Do We Really Need The World Bank Anymore?Rudi Dornbusch
The Mexican meltdown has disappeared in the rearview mirror, and huge sums are again flowing to emerging markets. A decade ago, capital flows to the developing countries--direct investment, equity, and loans--amounted to less than $40 billion a year. In 1996, the number was $250 billion, and this year it will be higher. One must therefore ask if the World Bank, the International Monetary Fund, the many regional banks, such as the Inter-American Development, and all the other pots of intergovernmental money are rapidly losing their reason for existing. If the capital market is perfectly capable of identifying worthy projects and readily finances private investment and public budgets around the world, who needs these remnants of foreign aid and statism? Using them to finance governments when the same ventures would be better served by the private sector is a waste. Keeping them around just for bailouts in emergencies isn't a good idea either.
This is particularly true when the U.S. Treasury stands ready to provide emergency loans in time of financial crisis. Far from discouraging international lending to emerging markets, the Mexican peso crisis has functioned as a dress rehearsal for all future disasters. When the U.S. Treasury rescued Mexico with an emergency bailout, it convinced lenders that the peso fiasco wasn't so bad after all. The flood of capital flowing into emerging markets from that point on has been truly astounding.
VIBRANT BABY. The question now is whether this current surge in lending is temporary, spurred on by low U.S. interest rates, a growing world economy, and rising stock prices, or whether it reflects a more fundamental phenomenon. The answer is unambiguous: Large-scale private financing for emerging economies is barely getting started and is here to stay.
There is nothing new in the idea of lending to risky, emerging markets. International finance of the 19th century did just that. The U.S. was developed with the help of British money, as were Australia, Canada, and Latin America. The late 19th century was a golden age of international bond markets financing ports, railroads, power plants, and waterworks. The process was briefly suspended in the late 1920s when the global capital market collapsed and debtors defaulted worldwide. In the postwar years, lending got under way once again, with commercial banks providing much of the credit. The debt crisis of the early 1980s, brought about by overlending and dramatically high U.S. rates, made no lasting impression. The next lending wave was composed of equity capital, bonds, and increasingly direct investment. Mexico's crisis of 1995 curbed the flows only temporarily.
What drives the current round of investment? Two financial strategies. Investors are searching for higher yields offshore while, at the same time, diversifying their risks. Asset prices around the world are low. There are plenty of bargains. Most important, genuine reform and a farewell to big-government policies worldwide are turning economies from statist-stagnant to private-dynamic. That has opened up profitable opportunities. The emergence of a vibrant private economy in the developing world is the single most important reason for the large increase in resource flows.
STAYING POWER. The market economy is here to stay, and its roots are growing deeper by the day. Take Brazil: It has always been the country of the future. Even if the government is still bungling its program to stabilize inflation, the private economy is vigorously at work restructuring itself to become more competitive. In Argentina, the reform process has deeply changed the economy and is already paying off. The country has embarked on a course of economic reform similar to the one Chile has experienced over the past decade. And the same can be said of Poland and Vietnam. We have moved to the point where money is simply not the issue. If the prospects are right, capital will go to the ends of the earth for a little extra return.
How might this optimistic view of a worldwide capital market go sour? Pessimists wait for a U.S. stock market crash. In that event, emerging markets will sell off with a vengeance and capital will flee to safe havens. But not for long. The very fact that there has been a sell-off will bring investors back in no time to pick up the pieces at bargain prices, just as happened in 1995 in the aftermath of Mexico. The opportunities are there, and a reform process is moving forward that makes Argentina more plausible than Spain. Foreign investors won't miss out on making a bundle. The occasional setbacks are certainly painful, but they won't discourage this hot line of finance.