Foreign Relations of the United States, 1981–1988, Volume XXXVIII, International Economic Development; International Debt; Foreign Assistance

309. Paper Prepared in the Department of State¹

Washington, undated

MDBs are the Best Friends of LDC Private Sectors

Much criticism of the MDBs’ performance is out of touch with current realities at those banks. In the early years of those institutions, their officers and many of the LDC officials with whom they were seeking to promote economic development had only limited experience with the growth process. Frequently, they found statist, planning oriented approaches very attractive. After several decades of experience with the development process, most MDB and many LDC officials have concluded that, regardless of what economic theorists may say, experience shows that market forces and private initiative produce more growth than state controls and economic planning.

The critics of the multilateral development banks (MDBs) who still allege that the MDBs encourage development of the public sector to the detriment of the private sector are wrong. In fact, the public sector investments sponsored by the MDBs are predominately for physical and social infrastructures, which would be provided by the public sectors in the United States and other developed countries. These investments help provide an environment supportive of and essential to the private sector.

MDB projects are also accompanied by policy prescriptions. Given the proven effectiveness of market forces and entrepreneurship in promoting economic growth, MDB prescriptions promote freer markets and incentives for private initiative. The proper policies can be as critical to the promotion of private sector development as the provision of dams, roads and other basic infrastructure. The MDBs, and particularly the World Bank Group (IBRD, IDA and IFC), are well positioned to promote such policies.

Finally, the MDBs play an important role in the development of financial markets in developing countries. Effective mobilization of domestic resources (savings and the like) is essential for a sustainable development effort. Here the MDBs stress interest rate and exchange rate policies to allow market forces to allocate capital. In 1983, for example, World Bank projects in Brazil, Ecuador, Korea and Mexico were designed to improve the flow of capital to small and medium enterprises.

Initially, MDB emphasis was primarily on physical infrastructure projects, such as roads, ports, railways and power networks. Through 1970, nearly 60 percent of World Bank loans were in the electric power and transportation sectors. In the 1970’s there was some shift in emphasis, with more attention to income distribution. This resulted in more investment in social infrastructure, e.g., health facilities, drinking water and sewerage systems, education and housing sites and services. Cumulative lending for agriculture and rural development increased from 11 percent in 1970 to 25 percent in 1983, and lending for health and education increased from 3 percent to 5 percent in the same period. Here the emphasis has been on improving the productivity of the labor force, and the approach is best described as growth with equity.

The impact of the oil price increases of 1973 and 1979 forcibly brought to light the need for structural reform in many developing countries. As a response to this need, in 1980 the World Bank began a program of Structural Adjustment Loans (SALs). These loans are designed to provide balance of payments support to countries undertaking broad economic policy reform efforts. These loans have promoted reforms such as freer trade regimes, reduction and elimination of subsidies and price controls, divestment or greater autonomy and fiscal responsibility for parastatal enterprises, energy conservation and the like. The reform programs are tailored to the particular problems and capabilities of the recipients. SAL loans to Korea, Turkey, Jamaica and Thailand have assisted these countries in reform programs designed to vitalize their private sectors.

The MDBs, and particularly the World Bank, have been much more successful at promoting reforms beneficial to private sector development than bilateral donors. Borrowers respect the experience and knowledge accumulated by the MDBs, and see their advice as relatively apolitical. The MDBs further this perception by stressing the economic efficiency aspects of their policy prescriptions. Bilateral donors are often reluctant to discuss delicate policy issues because of concern that it will be detrimental to bilateral relations. Furthermore, other donor objectives—e.g., political, military or commercial—may prohibit placing primary emphasis on economic reform in the provision of bilateral assistance.

Paradoxically, in recent years private banks and companies have done more to increase the public sector’s role in LDCs than to promote local private enterprise. The banks seek security for their loaned funds above all else, especially in these days of threatened massive defaults. The most secure borrowers in LDCs are their governments, and the banks lend mainly to central governments or state enterprises. In several recent debt crises the private banks encouraged LDC governments to extend greater controls over private LDC international borrowers, even to the point of nationalizing them.

Private investors from developed countries, especially the larger companies, increasingly have found LDC governments to be their most advantageous local partners or interlocutors. This is especially true in the smaller LDCs. Private LDC firms have proven much less satisfactory partners for foreign investors because of their small size and unwillingness to take a long-term approach to investments.

Conclusions

Changing policies in LDCs to make their economies more market oriented can only be successfully carried out if a government sees it as being in its own interest. However, the assistance and advice of an outside international agency can make these changes easier or more politically acceptable domestically.

The MDBs—especially the World Bank—have been the most active and successful at achieving such changes. Bilateral lenders naturally are reluctant for political reasons to seek to intervene in LDC domestic policies, and if they do make suggestions their involvement may prove counterproductive if they become the political target of interest groups opposed to the policy changes.

Private banks seek policy changes only when their loans are in danger of default and then usually only through the intervention of the IMF.

Consequently, the most effective proponents of free enterprise in the underdeveloped world in practice have been the international bureaucrats of the MDBs.

1. Source: Department of State, Bureau of Economic and Business Affairs, Office of International Finance and Development Files, Lot 86D112: ODF Chron—July. No classification marking. Drafted by Ronnie Woody (EB/IFD/ODF) on December 15, 1983. Sent under a June 13, 1984, covering memorandum from Gerald Lamberty (EB/ODF) to James Burnham, U.S. Executive Director of the World Bank which stated that it was done “some months ago.” (Ibid.)