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Speeches and Papers

Governance and Evaluation in International Financial Institutions

by Edwin M. Truman, Peterson Institute for International Economics

Remarks to the Retreat of the World Bank’s Independent Evaluation Group
May 31, 2007

© Peterson Institute


It is a pleasure to be with you today to share some perspectives on the World Bank Group’s governance and the work of the Bank’s Independent Evaluation Group (IEG).1 My comparative advantage on this topic is with the Bank Group’s Bretton Woods sister institution, the International Monetary Fund (IMF). However, many of the governance issues are the same for both the Bank and the Fund, at least at the conceptual level. Governance arrangements have not evolved significantly in either institution since their founding more than 60 years ago, and this is a problem.

My point of departure is that the Bank and Fund are key components in a fragile global governance structure. This fact has two major implications: First, success or failure of one institution affects the other. As I have said in comments about the Malan Report on Bank-Fund collaboration, the Bank and the Fund either can hang together or will become irrelevant and be hung separately. Second, in all their activities, albeit in differing degrees, the two institutions provide global public goods broadly defined to include not just in their support for health programs and sharing knowledge and best practices but in their lending activities as well. Poverty is a “global public bad”! Thus, I reject the notion that the Bank or the Fund should be viewed as institutions in which one group of countries (the creditors) provides financial and other resources to another group of countries (the borrowers). Instead, in Nancy Birdsall’s terms, both should be viewed as global clubs in the context of a broader global compact.2

The tragic events of the past two months have thrown into sharp relief many issues involving the governance of the World Bank Group. My purpose is not to comment on those events other than to say that they fill me with sadness and great concern. Whether the Bank is able to recover will depend, in my opinion, on the capacity of the membership and the institution to address long-overdue governance issues.

For any institution, governance involves three dimensions: legitimacy, accountability, and efficiency. The meaning of these abstract concepts is often disputed. In my view, legitimacy involves the processes through which decisions are made and whether the processes are perceived as valid. Accountability involves whether those engaged in the processes of decision making have acted appropriately in pursuing the mission of the institution. Efficiency involves whether the decisions themselves have been effective in advancing the goals of the institution. These three dimensions are inter-related. Without legitimacy, it is difficult to hold anyone accountable. Without accountability, legitimacy is meaningless. Efficiency is enhanced by both legitimacy and accountability, but it also involves weighing costs and benefits.

Governance is particularly complex in international organizations because judgments about legitimacy, accountability, and efficiency may differ across the membership of the organization based on national histories and cultures. In addition, in today’s world, nongovernmental interest groups not only pass judgment about how the international organizations are performing in multiple dimensions but also pressure them to respond to their own priorities.

One way to think about governance in an institution such as the World Bank Group, or the IMF, is to consider three aspects: structure, implementation, and evaluation. In the balance of my remarks I use this three-part organization, first, to sketch briefly the challenges faced by the Fund today. Next, I comment on the extent to which the Bank’s governance challenges are similar. I conclude with some observations about governance in the World Bank Group going forward and the role of the IEG.

With respect to structure, the Fund faces three major challenges. The most obvious involves management selection and the convention that Europe nominates the managing director of the Fund and the United States nominates the president of the World Bank though in each case other nominations are possible and the executive board must approve the nominee. Since the controversy surrounding the choice of Horst Köhler as IMF managing director in 2000, other international organizations, such as the World Trade Organization (WTO), the Organization for Economic Cooperation and Development (OECD), the United Nations, and the Bank for International Settlements (BIS) have moved toward more transparent, merit-based selection processes. The Fund and the Bank are seriously lagging behind. Progress in this area either can be evolutionary, for example, starting with multiple candidates from one country or region, or revolutionary, involving a brand new set of processes and procedures such as were suggested in 2001 by the committees of Bank and Fund executive directors. Under a revolutionary approach, consideration might be given to instituting a double majority of countries and weighted votes. What is needed is progress, but it does not appear likely right away!

The second and third structural challenges facing the Fund involve shares (voting power) and chairs (representation on the executive board).3 As you know the Fund has agreed to a road map toward agreement within 15 months, at the latest, on a realignment of quota shares, and as a consequence voting shares, with countries’ weight in the global economy along with an increase in the basic votes of each member. It remains to be seen whether the Fund will meet its timetable and achieve substantial reform.4 On executive board representation, the principal issue is the historic overrepresentation of European members. The Europeans and IMF Managing Director Rodrigo de Rato have refused to put this matter on the table.

