Congressman Gary Miller held hearings earlier today on the impact of the World Bank and other Multilateral Development Banks on U.S. National Security.

I was asked to submit testimony. If you sort through the details, the stakes could not be higher for the United States and our continued leadership in the world.

The context for the hearing is that the Obama Administration is asking for five $400 million installments for what is called the "General Capital Increase" for the World Bank and several of the regional multi-lateral development banks including the African Development Bank, the Inter-American Development Bank, and the European Bank for Reconstruction and Development. This money is not the typical hat passing exercise that the Hill sees every few years for the lowest income countries (the so-called "IDA replenishments"), the General Capital Increase is about the United States maintaining its de facto control over these institutions and ensuring that they remain instruments of an American Style Globalization.

Asking for additional money for the World Bank and other multilaterals at this time has got to be one of the hardest things I can think of. There are many reasons that Republicans criticize the multilateral banks including the World Bank. Having worked at the World Bank Group for four years, I am keenly aware of the many shortcomings of these institutions but I also understand how useful these institutions are to the United States and our economic and national security interests.

During the 2008-2009 Financial Crisis, we, along with the other owners of the Banks told them to "send everything that can fly." These institutions provided critical financing including trade financing to keep the global trade system open and they supported our friends and allies at a time of great challenge for the global system. As a result, the financial crisis in many parts of the world was less dramatic and they covered for us while we were tending to our problems here at home. The problem is that these banks lend against shareholder capital and all of the existing capital is now "spoken for" because of this massive lending as part of our response to the crisis. If we want these exporters of a U.S. version of globalization to continue we are going to have to put more money into these institutions.

For those of us who live in DC, it is common to think of the World Bank as an exotic institution. If you peel back the accents and the hauteur, you find an American DNA: all the experts studied in the States, they all work in English, they export policy ideas that were made in America, they use U.S. or British law for much of their work and they export American invented standards. U.S. policymakers worry about developing countries taking money from Venezuela, Russia, Iran, or China. The World Bank and the regional development banks (plus the IMF) are our set of alternatives to these funders and models of development. Oftentimes developing countries would prefer to take World Bank money and the expertise that comes with it because these institutions for all their problems have some of the best experts in the world.

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Secretary of Defense Gates is right. It would be a tragic irony if, having come this far in Iraq, the United States faltered and failed to fund adequately the next phase of the mission. Even with adequate funding, the mission will be hard enough.

Congress is right to take a hard look at the Iraq situation. The security needs in Iraq exceed anything the U.S. State Department ever has dealt with in the past. The current plan, which will shift the burden almost entirely from the Department of Defense to State, is distinctly inferior to the original plan, which envisioned a renegotiation of the Status of Forces agreement to allow a modest U.S. military presence as a stabilizing factor. The administration fumbled the original plan and while Gates hints at the possibility of reviving it at the eleventh hour, it may be too late. The current plan relying on the U.S. State Department to do more than it ever has done before is a barely satisfactory Plan B. But it is manifestly superior to Plan C, which involves walking away from Iraq entirely and hoping for the best. I believe once Congress has looked at and thought about the situation carefully, it must conclude that funding the State Department plan is the only responsible course of action available at this point.

I understand the frustration of people who believe the Iraq war was a mistake from the start, but I do not understand their desire to compound what they believe to be one error with strategic blunders of comparable proportions: abandoning Iraq or failing to provide the resources necessary to keep Iraq on a successful trajectory.

Foreign aid is once again under fire. Every so often a few politicians -- usually Republicans -- get up in arms about our government's gift of large amounts of money to other countries. Equally often, media stories appear detailing how ineffective aid supposedly is. The picture emerges that foreign aid is unnecessary, ineffective, and wasteful.

For example, the Republican Study Committee (RSC) released a proposal last week to cut the budget for the U.S. Agency for International Development (USAID) by $1.39 billion as part of a broader package of deficit-reduction proposals. (Hat tip to our friends at The Cable for their post on the subject.) There were similar rumblings after the Republican takeover in 1994. Republicans seem to have an inborn suspicion -- usually dormant, but one that fitfully flares up once per decade -- that aid is just a handout from rich countries to poor ones to help the former ease their consciences.

