness to access capital markets, the International Development Association (IDA) was created in 1960 to offer very low interest long term loans (later changed to grants) to the poorest of countries.

The IBRD model of financing uses limited public money to leverage private financing from global capital markets, and to share burdens amongst shareholders. It is an investment bank – a point that is important when thinking about its future roles and focus. IBRD’s capital comes from its 189-member countries, who own shares based on economic size (the U.S. is the largest shareholder with 16.2 percent of shares). But only a small percentage of the capital is actually paid into the World Bank; the rest is held on country books. Since 1944, the U.S. has subscribed to $38.5 billion of shares, of which only $2.4 billion has been paid in. Together with the paid-in capital from other member countries, a total of $252.8 billion, IBRD has leveraged over $600 billion in loans.  In short, a small investment by the U.S., spread out over 74 years, has increased capital flows to the developing world 14-fold. Compared to direct on-budget support, which is the model of public aid agencies, this is a significant return for limited investment – and an effective use of scarce public resources.

What are the criticisms of the current World Bank model? Critics have argued that many of the middle-income countries that IBRD lends to have access to capital markets. Their World Bank loans are subsidized and this should not be the case. Others have argued that the World Bank should cease lending to middle-income countries and focus only on IDA-eligible countries, in particular in Africa and in fragile states. There are arguments about overlaps with other regional development banks such as the African Development Bank, Asian Development Bank and InterAmerican Development Bank, and that these institutions should take the lead instead.  Finally, some call for a complete transformation of the World Bank into an institution financing only global public goods.

The first critique is that the World Bank has provided subsidized loans to middle-income countries that can easily raise money in global capital markets. While World Bank loan rates for IBRD’s loans have often (but not always) been less than commercial loan rates on a country by country basis, one factor in setting interest rates has been the Bank’s ability to use its AAA rating and prudent debt to capital management to tap global capital markets on behalf of member countries which would not receive such favorable terms. In short, it spreads the risk.  Moreover, the World Bank recoups its costs on loans through its spreads, which are adjusted to reflect market and other factors. Loan charges are based on LIBOR plus a spread (which has varied over time). With this spread, the World Bank earns a modest profit after covering its administrative costs (which remain half of those of private investment banks).

Research looking at subsidies within the IBRD financing model[1] has shown that in fact, it is the middle income IBRD borrowers who have provided net subsidies to the World Bank, as funds from money made on IBRD loans generate profits which have been used to build  reserves, contribute to IDA, and modestly fund some global goods (agricultural research has been a significant beneficiary). Annual contributions to IDA from both IBRD and IFC profits have increased resources available for the poorest countries beyond the amounts the higher income countries would otherwise have contributed.

The second critique is that the World Bank should cease lending to middle income countries and focus only on IDA-eligible countries, and in particular Africa and fragile states.  Shifting IBRD lending to these types of economies ignores the nature of the financing model – and the benefits it offers all members of the institution. IBRD would be unlikely to retain its AAA credit rating and its ability to tap global capital markets at favorable rates if its pool of borrowers were the most economically stressed and lowest income countries. Indeed, the World Bank would doubtless have to rely even further on member country contributions, as IDA’s financing model is more akin to that of a public-sector development agency, with replenishments from contributing governments every three years. IDA provides a combination of grants and very low interest loans (which are heavily subsidized).

Recognizing the limitations of relying on donor contributions in an age of constrained government budgets, the World Bank has introduced elements of the IBRD model to raise more funds for IDA. In IDA18, the current replenishment, the World Bank will leverage IDA’s capital (in this case, IDA’s reflows): IDA has obtained a AAA credit rating and will supplement pledges from governments with borrowing on capital markets, raising about a third of new funds in this way.

Why should IBRD continue to lend to the middle-income countries? First, most poor people live not in the poorest and most fragile countries, but in middle-income countries. Some 2 billion people, living on less than two dollars a day, live in middle-income countries, which account for nearly 80 percent of the world’s poor. These poor people are concentrated in India, China, Nigeria, Pakistan and Indonesia – all lower or middle middle-income countries. Reaching these poor populations will require engaging in middle-income countries.