With respect to implementation, the Fund faces three major problems: size, the role of management, and the role of the executive board. With about 2,700 full-time-equivalent employees and a substantial number of outside consultants, the Fund has evolved into a silo structure in which the components too often are unwilling or unable to work together. The management, consisting of the managing director and three deputy managing directors, does not function effectively as a team, in part because of the lack of an open, merit-based process of selection. Finally, the executive board is opaque and defensive about its prerogatives. Members are torn between trying to micromanage the institution and providing broad policy guidance; at the same time they are torn between the interests of the countries they represent and the interests of the institution as a whole. Plus, the board knows that the International Monetary and Financial Committee will soon be meeting and wants to pronounce its guidance.5

On evaluation, the Fund historically has used a combination of internal and ad hoc external reviews of its policies and programs. Its Independent Evaluation Office (IEO) began to function only in 2001 after years of controversy and negotiation. My impression is that these processes to date have fallen short of their goals: careful evaluations followed by implementation that leads to significant changes and increased efficiency and effectiveness of the Fund.

As evidence, I would point to the 2006 McDonough Report on the organization of financial sector and capital markets work in the Fund. It is widely available but was never released to the public. Its principal criticism of the Fund’s activity in this area was that there had been a failure of management, but the result was the creation of a new mega-department in the Fund without making any fundamental change in the how the management of the Fund (the managing director and his three deputies) ensures improved performance. I would also point to the recent IEO evaluation of IMF exchange rate policy advice. The report is critical of the Fund’s policies and practices in this area, but the response of staff and management based on a parallel internal review was to argue that the IEO report “presents a narrow interpretation of the evidence, does not recognize progress made over time, and therefore does not offer a balanced perspective identifying remaining weaknesses and their relative importance.” As outsiders, why should we trust an internal audit more than an external audit?

How does the governance in the Fund compare with the situation in the Bank in terms of the structure, implementation, and evaluation? My impression is that the Bank’s challenges are essentially the same but more acute. The structural issues are the same. The implementation issues are similar, but the Bank faces bigger challenges because it is four times as large, it is less focused and faces more competition, and its management structure, under the previous president, and some would say presidents, was essentially nonexistent even before Paul Wolfowitz arrived on the scene.

With respect to evaluation, a decade ago, the Bank was ahead of the Fund, but partly as a consequence, its structures are substantially less independent, and any recommendations are more timid and easier for the Bank’s executive board, management (such as it is), and staff to ignore if they choose to do so. Both institutions face criticism for the amount of spending on governance, about 10 percent of the IMF’s operating budget and $80 million in the Bank, a somewhat smaller percentage of the Bank’s much larger administrative budget. My fellow panelist, Devesh Kapur, has asked “what does this massive expenditure achieve?” The implication is not as much as it should.

Against this background, I offer four observations, starting with structural issues. It is symptomatic of the challenges faced by the Bank and by the Fund that their structures are similar in terms of the distribution of voting shares, the size, composition, and roles of the executive board, and their loose management practices. The simplest explanation is that the Bank and Fund were established at the same time, they have evolved in parallel, and the Bank has tended to follow the Fund. There is no particular logic to the current situation. Both institutions need to redistribute voting power and to try to reestablish a greater sense of common purpose in motivating all member countries and their representatives on the Board. However, they are different institutions. Why shouldn’t their structures differ more than they do?

I was shocked and surprised to read in the recent Options Paper on Voice and Representation in the World Bank Group prepared for the April 2007 meeting of the Development Committee that capital subscription shares in the Bank have been patterned historically, and by implication should be patterned going forward, on quota shares in the Fund. Moreover, this practice was not questioned despite the fact that the evolution of IMF quota shares has been based largely on historical inertia and is broadly considered to be inappropriate.

I am aware of the proposals in both institutions that the executive board should be nonresident with the expectation of more detached oversight of basic policies and less attention to details of country programs and loans. While I agree that the activities of the respective boards should be more focused, and the Boards need to spend more time on the big picture issues, I think it is naïve to think that nonresidency would contribute to more responsible management and to less preoccupation with short-term political or tactical matters.

I am also aware of proposals that executive directors in the two institutions be “double-hatted” in order to promote better coordination between the two institutions and, perhaps, to reduce administrative expenses. Since I favor greater focus and differentiation in the activities of the Bank and the Fund and collaboration based on exploiting comparative advantage, my view is that such a structure would be a hindrance not a help to progress. Moreover, the current situation with almost identical constituencies in the two institutions makes little sense, in particular, where a constituency combines industrial and nonindustrial countries and the rules do not permit split voting. I also note the Bank is considering expanding the size of its executive board beyond the current 24 while there are pressures within the Fund to return to a 20-member board. This differentiation may well make sense.

