Foreign Aid: Planning for Capitalism

Central planning brought ruin to Eastern Europe, a $450-billion foreign-debt burden to Latin America, and even greater poverty to sub-Saharan Africa, where per capita incomes are lower today than they were in 1970. Yet the United States continues to support the institutions that counsel and finance still more central planning—the World Bank, the related regional development banks, and the International Monetary Fund.

Now Washington is poised to sidetrack Eastern Europe's opportunity for a true free market by joining the World Bank and related organizations in promoting a variety of rear-guard socialist planning efforts.

In Eastern Europe, the World Bank and the IMF are extending unprecedented levels of loans to governments. Since February 1990, the IMF has committed about $2 billion to Poland, Yugoslavia, and Hungary. The World Bank plans to lend $7 billion to $8 billion in the region over three years. Furthermore, the Bush administration has pledged $1.2 billion in U.S. funds to support a new multilateral bank for Eastern Europe.

And in 1989, Congress approved the $938-million Support for East European Democracy Act, which provides $300 million for "private enterprise" loans in Poland and Hungary. Government-appointed boards of directors will dole out $240 million in Poland and $60 million in Hungary. As former Assistant Treasury Secretary Paul Craig Roberts told a congressional panel in 1990, "Contracts and financing will be awarded based on political connections.…The economic process will be taken over by 'rent-seekers' competing for a share of the largess. Real private enterprise will languish as entrepreneurial skills are directed into the political arena."

In May, the Bush administration formally pledged U.S. participation in the European Bank for Reconstruction and Development. (Congress has yet to authorize support for the project.) Designed to lend to governments in Eastern Europe and the Soviet Union, this new multilateral bank will have $12 billion in initial capital.

During international negotiations over the creation of the European Bank in early 1990, U.S. Treasury officials portrayed the institution as a new and improved development bank. They suggested that the bank will play an important role in Eastern Europe's privatization efforts. Yet multilateral development banks have never linked significant amounts of assistance to privatization of bloated, money-losing state enterprises. The World Bank's emphasis remains rehabilitation, not privatization. Despite its market-oriented rhetoric, it continues to tinker with socialism and central planning.

Advocates of the European Bank emphasize that many of its loans will go directly to firms that are already private. But the World Bank provides the principal model for channeling multilateral bank money to private borrowers. Its "directed-credit" system funnels money through "development finance institutions," generally state-run banks.

The World Bank lends DFIs hundreds of millions of dollars, which they in turn are supposed to lend to small and medium-sized private enterprises. Government bureaucrats run most World Bank–supported DFIs, allocating credit by "picking winners"—or, in reality, picking anyone. Since the mid-1970s, the World Bank has lent some $30 billion to DFIs throughout the developing world.

In 1985, an internal World Bank review looked at a sample of these banks and found that many borrowers had failed to repay their loans. In almost half of the cases, more than 25 percent of loans were delinquent; at nearly one-quarter of the DFIs, more than 50 percent of loans were delinquent. "Many governments used credits from DFIs for low interest rate lending to public and quasi-public institutions," the report said. "On loans made at the behest of government, financial discipline was often poor, and for political reasons the DFIs were not able to foreclose on delinquent loans." The review concluded that "few DFIs have become financially viable, autonomous institutions capable of mobilizing resources from commercial markets at home and abroad."

But the World Bank continued to extend about $2 billion in new loans to DFIs each year. In 1989, the bank's annual World Development Report issued another damning verdict. Among a sample of 18 DFIs, 50 percent of loans, on average, were overdue. "It is clear [directed-credit programs] have damaged financial systems," the report concluded, noting that cheap DFI loans had encouraged unproductive investments, promoted both unintentional and willful defaults, impeded development of capital markets, and fostered bank borrowing where equity financing would have been more appropriate.

Nevertheless, in February 1990 the World Bank approved two directed-credit loans for Poland. The National Bank of Poland, the country's central bank and monopoly lender, will disburse the money, which includes $245 million for export-oriented industrial projects and $100 million for agricultural processing industries. Funneling loans through the central bank will enhance its power and retard the development of a private banking system.

The track record for similar loans elsewhere isn't encouraging. In Yugoslavia in the 1980s, the World Bank channeled at least $700 million in loans through seven of the government's nine regional lending groups. The bank knew that these institutions were lending money at rates that were negative in real terms, ranging from minus 10 percent to minus 20 percent. In 1989, a confidential World Bank study disclosed that all the banks were in the red. In 1983, the World Bank provided a $275-million "structural adjustment loan" to Yugoslavia's state-owned Udruzena Beogradska Banka; four years later, the bank was $1.2 billion in the red. Yet the World Bank continues to bankroll Yugoslavia's socialist experiment: In April 1990 it approved a second structural adjustment loan, this time for $400 million.

The World Bank's credulous attitude toward Eastern Europe's self-destructive economic policies makes it an unlikely leader on the path of market-oriented reform. Consider this excerpt from a 1979 World Bank study of Romania: "Between 1950 and 1975 the economy grew rapidly within the framework of comprehensive economic planning made possible by the state's control of the major productive resources and its monopoly over foreign trade.…According to official statistics, Social Product and National Income grew by 9.8 percent per annum for 25 years.…Picture for 1981–90: National income should grow at 8 to 8.9 percent per annum."

This is sheer nonsense. As Sir Alan Walters, former top economic adviser to Margaret Thatcher, explained in a 1990 Forbes interview: "In 1975 Romania's per capita income was $800 or $700. If they grew at 10 percent per annum for the previous 25 years, then in 1950, they must all have been dead from starvation!"

More recently, a 1989 report by the World Bank's Economic Development Institute, Financial Reform in Socialist Economies, outlined how Yugoslavia can introduce a stock market without private property. (The state would own and trade the shares.) One chapter concludes: "The issue is not one of returning to capitalism, but of using its financial instruments by adapting them to socialism…not that of introducing private property rights, but defining alternative incentive mechanisms that could play the role they play in capitalist economies."

As Hungarian economist János Kornai and Polish economist Jan Winiecki argue, the nations of Eastern Europe need flesh-and-blood entrepreneurs more than anything else. Their point is simple: You can't have capitalism without capitalists. The countries of Eastern Europe must cultivate true capitalists—both domestic and foreign—on their own, through a functioning convertible currency, viable legal accounting systems, modest levels of taxation and regulation, and full, constitutionally-guaranteed property rights.

The World Bank's record throughout the developing world and in Eastern Europe demonstrates that it cannot be a catalyst for radical economic liberalization. Following in its path, the new East European Development Bank is fundamentally a socialist undertaking. Loans from multilateral development banks will only serve to further politicize economies already burdened by state control. The new political structures in Eastern Europe are weak, and the inflow of subsidized credit can easily forestall the necessary transition to market prices and private investment. With the verdict on socialism so clear, the United States and other Western governments should abandon the oxymoronic idea of planning for capitalism.

Melanie S. Tammen directs the Cato Institute's Global Economic Liberty Project.