Untapped
Resource
World Bank President Robert Zoellick
knows more about international
governmental institutional arrangements
than anyone in the world. He should leadthe effort for a new global growth agenda.

Robert Zoellick

An exclusive interview.
TIE: Is the developed world becoming like Japan—in other words, mired in debt
and unable to grow at more than mediocre levels? For 2012, Japan is expected to
grow at a higher rate than the rate achieved by both the eurozone and the UnitedStates. Do you agree with this “We’re all becoming Japan” scenario?

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Zoellick: The core issue for growth is to go back to the fundamentals. I’m not sure
how much more can be done with monetary policy one way or the other. Federal
Reserve Chairman Bernanke’s Jackson Hole speech did a service because he pointed
out that most fundamental decisions now lie with Congress and the executive branch.
Beyond fiscal policy, the real answer to your question about Japan is whether
countries are willing to address the structural elements of growth to free private sector
potential. When I talk about growth, I’m not talking about Keynesian macroeconomic
management. I’m talking about the fundamentals of growth and productivity, for example the work of Robert Solow. At the World Bank, I see many developing countries
working in this structural growth framework. As a striking example, when early in thecrisis I attended a G-20 finance ministers meeting in Scotland, the mood was as douras the sky. Then I flew to Singapore for an APEC session, and the Asian countries weremore upbeat, saying, “We’ve seen versions of this movie before, and we’re going tohave to focus more on how we deregulate, expand opportunities for private-sector
dynamism such as in services, and invest to create fundamentals of growth.”
TIE: How would you improve the fundamentals of growth in the industrialized world?

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Zoellick: The moods and coalitions of democratic politics
matter, so one needs to look beyond textbook economics.
For example, one can sense that across constituencies andpolitical groups, there’s a movement for broad-based tax
reform: broadening the base and cutting the rates, as in the
tax reform enacted when I was at Treasury in 1986.
Discussions and interest—like earlier in the 1980s—is along way from enacting major legislation. But tax reform

Social Security reform would send
one heck of a confidence signal.
could be a very good signal to drive investment and productivity growth. That would be high on my agenda.
Second, you can’t ignore spending, debt, and deficits,
but so far the United States government has been focused on
discretionary spending. That’s a start, but not fundamentallywhere the real bucks are. The challenge for policymakers isentitlements. Social Security is one area where by now people know the variables quite clearly. Social Security reform
would send one heck of a confidence signal to businesses
that are sitting on cash and to the world that the United States
can fix its problems.
An odd political dynamic has been created by both parties. Democrats don’t want to see so-called “cuts” in Social
Security—it’s part of their political base strategy.
Republicans want to show that they’re disciplined on spending so they want to emphasize the size of “cuts.” People ina fast-paced media world will turn off very quickly if one
talks about “cuts.”
But you can start by saying you’ll protect people who
retire by guaranteeing what they’re getting from Social
Security today plus cost of living increases. That’s not a cut.
That’s a respectable way to secure Social Security. The government would use the CPI for increases as opposed to awage index. Then add a year or two to the retirement age.
That just reflects the changed demographics and years oflife. If you want to make Social Security more progressive,
add means testing to limit increases. Social Security is justsitting there on the table waiting to get done.
First, we should do broad-based tax reform for growth,then Social Security reform. The third element—one of thebest drivers of structural change—is free trade in an open
economy. Our trade policy has been stagnant.
TIE: Is that it?