Although I believe that the World Bank Group faces major structural, governance issues, my overriding concern is that the governance crisis in the Bank will encourage opponents of fundamental governance reform in the Fund to seek to delay progress in that institution. The missions of the two institutions differ, and greater differentiation would be desirable, starting with reducing the parallelism in their governance structures and their reforms.

Second, in the future as in the past, the Bank will continue to be more about lending and less about policy advice and other activities than the Fund even if the share of lending activities in both institutions declines on average over time. This suggests to me that the emphasis in each institution’s approaches to accountability and efficiency as well as to implementation and evaluation should differ.

The Bank is more about money. Consequently, issues of financial management and responsibility bulk larger. However, this fact does not imply the need for a sharper differentiation between creditor countries and client countries in the organization and management of the Bank. Barbara Opper, who retired in 1998 as a senior advisor in the financial policy area and has been a friend for many years, recently pointed out to me that each of the four institutions in the World Bank Group is a financial cooperative based on capital structures that are principally derived from contributions from member governments. However, while the wealthiest countries have contributed the largest amount, it is the client countries that face the first line of financial risk as a result of mismanagement that drives up borrowing costs and drives down the effectiveness of programs. In particular because most loans are repaid on their original terms, the risk to the large shareholders is only as a last line of defense—contrary to the conventional rhetoric. It is principally in the interest of the clients that the Bank follows best practices with respect to governance, accountability, and independent evaluation. It is also in their interest that the design of the Bank’s financial products respond to the changing needs of the clients rather than being based on old formulas.

Third, it is not surprising that few people understand the organization and financial structure of the World Bank Group with its four principal component units. Few can comprehend how the pieces do or do not interact and relate to one another. Moreover, although I may be simple-minded in my view, I am troubled by the proliferation of off-balance-sheet operations of the Bank in the form of trust funds and allied organizations. I am sure that the motivations for establishing these mechanisms and structures are well intentioned, and I know that each is carefully reviewed before it is approved. However, their existence tends to erode the sense of common purpose underlying the overall institution because each entity focuses on its own priorities and may not follow unbiased, best practices in its programs and procedures. Moreover, the outside observer, whether NGO, government official, or part of the general public, does not, can not, and should not distinguish among the entities, which has consequences for perceptions and evaluations of the overall priorities and performance of the World Bank Group. In other words, this complexity raises profound questions, at least in my mind, about the legitimacy, accountability, and efficiency of the institution.

As long as one rejects proposals that the Bank should be abolished or merged with the Fund, which I do, and as long as the only realistic path is one of evolution, preferably rapid, not revolution, which is my view, the easiest and most effective way forward for the Bank in addressing these governance issues is strewn with landmines. However, increased transparency and accountability and improved structures of independent evaluation and feedback incentives are essential. This is my fourth observation, and it is where the activities of the IEG are central. As I noted earlier, I am sympathetic to the view that the IEG needs to be more independent, and its evaluations should more frequently produce changes in policies and their implementation in the Bank Group, but I have no doubt that in today’s world those activities are essential to restoring the Bank’s integrity and leadership as a major institution of global governance.


Notes

1. In light of the current sensitivity of these issues, it is incumbent upon me to stress that my remarks are my own and in no way should be interpreted as reflecting the views of the US government or any of the agencies of the US government in which I have previously served or the views of the Peterson Institute where I am currently employed.

2. See Nancy Birdsall, “A Global Credit Club, Not Another Development Agency,” in Rescuing the World Bank: A CGD Working Group Report and Selected Essays, 2006, edited by Nancy Birdsall, Washington: Center for Global Development: 69–85. Birdsall adopts a narrower definition of global public goods than I would favor by not including lending activities. She also does not explicitly mention the broader global compact or framework though what she says is consistent with that view.

3. See Edwin M. Truman, “Rearranging IMF Chairs and Shares: The Sine Qua Non of IMF Reform,” in Reforming the IMF for the 21 st Century, edited by Edwin M. Truman, 2006, Washington: Peterson Institute for International Economics and other contributions to that volume.

4. For an outline of the issues and suggestions for a way forward, see Richard N. Cooper and Edwin M. Truman, “The IMF Quota Formula: Linchpin of Fund Reform,” Policy Briefs in International Economics 07-1, Washington: Peterson Institute for International Economics (February 2007).

5. On April 10, 2007, the New Rules for Global Finance Coalition released a report on the deliberations of a “High-Level Panel on IMF Board Accountability.” The panel’s exercise was constrained to consider only changes that would not involve amendment of the IMF Articles of Agreement and chose to work within a four-part set of principles of accountability to stakeholders: transparency, evaluation, participation, and complaint and response. One does not have to agree with any or all of the recommendations in order to gain an appreciation of the many problems that the Fund, and by extension the Bank, faces in this area.


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