Second, the World Bank can be an effective financing partner to middle-income countries, helping to leverage a mix of financial flows to underwrite development. While it is true that many middle-income countries have increased access to world capital markets and foreign director investments, fund flows have been uneven in quantity and quality. Relying on global capital markets requires effective domestic monetary and financial sector policy management, as well as a level of domestic financial sector development. The good news is that in the last two decades, many middle-income have improved macroeconomic policy management in these areas. There is more to be done, and the World Bank has provided assistance for financial sector development and policy. Increased openness to global markets has risks, as was most recently underlined in the 2008/09 crisis which left many middle-income countries without credit lines and experiencing capital outflows. In this case, the World Bank Group was an effective countercyclical lender, providing financing for critical social and poverty programs providing a safety net.

Middle income countries will need to do more to generate domestic resources to help fund development programs, although realistically, lower middle-income countries have lower incomes and more limited revenue raising potential. The World Bank has provided assistance and financing to improve domestic resource mobilization, addressing budgeting and taxation in a range of lower middle-income countries.

In recent years, direct private investment has increased in developing countries, especially in high return projects: toll roads, airports, telecommunications. However, the private sector rarely invests in rural infrastructure or, outside of major cities, water, sewers, and transport. As is the case in most high-income countries, including the U.S., the public sector bears the burden of investments here. The World Bank has sought to “crowd in” the private sector in these projects. Through its investments, it has ensured good governance and environmental and social sustainability, encouraging private investors to buy in.

Third, the ranks of middle-income countries are increasing. Between 2001 and 2018, the number of countries classified was halved, as 33 countries moved into middle-income status (defined as per capita GNI between $1,005 and $12,235 in 2018). Only 31 countries are now classified as low income. IDA provides support to a total of 75 countries, which includes not only the lowest income but many small island economies which are not IBRD creditworthy (59 countries receive IDA-only lending), plus another 16 countries which receive a blend of IDA and IBRD resources (Nigeria and Pakistan for example). As countries graduate from IDA, their access to capital markets may remain limited due to lower incomes, and they will continue to face challenges of generating resources for development.

Fourth, the World Bank brings not only financing, but knowledge and technical assistance through its project lending. The World Bank does rigorous monitoring and evaluation of all projects that it funds, and shares results, providing one of the largest databases of development experience in the world. Project-specific data and results in turn contribute to the broad expanse of research done at the country and global level on a wide range of development issues. For middle-income countries, this knowledge is an important factor in seeking financing from the World Bank. In middle-income countries, the World Bank tends to finance more complex projects or it helps launch and spread new approaches (for example, conditional cash transfer programs which originated in Brazil as a safety net, and now have spread to Africa and other regions). In turn, experience from the middle-income countries is important to other countries, including low-income countries, in understanding what works in development. The World Bank partners with the private sector, especially on large infrastructure projects, providing its expertise in implementation, financing packages, governance, and social and environmental safeguards. It thus helps “crowd in” private investment.

Discussion remains on a suitable graduation policy for middle-income countries. Using an income cut-off poses some difficulties: as noted above, there are several small island countries in the Caribbean and Pacific which remain eligible for IDA under the “small states’ exception” due to their economic size. Other countries which are classified as “upper middle-income” have large numbers of poor people (Indonesia, China).

What about the critique of “overlap” between the World Bank and the other regional MDBs? Given the need for development capital, with the sustainable development goals requiring an estimated $1.4 trillion per year, there are more than enough projects and research that require funding – capital is scarce, and the World Bank and regional banks do not compete for investment opportunities. But one of the major differences between the World Bank and the regional MDBs lie in their focus: the World Bank is a global institution, leveraging knowledge and financing from throughout the world, and similarly spreading its lending risk amongst more countries. The regional MDBs are by definition regionally focused. This is important in some areas – regional MDBs have been able to be more flexible on issues such as lending for regional integration. But the World Bank has been able to provide leadership and focus on issues cutting across regions – from financial crises to safety nets to global warming, as argued below. World Bank shareholders who are middle-income countries use both the World Bank and regional institutions depending on the nature of the investments.

Finally, should the World Bank finance only global public goods and move away from its traditional country-level lending? It is difficult to see how this could be done—or if it could be done. Shifting to financing only global public goods cuts off key attributes that make the World Bank successful. One of the core strengths of the World Bank is its ability link its country relationships, in-depth country knowledge and project experience, with a global platform. The World Bank, through its country-based activities, gains deep knowledge of the range of development issues.  It also brokers knowledge amongst development practitioners (for example, the Latin American network of heads of units implementing conditional cash transfer programs, set up by the World Bank). But it marries that in-depth country knowledge with its global network.