Zoellick: There are other good possibilities out there. Take
infrastructure. Depending on the wage rate and how DavisBacon is handled, improving our infrastructure could lead toemployment and productivity growth. From what we’veseen in emerging markets, infrastructure enhancement offersa triple benefit: not only jobs today and productivity growth
tomorrow, but it also draws exports of machinery and services from the developed world.
But here’s the big difference. Most of the discussions on
infrastructure I’ve heard in the United States are still focusedheavily on public-sector models. Yet I cannot go to a developing country where people aren’t interested in publicprivate partnerships for infrastructure. This is significant. In
the middle-income countries, they want public-private partnerships not because of the capital, but because the projects
are better designed, better maintained, and operated morecost-effectively. The World Bank Group has created an
Infrastructure Finance Center of Excellence in Singapore tofoster projects and also help countries develop the legal andregulatory frameworks and pipeline capacity for private
financing and management of infrastructure. One of the projects that we’ve done is to monetize a toll road in
Chongqing, China. It’s ironic that in Communist China,
they’re very interested in privatizing the toll roads, but inthe state of Pennsylvania the legislature rejected the idea.
When I learned accounting, there were two sides of thebalance sheet: liabilities and assets. A lot of the states haveliabilities, but they’re also sitting on assets. The case ofIndiana Governor Mitch Daniels offers a good example. In
2006, the Indiana Toll Road was leased for seventy-fiveyears in exchange for a one-time payment of $3.85 billion.
With this revenue, the state financed a backlog of public
transportation projects and created a $500 million trust fundfor maintenance of the state highway system. At first thismove was politically unpopular, but it managed to work out
quite nicely for the governor and for Indiana.
And afterwards, Macquarie, an Australian firm that was
one of the leasing companies, analyzed some of Indiana’s
roadways and found, for example, that in one part of thestate it cost more to pay people at the toll booths to collect
the tolls than the state was getting from tolls. The stateswitched to smart cards.
TIE: Any other thoughts?
Zoellick: The World Bank has just completed some very
interesting work on gender equality. It starts from the logic
that if countries are not fully drawing on the talents of 50
percent of their populations, they’re not going to be as productive. Some of the statistics about increased productivity
are amazing—remember, growth’s about productivity. Not
all changes require money. In Ethiopia, the World BankFALL 2011

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worked with the government to change the land title forms
so that there’s room for two names. All of a sudden, women
have ownership as well as men, and now they can borrowagainst property and get credit for inputs. Giving womenrights and making them full members of a society can also
boost productivity. That’s another area of opportunity for
the United States. In emerging markets, people are thinking
about how to connect education to training to jobs to productivity. How do we build infrastructure for productivity?
How do we help women be more productive and lead fuller
lives? I’d also examine the regulatory impediments to entrepreneurial innovation, including to initial public offerings.
TIE: On another subject, is the export-dependent nature of
the developing economies sustainable?
Zoellick: Twenty years ago, I was part of the structural
impediments initiative discussions between the United States
and Japan. The idea was to help shift Japan from its traditional export-led model while opening up business opportunities, especially in the unproductive service sector. The
Japanese treated the structural impediments initiative as anegotiation. They did a few things such as open up retailstores, but they didn’t really take advantage of the opportunity. The World Bank is now engaged in a much fuller exercise with the Chinese about their future structure of growth.
The Chinese have been growing 10 percent a year for thirty
years. But the Chinese themselves recognize that the exportled, investment-led growth model just can’t keep producing this way. If China continues to grow at about the samerate, by 2030 it would be like adding fifteen South Koreas to
the world economy. That’s not going to work.
The Chinese know they’re going to need to change their
growth model. So for a year we’ve been working with theDevelopment Research Council of the State Council andwith the Ministry of Finance, with the blessing of the top
leaders, to examine what China needs to do to avoid the“middle income trap.” China has outlined the objectives ofa shift to greater domestic demand and increased consumption in its twelfth five-year plan. But the question is “how”

Giving women rights and making
them full members of a society
can also boost productivity.