Or take the lengthy Wall Street Journal story last week that declares, "A massive U.S. aid program that has made Pakistan the world's second-largest recipient of American economic and development assistance is facing serious challenges, people involved in the effort say. The ambitious civilian-aid program is intended in part to bolster support for the U.S. in the volatile and strategically vital nation. But a host of problems on the ground are hampering the initiative." Despite billions of aid, the United States remains unpopular in Pakistan; thus, the article implies, aid is ineffective.

These criticisms of foreign aid rest on faulty notions of what aid is and what it is supposed to accomplish. There are two views of aid reflected here, neither of which are helpful.

• National bribery. Some people think that the United States gives money to other countries to be popular. On this view, if the United States lavishes the Pakistanis with enough money, they will respect the United States. The problem is that if someone did this on an individual level, the United States would call it craven, insecure, and insulting -- which is probably how it is perceived by the Pakistanis. Aid as bribery doesn't work. Money can't buy me love -- not individually, and not between states.
• Charity. Others seem to think that the United States gives money out of the pure, unalloyed goodness of our hearts. Foreign aid is an extension of private goodness. Individually, we give money to the Salvation Army or World Vision so they can help our fellow man on the far side of the world. Foreign aid is functionally the same thing: the United States gives our tax dollars to USAID to do the same kind of charity work as NGOs. But why should the U.S. be charitable to someone in Nepal just because they live in an exotic country when there are Americans who need help? Additionally, there is no logical limit to how far the United States's charity could extend. The United States could bankrupt itself trying to save the world.

I propose a third view of foreign aid.

• Strategic investment. Foreign aid helps countries whose interests align with our own increase their capacities. The United States gives money to help select countries -- not the entire world -- improve specific abilities, like their ability to provide public security, defend their borders, or buy and sell goods.

The advantage of this view is that it is realistic. The United States can actually do this. The U.S. is not trying to change people's heart or minds, contrary to the bribery view. It is only trying to change their capacity. Additionally, this view helps the U.S. prioritize which countries should get aid, and what kind, contrary to the charity view. Giving billions to Tuvalu would be a commendable act of charity for the Salvation Army, but it would be folly for USAID because Tuvalu is not a strategic priority for the United States.

(I am not arguing that we should never be charitable. Rather, every possible foreign aid program is an act of charity. Charity by itself cannot help us decide which charitable programs to undertake. The United States either has to flip a coin to allocate our charity randomly, or consult our own interests to allocate it strategically.)

The Marshall Plan is a good model. The United States gave something like $25 billion (in today's dollars) per year to Western Europe after World War II. It was undoubtedly an act of charity. The money helped the Europeans rebuild their economies and saved tens of millions of people from poverty or even starvation. But it was also a strategic investment. Policymakers at the time worried about a return of the Great Depression following demobilization and the Marshall Plan helped Europe become a strong trading partner for the United States. Most importantly, U.S. officials feared the rise of Soviet power and hoped the Plan would bolster European governments' stability and prevent the spread of communism.

This view of foreign aid would help protect it from the kind of cuts the congressional Republicans are proposing. Aid is hard power. It is a weapon the United States uses to strengthen allies and, thus, ourselves. But this view would also help save it from the kind of limitless, grandiose visions Democrats sometimes seem to have for it. This is the sort of view that I hoped Secretary of State Clinton would incorporate in the recent Quadrennial Diplomacy and Development Review. But despite the document's many strengths it did not seem to offer a framework for prioritizing among the Unites States' many foreign aid opportunities.

During the mid-1970s, while working as a very junior banker in the City of London, I was an eyewitness to a bank run. It was not a pretty sight. Small savers in particular were desperate not to lose their life savings. And the desperation showed.

The run was a small part of a rash of bank failures that were taking place across Europe, among them the German Herstatt Bank, as well as London and County Securities in the UK. Apart from facing down angry clients, banks immediately pulled back from lending funds on the overnight market, for fear that they might not be repaid. This behavior only compounded an already difficult situation. (Ironically, one bank all we were ready to deal with was Moscow Narodny; everyone figured the Soviets would never let their bank go under.)

Afghanistan's largest bank, Kabul Bank, is now in the midst of fending off a run on its deposit accounts. As was the case those many years ago in Europe, it is the small depositors who are the most angry, vociferous, and panicked. Big depositors are bailing out as well. Somewhere between $180 million and $300 million have been withdrawn, and the bank has only some $250 million left in liquid funds.