The World Bank is a global platform that brings together a range of development actors—countries, project officials, the research community, the private sector—and provides a range of services. It funds projects. It does research. It provides technical assistance. It advocates for development issues (girls’ education, anticorruption, climate change mitigation). It advocates for global public goods. It brings together different actors: public sector, private sector, civil society. The strength of the World Bank is that it is both global and local.

Where the World Bank has been successful on climate change, for example, it has done this at many levels: through broad research and advocacy at the global level, but also through country-based research that led to financing projects on the ground to reduce emissions (for example in Mexico and Brazil) and mitigate climate change impacts. Without local focus and activity at the country level, the World Bank would be more similar to a global fund.  Indeed, existing global funds (for education or for health) have partnered with the World Bank and its local projects to deliver results. Through Education for All, for example, the World Bank invested in and carried out projects that served as vehicles for more aid financing for education; similarly, the Global Fund to Fight Aids, Tuberculosis and Malaria has relied on World Bank projects improving health systems.

As a multilateral institution, the World Bank provides a platform for countries to identify and set priorities at the global level. The evolution of focal development issues in the last twenty years—HIV/AIDs, migration, governance, climate change, to name a few—have all included World Bank research, advocacy and lending. The World Bank is a means to bring countries together around priorities—but also to get action. There are certainly other multilateral channels —the UN is a major one. But what sets the World Bank apart is its ability to get results on the ground through its lending and country relationships.

The World Bank brings other attributes. It has a strong track record of financial management, on both the borrowing and the lending ledgers. For this reason, it has been effective at managing additional funds (trust funds), including in reconstruction situations (Haiti, Indonesia). Unlike most private sector projects, World Bank investments are supervised, tracked and reported on—in a transparent way.

The U.S and other shareholders should continue supporting the World Bank. Many of the world’s most pressing issues require international cooperation and the World Bank is the premiere organization to lead these efforts. Promoting economic development, growth and the reduction of poverty helps stabilize states, reduce migration pressures—and create markets.  Disease knows no boundaries in the era of international travel, which can spread infectious disease globally in less than 24 hours. The 2008 financial crisis demonstrated the interlinkages of financial markets. Climate change is a global phenomenon, not a national one, and its effects are spread out across countries.

A strong U.S. presence has shaped the World Bank in the past and should continue to do so. The idea of setting up a bank for reconstruction and development—which emerged from Britain and the U.S.—was a way to tap American capital markets in 1944. And today the World Bank can help countries tap even larger markets. The pressure of using capital markets, rather than public budgets, forced the World Bank early on to invest in the project approach, strict monitoring, supervision and sound accounting of expenditures and outcomes. Over the years the U.S., through its role on the World Bank’s board, has pushed the institution to expand investments in health and education, improve financial accountability and reduce corruption, institute open procurement policies, put in place environmental and social safeguards, expand attention to gender issues, and promote private sector development.

Looking ahead, the World Bank needs to continue to adapt its role to the changing world, building on its strengths. Shifting to new ways of increasing IDA financing through borrowing is one example. The move to help countries boost domestic resource mobilization is another, as is the expanded role of the World Bank in leveraging private sector funds, which it has done in many instances (in large infrastructure projects). At the same time, the World Bank shareholder countries need to acknowledge the changing governance challenges. No longer is the institution a bipolar one (donors and recipients); it is a multipolar world now, and the share structure of the Bank (and the IMF) need to reflect this. The U.S. did not support a capital increase and shifting voting shares in the past, which in part led to the formation of China’s infrastructure bankthe Asian Infrastructure Investment Bank (AIIB)—leaving the U.S. without a seat at the table.

The World Bank continues to have much to offer—it has formidable knowledge and experience, it provides an open platform to bring countries and people together around global and development issues, and it gives value for limited investment. But there is a “pay to play” aspect. Unless the World Bank receives more capital, it risks continuing to shrink, and the space ceded to other actors and platforms where the U.S. has limited influence and impact.

[1] Willem Buiter and Steven Fries, “What should the multilateral development banks do?”  Working Paper No. 74, European Bank for Reconstruction and Development, June 2002