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to do it. Our work with China on the “how” is quitedetailed—urban versus rural development; natural resource
prices; reforms in land, labor, and financial markets; service
sector liberalization; open innovation; expanding the private sector; more and better quality public services; bringing
all public resources “on budget”; mobilizing more resources,
including from state-owned enterprise profits; promoting
competition and the rule of law—it’s extensive.
The devil will be in the details—whether China actually
can take the steps to implement the ideas. But the timing isuseful for the next generation of leaders in 2012. I’m struckthat a country that’s grown at 10 percent for thirty years could
easily try to keep doing what it has been doing. But the
Chinese are willing, even during a period of strong growth, tothink about structural change. Maybe it’s time for the UnitedStates and Europe to think about structural change, too.
TIE: A lot of analysts believe the European situation is significantly worse than that of the United States. Do you
agree?
Zoellick: In the near term, the problems in the United States
are commensurate in seriousness with those in Europe, but
not as imminent to the markets. I operate in the international
world, dealing with both developing and developed countries. Americans have to realize how quickly emerging markets are rising. If America wants to remain the power that it
has been—and I certainly want it to do so—these questions
are fundamental. Other than the supercommittee—theCongressional joint committee charged with recommending at least $1.5 trillion in additional deficit reductions by
November—I don’t know how much is going to get done
before 2012. But Americans really need to be taking up theseissues. Asians and others who admire American openness
and innovation say another decade of problems could lead toa very different United States in terms of influence andglobal standing.
For Europe, my focus has been two-fold. So far, theEuropeans have provided liquidity. I’m not against buying
time, but I believe you have to use the time. They’re goingto have to figure out exactly what they do with Greece, andthe ramifications of that action for others. They’re dealing
with each piece of the problem separately. But sovereigndebt, the banks, and competitiveness are all interrelated.
Some banks need more capital, but the amounts depend inpart on how sovereign debts are handled. With Greece it’s
not just a question of the debt, but also competitiveness.
The time for muddling through has passed. The realissue the Europeans face is deciding the future of theEuropean economic system. This has to be decided by
Europeans, because it is fundamentally a political decision.
But the eurozone really has to choose one of two paths. One

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Americans have to realize how quickly
emerging markets are rising. If America
wants to remain the power that it has
been, these questions are fundamental.
path is to create a political and fiscal union that’s complementary to the monetary union.
That’s not just a question of euro bonds. Should they
pursue a Hamiltonian assumption of past debts? What about
future debts? What incentives are there for markets versus
institutional disciplines? People talk about a European
finance ministry—what does that mean in terms of control?
And what is the target for competitiveness? Does everyone
become like Germany or does Germany become like everyone else?
The alternative path is not to become a fiscal union.
But then Europe must face the consequences of dealing withsome countries that are too indebted and some countries thatare uncompetitive. The current system cannot be sustained.
Ultimately, the European Union will have to face thesedecisions. At a minimum, leaders had better know where
they want to go. Sometimes crises offer opportunities forreform, but Europeans need to decide where they wish to go.
TIE: Some Germans suggest that in the end, the eurozone
won’t end up with a liquidity problem or even a solvency
problem; they will face a credibility problem for monetary
union itself because of soaring debt-to-GDP ratios, evenfor Germany.
Zoellick: There’s discussion about the size of the European
Financial Stability Facility, and ideas to multiply its effectiveness. Understandably, the Germans value fiscal prudence
and said, “Well, somebody’s going to have to stand behindthe EFSF, and what will it do to our credit rating?” The
Germans don’t want to have to bail everybody out. I believe
the EFSF could be used as a first loss or guarantee facility tocounter market worries about larger EU economies. The key
objective is to offer enough assurance so that Italy and Spain
can roll over debt even after Greece.
There’s an opportunity to design a union that would
have market disciplines in addition to bureaucratic checks.

