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 bank—the 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