Like so many other institutions in Afghanistan, Kabul Bank is both politically well connected and the subject of rumors about corruption. Moreover, the news that Khalilullah Frozi, one the two largest Kabul Bank shareholders, was recently ousted as CEO because of purported corruption by the bank's leadership, does not help matters at all. That one of President Karzai's brothers, Mahmoud Karzai, is the bank's third largest shareholder -- and that the bank manages the government's payroll -- provides particular ammunition for Karzai's enemies. Finally, because a bank run is not a rational affair -- depositors panic when they read of other depositors withdrawing funds creating the human equivalent of a cattle stampede -- it matters little whether the rumors of corruption are true or not.

The United States has rushed a small number of experts to Kabul to provide technical assistance to the bank and reassure depositors. Mahmoud Karzai wants more than just technical assistance, however. He is calling for American financial assistance to cover all depositors. Since the bank has assets of only about $1.3 billion, it is not a large sum relative to what the United States pours into Afghanistan on a monthly basis. The money is not really the issue, however.

The United States has still not pulled out of its own recession, and unemployment remains high. There is continuing resentment of the administration's various bailouts, with anger directed at Wall Street in particular. In these circumstances, bailing out a foreign bank whose leaders are being accused (whether rightly or wrongly) of corruption is a highly risky undertaking. It does not help that Kabul Bank has acknowledged that it made some large and risky investments in Dubai villas for rich Afghans. These investments turned to dust when the real estate bubble in the Gulf state burst wide open in 2008. Moreover, American taxpayers could legitimately ask why Afghans are rushing to pull out their money, and where those funds are being deposited. Are they back in Dubai? In Switzerland? In the Cayman Islands? Or have they been retained in Afghanistan -- as they should be -- and recycled into the eight other, smaller, Afghan banks? And will Kabul Bank continue to manage the government's payroll? Or will that lucrative business be transferred to another Afghan Bank?

It is critical that Washington continue to assist with the restructuring of the Afghan banking system in general, and with sorting out Kabul Bank's problems in particular. A healthy banking system is critical to the strength of the Afghan economy, which in turn is a necessary condition for winning the war against the Taliban and other insurgents that plague the country.

Nevertheless, before any American money is funneled into the Afghan banking system, that system needs to be completely overhauled. Too much money has been alleged to have seeped out of the country to foreign bank accounts. It is therefore critical that the banking system be a model of financial probity. Until now, bank regulation clearly has not been all that it should be, and that must change immediately. In addition, there should be a loosening of the nexus between private ownership of the banks and the government. The tight links between the two sectors seem to have hurt both parties. Only if those conditions begin to be met should American taxpayers' funds be used to prop up Kabul Bank -- but by then, Kabul Bank will have become a very different kind of bank. 

By Phil Levy

Tom Friedman tries to make the case for China as a juggernaut in today's New York Times in a piece entitled "Is China the Next Enron?" Not to worry, he writes:

[China] has a political class focused on addressing its real problems, as well as a mountain of savings with which to do so (unlike us)... Think about all the hype, all the words, that have been written about China's economic development since 1979. It's a lot, right? What if I told you this: "It may be that we haven't seen anything yet."'

There are a lot of factors that determine the fate of a country with over 1.3 billion people. Let's just focus on the question of savings, though, since it is central to Friedman's case and he has raised a basic fallacy that often drives China discussions.

The mountain of savings is China's accumulated foreign exchange reserves. Friedman facetiously offers up this wisdom:

...a simple rule of investing that has always served me well: Never short a country with $2 trillion in foreign currency reserves."

As he well knows, China's massive reserves are unprecedented. They may also now surpass $2.4 trillion. 

This image of a dragon sitting atop a hoard of gold colors a number of international policy discussions. It was central to the debate at Copenhagen, in December, when China led the developing world in asking for compensation from the West for policies to cut greenhouse gas emissions. This seemed risible to Western nations swimming in debt and trade deficits.

China's stock response is that it's a poor country. Just how poor depends on how you deal with China's misaligned exchange rate, but the numbers for 2008 range from about $3,000 to $6,000 annual income per person. That compares with roughly $47,000 per person for the United States.

