Dani Rodrik's weblog

What Next at the World Bank?

Guest Post by Danny Leipziger,Professor of International Business at George Washington University, and former Vice President for Poverty Reduction and Economic Management at the World Bank

A new president will take over the World Bank on July 1^st. Dr. Jim Kim inherits a venerable institution that has lost its way. As a lender, the Bank peaked with its massive precautionary lending in 2008-2009, only to be left capital poor. As an adviser, it has lost too many experienced staff to be taken seriously by more adept policy officials in borrowing countries. And as a voice for development, it has grown faint. To be sure, the Bank still has assets, its past reputation among them, but it is precariously perched, being surpassed and outclassed by regional banks, by the IMF, and by new lenders.

Re-enforcing this rather bleak diagnosis is the fact that senior officials of the Bank have lost hope; staff are now told that policy briefings with Ministers are a thing of the past, that others can analyze World Bank data better than the economists in-house, and that budget constraints limit the Bank’s ability to reach for new challenges. This is the institution that Jim Kim inherits. It needn’t have come to this. A recent Diagnostic Report of the 1818 Society, the Bank retirees group, noted many self-inflicted wounds caused by poor management, excessive decentralization and lack of accountability, mission creep, and horrific human resource policies.

Faced with this situation, a new CEO might be inclined to look for the silver bullet of one new initiative, one new partnership, or one new theme. That would be a colossal error. Turnaround management will require a new business model for the 65 year-old development bank. That new model should include retrenchment into regional hubs, staff reductions, a new organizational structure, and a return to a sensible human resource policy. The World Bank staff, its primary asset, needs to be recruited from the best places and needs to embody the best global skills. Only then will they get their meeting with ministers.

Its financial model needs to be rethought to gain more leverage from existing capital and to start lending to sub-national entities that will for the next decade be the growth drivers and either the greatest polluters or largest carbon-reducers. Its mission must change from an excessive focus on fragile states and its IDA business to a better balance with middle-income engagements based on bundled services of expertise, financing, and convening power. This work cannot be done by term- contracted appointees with neither the requisite experience nor the institutional memory of knowing what has worked and what has failed in the past.

Most of all, the Bank needs to get it "mo-jo" back! It has been on its heels since 2005. It has not reacted to new global challenges to redefine its role. It failed to capture the climate change agenda; it responded to the financial crisis with one-time lending, but failed to provide the risk mitigation instruments that emerging market economies want; and it has not responded well to the growth and employment challenges facing middle-income countries. And it has lost its intellectual leadership on issues that matter to those not in the developed world.

New leadership can turn the World Bank around, but piecemeal reforms will not work. Visionary leadership and hands-on management is required, and one can only hope that President Kim will have the perspicacity and the perseverance to re-invent the Bank, restore its excellence, and regain global relevance.

What I learned in Latvia

I spent a few short days in Latvia last week. My meetings centered on industrial policy, which Latvia is serious about – quite interestingly for a country that is often viewed as a hotbed of conservative economics. But my time there also gave me an opportunity to reflect on the country’s much discussed response to economic crisis.

Briefly, Latvia rejected much external advice and did not devalue, despite a huge current account deficit that exceeded 20% of GDP in 2007. The lat had been pegged to the euro in anticipation of Eurozone entry and the government refused to do anything that would jeopardize that goal. The IMF were told to go home if they were going to insist on devaluation. 

In the end, the country implemented a radical fiscal contraction that pushed the country back into external surplus. The shock produced a loss of output of almost 20% of GDP in one year, and a rise in unemployment to 18.4% (from 6% in 2007). By 2011, the worst seemed over and the economy grew at a healthy rate of 5.5%, one of the highest in Europe. 

If you listen to advocates of fiscal austerity, such as central bank governor Ilmārs Rimševičs, Latvia is a huge success -- an example for Greece, Spain and others on how to do it. On the plus side, growth has returned faster than most anticipated, exports are up, unemployment has come down, and the political system appears more stable than it has been for some time. Despite complaints about the legal framework and poor implementation, foreign investors are reasonably satisfied. Eurozone entry is still planned for 2014.

On the negative side, the collapse in GDP was the deepest any country experienced during the present crisis. Even though a recovery seems apace, the country is still far from recuperating to output levels prior to the crisis (see chart).  Iceland, which was hit with an even larger financial crisis, imposed capital controls, devalued its currency, and avoided as sharp an economic contraction as Latvia. When I brought up this counterfactual, Rimševičs cut me short and argued that Iceland benefited from special export conditions.   

Even though Latvia’s external imbalance was eliminated, it is not clear that there has been a sizable improvement in competitiveness.  The much vaunted internal devaluation has been small. Wage cuts have been mostly in the public sector, where they don’t really help with export competitiveness.  Private sector wages have been surprisingly resilient.  As the next chart shows, the unit labor costs-based measure of the real exchange rate has come down (depreciated) only moderately, following a huge rise over 2004-2008. Consequently, it is not at all clear whether Latvia has regained sufficient competitiveness to sustain growth without running sizable external deficits yet again.  

To an outsider what is the most striking aspect of the Latvian experience is the relative absence of political conflict and social strife during what must have been a catastrophic economic crisis. When I brought up the news articles that mentioned Lativa’s largest street protests since the Russian occupation at the height of the crisis, my hosts assured me that these were in fact minor. Just a few hundred people, acting up for the cameras, they said.  Greece this was not.

Why? Not because the political system is particularly functional (there are in fact too many small parties) or there are no ethnic cleavages (the Latvian-Russian divide remains deep). I was told that Latvians are stoic people, that they keep their problems to themselves. 

The main lesson I take from all this is the need to avoid easy generalizations that do not respect country peculiarities. Fiscal austerity missionaries are surely off base when they say Latvia’s experience decisively proves Keynesians and advocates of currency depreciation wrong.  It is too early to judge the Latvian experience a success.  But it is also too early to say Latvia has been a failure.  Growth may continue, in which case the country will look better and better.

One thing we can say for sure, however, is that the kind of drastic fiscal austerity that proved feasible in Latvia would not be possible in many other countries.  Rimševičs and others stress that Latvian policy was successful because they took it on the chin and implemented the fiscal measures with speed and determination.   Perhaps.  But it is also true that they got away with vastly underestimating the costs of their measures.  Latvian policy makers had expected a 10% fall in GDP in 2009; instead they got one that was nearly twice as large.  The real secret of their success is that they did not have a revolution on their hands.