One idea would be to combine a European assumption of
past states’ debts while retaining state responsibilities for
future debt. That is what Hamilton designed for a new federal U.S. government in its relations with the states. In thenineteenth century, some U.S. states defaulted. Thisapproach still enables market discipline to take its course.
Greece is still going to be a big challenge because how theEuropeans manage Greece will affect the perceptions of how
they would manage other crises.
TIE: The Europeans have a new favorite word. They want to“ringfence” Greece, the banks, and sovereign debt. What
does that mean? Something like controlled default?
Zoellick: When people start to use metaphorical terms, I
get nervous. I want to know what’s the machinery behind themetaphor.
TIE: How confident are you that the emerging markets willsave the global economy?
Zoellick: Coming into August, the emerging markets—
which now represent about half of global growth—were theeconomic bright spot.Their biggest worry was overheating.
But after the August shock, developing country bond spreads
started going up, their equity markets tumbled, and a number of currencies fell. Trade financing is starting to tighten.
Exports from developing economies to developed
economies have never fully recovered in this crisis, butthere’s been a healthy growth of south-south trade. We’rewatching very closely now to see whether the loss of confidence that hit Europe and the United States extends toemerging markets. If developing market consumers andbusinesses retreat for lack of confidence, suddenly we are ina very different environment. Their growth would slow.
A number of developing economies had rapid credit
expansion. High growth often hides problems with asset values, so with slowing growth one would expect to start to see
more non-performing loans. The message that I have been
conveying to the Europeans is that only they can make thedecisions for the eurozone. But we all have a stake in what
they decide, and Europe needs to understand the effects of
its decisions on developing markets.
TIE: Our sense is that the Germans still do not have an
endgame. Do you agree?
Zoellick: Some people—the arch protectors of the European
Central Bank and the Bundesbank—face a serious question:
until they get the other instruments, who’s going to hold the
eurozone together? Some may be making a point of intellectual protest. They know the European Central Bank’s
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going to supply liquidity through innovative steps, butthey’re making a point for the institutional future of the
ECB. I understand and even appreciate that.
TIE: Well, that’s correct. The Germans, even though theyprotest various actions by the European Central Bank, arereally not in complete control anymore. That brings up a
curious question—whether the Germans allowed a situation to develop in which the central bank, which was supposed to be “as good as the Bundesbank,” now has an
executive board where Germany and France are in a distinct minority. Five of the six members will be new. Debtor
countries will have a strong voting majority within the allimportant executive board. Have the Germans set up a situation in which the ECB becomes the whipping boy for all
that’s wrong with the eurozone?
Zoellick: I think the Germans are putting down a policy
marker. Jens Weidmann, the new head of the Bundesbank, issaying he’s not against financing to support the eurozone but
it needs to be done through the proper institutions. He’s making points about the future structure of the European system.
At the recent IMF/World Bank meetings, German
Finance Minister Wolfgang Schäuble said they were committed to creating a political union. That is the basis for a fiscal union. I don’t know whether France and others will takethese steps.
There are different voices in Germany. The German
taxpayer is saying, “Look, don’t expect us to bail everybody
out forever.” But the Germans by and large are still very
committed to Europe and European institutions. They don’t
want to just throw away money, and they don’t want to be
told again and again they have to bail others out. They don’t
want to have to work hard while others are having vacations
and hiding their income. But if Germans are told their financial contributions are part of creating a new European structure with much more fiscal and market discipline, I thinkthey could be persuaded and supportive.
TIE: The sensitive point is the way it’s phrased. If it’s statedas, “We need to bail out the banks,” then the public reacts
in the negative. And if it’s stated as, “We are going to bailout the French banks,” then for sure the proposed changes
are not going to happen. If the line is, “You have to savemonetary union and the euro so that we don’t have a third
world war in less than a century,” the proposal might havea chance of being accepted.
Zoellick: As I said, Europe needs its own structural growthreforms, too. I was talking with a German visitor recently
about Google and Facebook, and we realized SAP is the
only main European software company left. German man24

