Note: Title credit goes to Jeff Frankel, who moderated a panel I participated on.
Paul Wolfowitz just took over at the World Bank. He already seems to have indicated that is not going to follow Desmond Lachman’s advice, and stop lending to middle income countries. Alan Meltzer and Adam Lerrick must be slightly disappointed as well. Nancy Birdsall and the folks over at the Center for Global Development, on the other hand, should be encouraged.
Why not go one step further. Perhaps Wolfowitz should consider expanding the World Bank’s lending to middle income countries. Someone needs to put that global savings glut to work in places other than the US and Europe!
The standard argument for World Bank lending was that developing countries otherwise would not have access to sufficient capital. But it is possible to make a different argument: too much money from emerging economies is being invested at too low a return in the government bond markets of already rich countries. There should to be a way to recycle the growing reserves of the emerging world into new lending to the emerging world.
The World Bank was initially set up to mobilize the savings of rich countries to finance lending to the world’s poor countries. But right now, the world’s surplus savings can be found in the world’s emerging economies, not in the world’s richest countries. The World Bank provides -- at least in theory -- one pontential way to use those savings to finance investment in other emerging economies. The World Bank issues high quality bonds -- bonds that work perfectly well as reserve assets. The proceeds of those bonds are used to finance its lending to other emerging economies.
The standard argument against World Bank lending to middle-income countries is that they have plenty of access to world capital markets, so they can finance themselves privately. And right now, there certainly is no shortage of financing for emerging economies. Spreads on their dollar-denominated international bonds are very low. But there is one catch: emerging economies no longer trust private capital markets to be there when they need them. Rather than spending the money the capital markets are sending to their countries, they are saving it.
Capital flows to emerging economies don’t finance investment in emerging economies these days -- or to be precise, investment in excess of savings, i.e. a current account deficit. Right they finance faster reserve growth. Indirectly, more capital flows into emerging economies means more support for US treasuries and German bunds.
More World Bank lending would only change this equilibrium if it made middle income countries more willing to spend loans from the World bank than private capital inflows. Whether it is higher consumption or more investment, the reserves of one emerging economy can only be recycled inside the world’s emerging economies if at least a few emerging economies are willing to run current account deficits. Otherwise, more lending would just produce higher reserves -- the last thing the world needs right now.
Yes, it is a slightly crazy idea. But talk of a global savings glut when the US hardly saves at all would have seemed a bit crazy a few years ago. The bond market is a bit crazy. And a world where the poor finance the rich is a bit crazy. So even if this idea has a few problems, I thought at least it should be tossed around.
Endnote: The Bank finances its its subsidized lending and grants to very poor countries in two ways: a) budget appropriations -- i.e. gifts -- from rich countries, and b) the profits it earns lending to middle income countries.