What will be the World Bank’s role in the 21st century? Under its new President, James D Wolfensohn, the Bank has begun to face these issues. According to Christopher Gilbert (Queen Mary and Westfield College, London and CEPR), however, the Bank’s ‘strategic compact’ proposal is misconceived. Speaking at a CEPR meeting on 23 January 1997, Gilbert argued that the World Bank should capitalize on its complementarity with private-sector banks and allow middle-income countries to graduate to private-sector lending. He asserted that this complementarity principle imposed qualifications on Wolfensohn’s objective of making the World Bank market-led: the Bank should become more business-like, but it should ask where it has a comparative advantage over the private sector in providing development finance. As part of this process, moreover, the IFC (the Bank’s private-sector arm) should be partially privatized.

Gilbert, who ñ together with colleagues Raul Hopkins, Andrew Powell and Amlan Roy ñ has been examining the Bank’s role as part of the CEPR/ESRC Global Economic Institutions (GEI) research programme, noted that under Wolfensohn’s direction, the Bank must take some of the most important decisions in its fifty-year history. The Bank was originally conceived as a public-sector development agency, lending to developing-country governments or against government guarantees. Its brief was to augment deficient capital flows to developing countries in a culture where governments were seen as the main agencies for growth. The Bank now had to adapt to a world in which; private capital flows to developing countries were at an all time high; the private sector was the dominant engine of growth in developing countries; environmental issues were creating new demands; and; the Bank’s own resources were becoming increasingly stretched as a consequence of cuts in its administrative budget.

Wolfensohn had launched a major strategic review in response to these challenges. One possible response to the Bank’s dilemma would be wholesale privatization, as suggested some years ago by Alan Walters, then adviser to Mrs Thatcher. But, said Gilbert, this suggestion ignored the functional complexity of the current World Bank group, which could not easily be sustained in a privatized organization. The Bank combines banking (financial intermediation) and development assistance functions, with each function benefiting from the other. The two functions are ‘cemented’ by policy conditionality, which enables the Bank to lend with greater security than private banks and allows it to reward governments that pursue successful development strategies. While Walters was right in arguing that privatization would introduce important market disciplines, a privatized World Bank would lack the authority to apply policy conditionality. The world would gain one more large international bank, but lose its leading development agency.

Wolfensohn himself sees the solution, not in privatization, but in the Bank’s becoming more business-like. He contends that the Bank should [not??] decide which products to market, and which are best suited to each client - it should be market-led. His mission is greatly complicated by contraction of the Bank’s budget, however. He had therefore proposed a ‘strategic compact’, under which member governments would grant the Bank additional resources over three years to give it breathing space and to allow it to improve its investment portfolio and release resources for development assistance.

The research team believed, however, that Wolfensohn’s approach, though refreshing, was misconceived. First, it would lead to the Bank competing directly with private-sector banks, effectively lending at subsidized rates to middle-income countries that face little difficulty in borrowing from the private sector. Second, as in all previous crises, it would result in the Bank expanding when it should be contracting ñ a response against which, ironically, it constantly warns client governments. Third, the proposed reform also seemed unlikely to put sufficient emphasis on private-sector investment.

A more appropriate response, in the opinion of Gilbert and his colleagues, would be for the Bank to emphasize instead its complementarity with private-sector banks and encourage middle-income countries to graduate from the Bank to the private market. If fostering private-sector investment in developing countries were to become the World Bank’s main objective, however, it would entail a substantial reorganization of the World Bank group. The group currently comprises four separate entities with economic functions: 1) the IBRD (International Bank for Reconstruction and Development), which lends to middle-income countries; 2) the IDA (International Development Association), which lends at subsidized rates to the poorest countries; 3) the IFC (International Finance Corporation), which lends for private-sector investment; and 4) the MIGA (Multilateral International Guarantee Agency), which guarantees private-sector investors against expropriation and repatriation risks. Also included in group is a juridical institution, the International Centre for Settlement of Investment Disputes (ICSID).

The IBRD borrows from financial markets against member-government guarantees and on-lends against client-government guarantees, while the IFC borrows and lends in its own name, without member- or client-government guarantees, to private-sector projects. MIGA is financed via the IBRD; and the IDA is financed from group net income and by direct grants from member governments. The IBRD and IDA historically have been the largest components in the World Bank group; in Gilbert’s view, however, a shift towards lending to the private-sector would require a major shift of resources towards the IFC and MIGA and away from the IBRD.

Indeed, the research pointed to the need for member governments to agree urgently to the refinancing of the IFC and MIGA. Refinancing of MIGA presented no major problems, since it could be effected through direct transfer of resources from the IBRD. The urgency stemmed from the fact that MIGA was already in an actuArial,Helvetica,Sans-Serifly precarious position. The IFC’s funding structure, however, differed from that of the IBRD in a way that made refinancing via transfer of resources very expensive. The sums of money potentially involved were also very large. The IFC therefore should be recapitalized via an injection of private-sector funding, perhaps involving private-sector banks becoming minority shareholders.

This proposed injection of private-sector finance into the IFC would amount to partial privatization. It would simultaneously increase the World Bank group’s capacity to lend to the private sector, while subjecting it to the discipline of producing an adequate return to equity holders. Placement of shareholdings with private banks would reinforce the principle of complementarity with the private sector. The proposal would put the IFC in a position to become the leading development agency in the opening decades of the new century. With the poorest countries continuing to rely on IDA funding ñ which should remain the priority for investment of World Bank group profits ñ the development assistance capability of the whole World Bank group would be maintained in respect of the entire range of developing countries, including the least developed countries.