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By Dan Blumenthal

Overall, Obama's Asia policy has been largely driven by events and domestic priorities rather than by an overarching strategic vision. The Obama team had to closely coordinate with China on financial matters in response to the financial crisis. Passing a cap and trade bill at home means that we need China to sign up to a global climate change pact; Americans will chafe at a costly bill if the world's largest carbon emitters do not agree to carbon reductions.

The Obama team attempted a new policy on Burma. The idea is to find a way to engage the military junta which would strengthen relations with the Association of Southeast Asian Nations, of which Burma is a member. But the policy change has been overtaken by events.

Aung San Suu Kyi was unfairly punished when an American swam across a lake to her residence. And the junta began a new round of repression, as its leaders jail and harass political opponents in the run up to their 2010 "elections." Obama could not radically shift Burma policy. Rather, adjustments to our relations with ASEAN and Burma have been only marginal. There has been some more contact with the junta. And as part of the broader attempt to build stronger relations with Southeast Asia, the administration signed the Treaty of Amity and Cooperation (TAC). These and visits to Southeast Asia by Secretary Clinton and her deputy, Jim Steinberg, demonstrate a desire to deepen American engagement with that region. It is unlikely that engaging Burma or signing the TAC will increase America's regional influence.

Surprise?

There are several Obama Asia policies that have been surprising. On a positive note, the Obama team has given much greater attention to the Japan alliance than I had expected. Secretary Clinton's first stop in Asia was in Tokyo, which eased Japanese concerns that they were in for another round of "Japan passing." Since the Democratic Party of Japan took over last September, Obama officials have visited Japan frequently to get a sense of how to deal with a party that has never before governed. The Obama team should be commended for trying to find its way with this inexperienced and eclectic ruling coalition.

Constructive Criticism?

Other policies should give us pause. For example, Obama is sticking to his campaign promises on trade, which means we have no trade policy. The Korea-U.S. Free Trade Agreement has been collecting dust in the Congress. The rest of the region, however, is not standing still. China seems to sign a trade agreement a minute and South Korea is moving forward on an FTA with the EU. If this continues, not only will our economy be disadvantaged, but our regional leadership will also suffer. While the Obama administration has done a fine job showing up to Asian multilateral meetings, without new trade proposals it has shown up empty handed.

A second troubling policy is the absence of any agenda on Taiwan. The Obama team was effusive in its praise of President Ma when he was elected in March 2008 and they applaud his attempts to ease tensions with the Mainland. The Taiwan president is doing what he thinks Washington wants - easing cross Strait tensions. But there was an implicit bargain with Taiwan that we are not upholding. We were supposed to strengthen Ma's hand by strengthening our ties to Taiwan. The Obama team is not helping Ma.  We have not sold any arms to Taiwan even as China has continued its arms buildup across the Strait. And Obama has no plans of yet to deepen economic ties as Taiwan goes forward with a China FTA.

Third, the bluntness with which the team has downplayed China's miserable human rights record is an unfortunate break with past administrations' practices. Secretary Clinton announced that she would deemphasize human rights concerns on her first trip to China. This was followed by the president's refusal to meet with the Dalai Lama when the Tibetan spiritual leader was in Washington last month. The administration has also been silent on Uighur repression and will not meet with Uighur leader Rebiya Kadeer. It does not help either country for us to pretend that we are indifferent about Chinese respect for human rights, when in reality we have a huge stake in China's political liberalization.

Overall, despite a regular barrage of criticism by Candidate Obama directed at President Bush for his supposed neglect of Asia (never a fair criticism), the Obama team has not wowed the region with new ideas or lavished it with attention. During Bush's first year, his administration had offered the largest arms package ever to Taiwan, was well on its way to substantially upgrading ties with Japan, and was negotiating a diplomatic breakthrough with India of historical significance. Then-U.S. Trade Representative Bob Zoellick was negotiating free trade agreements with Singapore, Australia, and Korea.

The criticism of the Bush administration was that it was "distracted" by the war on terror. The Obama team is learning that fighting a war saps a nation's energy and attention. Now in office, the Obama team can see that the threat from Islamic extremism is very real. The Obama team may have really believed that they could "fix" Afghanistan, disengage from Iraq, and then move on to "re-engaging" the rest of the world.

