Meltzer/Lerrick: "The World Bank Is Wrong to Oppose Grants"

["Robert Naiman" <naiman@xxxxxxxx>]

Wall Street Journal
July 26, 2001

Commentary -- The World Bank Is Wrong to Oppose
Grants

By Adam Lerrick and Allan H. Meltzer. Messrs.
Lerrick and Meltzer are director and chairman,
respectively, of the Gailliot Center for Public
Policy at Carnegie Mellon University. They served
as senior adviser and chairman of the
International Financial Institution Advisory
Commission of the U.S. government, and are
presently advisers to the Joint Economic Committee
of Congress. Mr. Meltzer is a visiting scholar at
the American Enterprise Institute.

As rich countries commit ever more resources to
building a better life for poor nations, they must
cast a more critical eye on the World Bank's
stewardship of $500 billion in aid flows over the
past 50 years. By the bank's own reckoning, less
than one in three of its sponsored projects in the
poorest countries yields satisfactory and
sustainable results. Forty-two needy countries now
carry a load of $175 billion in official debt they
are clearly unable to repay, and have nothing to
show for it but a 25% decline in their standard of
living since 1980. Numbers like these call for a
major change in the way aid is delivered and
administered.

Last week, President Bush put forward a plan to
move from loans that disburse funds before results
to outright grants tied to performance. Opposition
has been orchestrated by the bank around the
faulty argument that grants will deplete its
resources, together with its ability to help the
poor, unless the grants are accompanied by an
immense infusion of new funding -- $800 million
more each year from the U.S. alone.

Superficially, this sounds logical: After all,
when money is given away, instead of being lent,
the stockpile of funds can be expected eventually
to vanish. Not so. Grants can provide the same
amount of aid, make every dollar more effective,
provide a permanent exit from debt for the poorest
countries, protect donor contributions from risk
of loss -- all without diminishing the funding
pool or asking for more money from the taxpayers
of the industrialized world. The advent of
sophisticated capital markets makes the
difference.

The president focused on the International
Development Association (IDA), the arm of the bank
that offers $6 billion of funding per year, at
near-zero interest rates, to 72 countries with
less than $1,500 per capita income. Grants could
have their greatest impact in the 59 neediest
nations, where people exist on less than $2 per
day.

There would be a string attached to these gifts.
Unlike the current trend toward lending sums for
indeterminate government plans, grants would be
project-linked, monitored for results, and paid
only for performance. For the easily quantified
necessities that improve the quality of life and
are the preconditions for economic growth --
health, primary education, water and sanitation --
the grant system would count and pay for numbers
of babies vaccinated, children that can read, and
water and sewer services delivered to villages. No
results, no funds expended. And no funds diverted
to offshore bank accounts, vanity projects or
private jets.

Grants and loans have the same funding requirement
when the level of aid is the same. Donors will not
have to give more unless they wish to give more
aid. The IDA extends 40-year loans that carry an
interest rate of 0.75%. The present value of these
payment promises is only 25 cents on the dollar
and translates into a gift equal to 75% of their
value. A loan that has a 75% gift component cannot
cost more than an outright grant that covers 75%
of program outlays. In both cases, countries pay
the remaining 25%. How can lending $100 and asking
for only $25 to be repaid be any different from
giving $75? There is a hidden cost to the present
system: The poorest borrowers seldom repay loans.

In order to discredit the grant concept, confuse
Western donors, and justify increased resources,
the World Bank has swapped apples for oranges.
Their calculations raise aid levels 33% by
comparing grants covering 100% of program costs
with traditional loans that contain only a 75%
grant element. Again, if the same level of
assistance is maintained, grants cannot cost more
than loans.

Shrinking resources, caused by the lack of loan
repayments into a circulating aid pool, are always
advanced as a reason to block the shift to grants.
The bank's practices give the lie to this "reflow"
claim, for many loans are never truly collected.
Most debts are simply recycled to the same
borrowers, with more added to cover interest
payments. Ultimately, many debts must be forgiven,
as in the current relief initiative that covers 41
of the neediest nations. Whether recycled or
forgiven, loans are simply grants in disguise.

A grant system would not rely on illusory reflows
for self-sustainability. The pool of donor funds
now used for lending, and future contributions,
would be transformed into an endowment that
invests in the capital markets and generates the
income to supply grants. There are already $108
billion of rich-country contributions on the IDA's
balance sheets, partly in loans and partly in
cash.

These cash balances, augmented by future loan
repayments, would be invested for a conservative
8% return and eventually yield $8.6 billion in
grants each year, while leaving the endowment
intact. This stream will be leveraged by the
capital markets, which will provide financing
because the bank's responsibility for the lion's
share of every payment will greatly reduce risk.
Thus, an identical $108 billion in outstanding
development programs would be sustained in
perpetuity.

As the IDA moves from lending to grants over a
40-year transition, the volume of development
programs and the flow of financial resources to
poor countries would match what would have been
delivered by loans. Failures to repay old loans
would reduce resources, but no more so than under
lending.

Lack of basic arithmetical skills cannot explain
the bank's continued defense of an outdated method
for delivering aid, designed at a time when direct
loans were the only option. Capital markets are
now able to provide financing, and willing to
tolerate the risk that once deterred projects in
the developing world. The institution does not
welcome a career change from being an elegant
banker dispensing large volumes of largesse to
being a gritty development agency with a demanding
workload. And it harbors a well-founded fear that,
with grants, it must account for the effectiveness
of programs.

The bank will soon seek replenishment funding for
the IDA, as happens every three years. The amount
of money is significant; last time, it was $12
billion. Giving to needy nations is a continuing
obligation, but so is the responsible use of
taxpayers' funds. Finance ministers and
legislators should insist on the use of grants
when making new contributions. The increased
effectiveness of aid might then encourage them to
give more, and with good conscience.