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With more than 1.2 billion of the world's people still living on less than $1 a day, there is no more important challenge than improving living standards and eliminating poverty. The World Bank and other multilateral development banks have a crucial role to play in meeting this challenge. To do so, they need to change their ways of doing business.
Today President Bush will speak about how we might spread development and prosperity to other parts of the world. In addition to describing the benefits of trade expansion, the president will point out that the key to improving living standards in poor countries is to design development strategies that focus on economic growth.
Earlier this month in Rome, at a meeting of finance ministers, I had the opportunity to share ideas for improving the development banks with both officials of G-7 nations and heads of several of the banks themselves: the World Bank, the African Development Bank, the Asian Development Bank, the European Bank for Reconstruction and Development, and the Inter-American Development Bank.
All of these development banks, whether they operate worldwide or regionally, try to use capital provided by richer nations to modernize the economies of the world's poor countries. But too often the millions or billions of dollars they have lent to finance development projects have not led to the hoped-for economic growth. To improve the lives of the poor significantly, these banks need to be more effective.
First and foremost, the development banks must focus their efforts on raising productivity growth in the developing world. Virtually all differences between rich and poor nations can be explained by differences in productivity — the amount of goods or services each worker produces per hour of work. Higher productivity translates directly into higher incomes. To start, the banks should devote more resources to the development of human capital. Education is inextricably linked to improving living standards, and it is critical that the banks place greater emphasis on it. Over the past five years, education projects accounted for only 7 percent of total World Bank lending. My colleagues in Rome agreed that this must change.
The banks should also promote the right kinds of investments in physical capital. Not all capital investments are equal. Economic history has taught us, for example, that investing in agriculture while laying the foundation for diversifying into competitive, privately owned manufacturing is a key to development. Investments should support the production of real products for real customers in competitive markets: it is important that the banks do not induce countries to invest in business sectors that are already globally oversupplied.
Because a market economy relies on institutional bedrocks like the rule of law, enforceable contracts and a stable government free of corruption, the development banks should actively promote sound governance and public-sector management in borrowing countries. They should lend only to those with governments committed to meeting these standards.
The banks must also adopt a bolder, more aggressive stance on the use of outright grants of money, as well as loans. During the past two decades, many of the poorest nations became so highly indebted that now they are unable to make payments on their current loans, let alone borrow and pay back more. Grants are the right way to help an already heavily indebted country provide education, health, nutrition, water and sanitary needs for its poorest people and to help fight AIDS and other infectious diseases. Loans should be made only when there is an expectation that principal and interest will be paid back in full and on time.
Countries that do not have access to capital lent by private financial institutions are in the greatest need of the development banks' resources. As the financial conditions of individual countries improve, we should create a system of loan rates that moves toward the private-market interest rate. This will keep the development banks from competing with the private sector and help concentrate their lending on countries that lack access to the private financial markets.
Finally, it is essential that the multilateral development banks become more rigorous about measuring their own results. In education, to take an illustrative example, measuring inputs — classrooms, teachers — is secondary to measuring the product — ability to read and write and compute at an appropriate level. Similarly, in assessing the performance of the development banks, we need to develop specific ways to assess progress toward development objectives; we must be hard-minded and demanding about the necessity that the money lent really produce results.
I strongly believe that the multilateral development banks can be more effective in promoting world economic development by focusing their knowledge and resources on improving the lives of the world's poor.