As Obama is learning, it is not so easy to "move on" when you are at war. No president can disconnect a major foreign policy issue such as war from other foreign policy issues. Asians have a stake in America's Afghanistan policy. A loss in Afghanistan would have stark consequences, as friend and foe alike would question our resolve, and Islamic extremism would rear its head again in Southeast Asia.

Prediction?

Obama's Asia team must be finding that during wartime, presidential attention is the scarcest of commodities. Obama has no choice but to focus on "the wars we are in," often at the expense of the Obama team's hopes for a grand "re-engagement" with Asia.

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By Phil Levy

The Pittsburgh G-20 meetings concluded with a call for strong, sustainable, and balanced global growth. Countries were going to get their acts together, to shape up, to mend their ways. And if they don't? What if they just go with their own domestic political imperatives? Then someone will call them out, the leaders said.

But who? The International Monetary Fund, perhaps. After a meeting of finance ministers, the AP reported:

Four governments -- including the United States and China -- renewed promises to enact policies aimed at rebalancing global trade.

They said an orderly reduction in the U.S. trade deficit and trade surpluses in Asia would benefit the world by defusing protectionist trade action...

"It was agreed that a rebalancing of domestic demand growth across economies would be key to reducing imbalances...," said the statement, issued on behalf of the group by the IMF.

China pledged to take steps to increase domestic demand, deepen financial reforms and increase the flexibility of its currency, a step long demanded by the United States and other industrialized nations.

Wait! This story is from April 2007, on the eve of the global financial crisis. (Plus ça change...). That meeting followed a 2006 agreement that the IMF would adopt a new surveillance system to identify misaligned exchange rates. The surveillance program essentially came to naught. This ineffectiveness was not due to any analytical weakness on the part of the good folks at the IMF. It turned out, rather, that big countries like the United States and China dislike being publicly criticized.

Of course, smaller nations share this distaste for criticism, but they usually have no choice. The IMF has leverage when it lends money. When a nation like Hungary or Iceland finds itself in serious trouble, it must accept IMF policy prescriptions along with the cash. The bitter memories of this cash/criticism combo from the Asian financial crisis of the late 1990s help explain why Asian countries have built up such substantial piles of exchange reserves; they want to ensure they are not in that position again.

Why should the IMF or World Bank care, though? Why not just call it the way they see it and let the big countries deal with their own bruised egos? Because the big countries are the IMF and World Bank. The leaders of the bank and fund spend their days reporting to boards of executive directors, seeking the boards' approval for all they do. These institutions are not like the U.N. General Assembly -- one country, one vote -- the executive directors' votes are roughly weighted according to the economic heft of the countries they represent.

This creates a dynamic that played out this week in Istanbul, where the bank and fund are holding their fall meetings. According to the Financial Times, World Bank President Robert Zoellick asked his governing council for an infusion of $5 billion. Without it, he said,

"[A]s we start to get towards the middle of next year we are going to start to face some serious constraints and we would have to ration..." He said uncertainty over future financing capacity was already affecting bank work with developing countries.

Developing nations voiced unanimous support for a capital increase.

But developing nations are not the ones paying the bills. Zoellick faced a much more skeptical reception from the British, the French, the Japanese, and the Americans. It is the major donors to which any bank president is beholden. This dependence did not stop Zoellick from making a relatively forthright speech about global imbalances last week at the Johns Hopkins School of Advanced International Studies, but the FT pictured him yesterday with his head in his hands.

The independence deficit of the IMF and World Bank is serious, but perhaps not the most significant obstacle to achieving global rebalancing through coordinated reform. Even if Bob Zoellick launched the kind of scathing critique of which he's certainly capable, it would not suffice to bring serious cuts to U.S. federal deficits or to prompt revaluation of the Chinese currency. President Obama's political prospects depend heavily on delivering a costly expansion of health-care coverage. The Chinese leadership's legitimacy rests heavily on maintaining employment in the manufacturing sector. In each case, the domestic political stakes are far too high to be overcome by global opinion, no matter how blunt.

Change will come, of course. But it will be through average American voters worrying about borrowing from their grandchildren, or from average Chinese worried about the value of their massive dollar holdings. Right now, even if the IMF or the World Bank were to call out, those key constituencies aren't listening.

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