Give and take - Europe is worried by US proposals to replace half the World Bank's development loans with grants



By Alan Beattie

19th July, 2001.

When President George W. Bush arrives in Genoa on Friday, he may receive a less than effusive welcome. Not only will he be a target for the thousands of anti-globalisation protesters massing in the Italian city; he has hardly made himself popular with several of the other Group of Eight industrialised nations.

Mr Bush's call this week for half the loans made to some poor countries by the World Bank to be converted into grants has alarmed several European countries that are shareholders of the Washington-based institution. Coming soon after the abrupt US decision to abandon the Kyoto protocol on global warming, it has renewed fears about US unilateralism in policymaking.

The Bush administration's instincts on policy for the International Development Association - the arm of the World Bank that lends to poor countries - were already known. And they were not entirely original: Paul O'Neill's predecessor as US Treasury secretary, Larry Summers, had proposed an increase in grants. But the size of the proposed switch - and the fact that it came out of the blue just before the Genoa summit - was a shock.

The IDA lends about $6bn a year to a selection of its 78 eligible countries, which have a combined population of 2.3bn people. It lends on extremely soft terms - over 35 or 40 years, with a 10-year grace period before repayment and a "service charge" of just 0.75 per cent per year. The US proposes replacing about $2bn of this lending with grants - or half the portfolio for the very poorest countries within the IDA - rather than half the IDA total.

Unlike the Bank's lending to middle-income countries, which is funded from borrowing in capital markets, the capital for IDA lending comes mostly through contributions every three years from rich nation shareholders. From its beginning in 1960, countries have contributed a total of $96bn, with the US and Japan providing about a quarter each.

One worry among World Bank officials and other developed countries about the US proposal is that if the sums disbursed by the IDA were not repaid, it would gradually erode the organisation's finances. Some estimates suggest the Bank could lose more than $1bn a year in repayments. Some cynics point out that, by the time the funding constraint started to bite, Mr Bush would be out of office.

The US administration dismisses this argument. John Taylor, under-secretary for inter-national affairs, says the plan would reduce IDA income only by about 4 per cent over 20 years. "It is hard to believe it wouldn't be possible to fill that gap," he says. He adds that grants will make it much easier to tie funding to specific goals, such as school tests or infant mortality, which will increase rich governments' willingness to contribute. "You will get more for your money - and that will make people more willing to give."

Mr Taylor admits that as time goes on, the gap in the World Bank's funding will increase - but says the efficiency gains will outweigh this. As for the gap in the funding in decades to come, he says: "I'm an economist and that makes me realise the difficulty of forecasting over more than 20 years." As a rough estimate, he suggests that - without a real increase in government contributions - the World Bank will end up with about 15 per cent less to give out at the 40-year mark. He also says that the 50 per cent grant proposal is not set in stone and could reduce as countries become richer and more able to repay loans.

Since the US is the World Bank's largest shareholder, its views are taken seriously by others. But European officials say the comparative lack of aid flowing from the US to the developing world undermines its moral authority. They note that the US gives only about 0.1 per cent of its national income in bilateral aid - less than half the average for OECD countries. Only 0.02 per cent of US national income goes to the least developed countries.

Tensions between the US and other World Bank shareholders go deeper than the matter of grants versus loans. There are also differences over the way in which aid should be given to poor countries. The traditional means of giving financial assistance to a country is to tie the money to a specific need - whether building a dam, running a vaccination programme or installing a computerised tax collection system. Countries such as Japan and the US are still attracted to this means of giving assistance and - despite its reservations about the Bush plan - so is France. Government ministries of Francophone African countries are regularly staffed with seconded French civil servants who help to administer programmes supported by loans and aid.

But Scandinavian countries, which have comparatively large aid budgets, have increasingly moved towards supporting poor countries' national budgets directly through loans. They believe that a multiplicity of stand-alone projects can weaken the developing countries' feeling of involvement in the process. The principle of using loans is important in building up a credit culture in recipient governments, they believe.

The UK and Germany are also moving towards this approach. During a recent meeting on the forthcoming round of donations to the IDA, which was held in Addis Ababa last month, the most vocal objections to replacing loans with grants came from the UK, Denmark, the Netherlands, Norway and Sweden.

The US argues that the budget support approach gives inadequate reassurance against funds being misused or projects going off track and prefers to tie specific parts of aid to specific projects. The intellectual genesis of the grants proposal is not hard to find: last year's US congressional commission on the IMF and World Bank, chaired by the conservative academic Allan Meltzer. Adam Lerrick, a former senior adviser to the commission and an academic at Carnegie Mellon University, is delighted by the US proposal. "The real reason the World Bank object to this proposal is that they are terrified that the effectiveness of their aid will be continually assessed," Prof Lerrick says.

As with the Meltzer commission's support for debt relief, the preference for grants has created unusual alliances between conservative Republicans and some development campaigners, who fear that World Bank lending will end up as unpayable debt. "For very poor countries, it makes perfect sense to give aid in the form of grants rather than loans," says Tony Burdon, a policy adviser at Oxfam International.

But in spite of a claim by Mr Taylor that Oxfam supports the US proposal, Mr Burdon is circumspect: "What is needed is to maintain, if not increase, the size of IDA flows. If IDA shifts to more grants without compensatory increases in funding, the danger is that total aid flows will decrease." He also rejects the culture of stand-alone projects, saying that grants must be used to support national budgets.

Jubilee Plus, a successor organisation to the debt relief campaign Jubilee 2000, goes further, backing the Bush project in its entirety. "European leaders opposed to Bush's proposal are simply defending corporate interest in their own countries," says Liana Cisneros, Jubilee Plus's Latin American co-ordinator. "World Bank loans effectively provide subsidies to big companies wanting to do business in developing countries."

The US proposal will not be adopted without a fight. It will require a majority among the governors of the World Bank, in which the US holds just over 20 per cent of the votes. Apart from the European objections, poor countries will also be reluctant to support any proposal that might reduce their overseas aid. Most other G7 countries seem willing to convert about 10 per cent of loans to grants. But the adoption of Mr Bush's ambitious plan in its entirety looks some way from fruition.

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