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My main point on banking regulation is
beware of unintended consequences.
ufacturers are innovative. But Europeans face the risk of stifling some innovative sectors.
TIE: And does the United States need its own new structure?
Zoellick: A non-American recently asked me whether there
could be any positive surprise for the United States. The only
one I see on the near horizon is the supercommittee on deficit
reduction. It will be interesting to see whether the supercommittee can start to move on some structural growthissues—such as tax reform—while exceeding estimates onspending reductions, which really means just slowing therate of spending growth. Congress established a voting procedure that enables the supercommittee to ensure votes onthese recommendations even if they propose hard decisions.
TIE: Let’s go back to the big picture. When the history ofthis period is written, we may conclude that what really
happened was as follows: Bubbles burst—a real estate
bubble in the United States and a sovereign debt bubble
in Europe—and then the elite powers on Wall Street and in
and around the European banks forced their governments
and their central banks to try to prop up the asset values onbank balance sheets at levels that were simply unsustainable. Values continued to drop. With QEII, we discoveredthat people don’t become confident consumers, even witha stock rally, when they know that the value of their homes
could drop further. It’s a similar situation in Europe. People
have known that the banks have been in deeper trouble
than government officials have admitted. This is one reason the public is so pessimistic. The bailouts are attempting to do the impossible. Do you buy this assessment?
Zoellick: The officials who have faced crises have been trying to do the best they can to stop the financial system fromfurther unraveling. Whether Rogoff and Reinhart are rightand an over-leveraged system needs to deleverage, orwhether we should be looking at problems from the asset
side of the balance sheet, real estate is certainly a big pieceof the bleak picture. Government and legal actions could
exacerbate the problem, lessen it, or not affect it at all. But
we will still need markets to clear.
Continued on page 61

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Continued from page 24
We want to encourage the clearing as quickly as possible without breaking the financial system or the society. In
the U.S. housing market, I worry about all the litigation
that’s tying up resolutions and lowering values further.
Meanwhile, the value of those houses declines as they sit
uninhabited with no one taking care of the house and neighborhood. At the same time, policy needs to try to provide
people with effective safety nets and support. The WorldBank is doing interesting things in emerging markets.
Instead of propping up the whole system, support goes tothose most in need. For example, there are conditional cashtransfer programs in forty countries where, for a half of 1
percent of GDP, 15 to 20 percent of their poorest people
receive income support and in return must send their children to school and get health checkups.
You don’t want government interventions that are costly
and less effective. You do want to combine intervention withgrowth strategies. We haven’t touched on protectionism butthat could rear its head in days ahead.
So when history’s written, the real question will bewhether people at the appropriate point stepped in to stop thebottom from truly dropping out. There will be a whole seriesof Ph.D. dissertations on small steps like QEII, which people will write about until the end of time. And they’ll basically conclude that these steps may have done somethingmodest for a limited time. The bigger story is the one that
relates to structural growth.
The main advice I would give on banking regulation isthat it’s always the problem you didn’t see that gets you. I’ll
give you an example. The Basel Committee on Banking
Supervision looked at trade finance and assumed every
instrument is at least a year’s term, which it isn’t in tradefinance. And they assumed that the credit of all the emerging market banks is weak. Peter Sands, who has a goodbank, Standard Chartered, said the greatest disconnect
between his capital model and Basel was on trade finance.
Based on supposed reforms, many banks pulled their moneyout of trade finance. It didn’t make sense. And all of a sudden you find trade drying up in a lot of emerging market
countries. My main point on banking regulation is that peo-

The German taxpayer is saying,“Look, don’t expect us to baileverybody out forever.”ple at Basel or others don’t always get it right, and bewareof unintended consequences. So build in feedback loops totest how new rules actually work.
TIE: In a crisis, we’d be the first to say when you’re looking over the precipice, deal with the cards that you’re dealt.
But even in that environment, you can still haircut AIG.
Former Treasury Secretary Paulson’s initial instinct was correct: Don’t repeat the Japan mistake. Get the toxic assets off
the bank balance sheets, or else you’re going to live with asluggish economy for decades. But that never happened.
We still have all this junk on bank balance sheets and thebanks are not lending. They say there’s no loan demand.
But two years ago there was, and they weren’t lending then,either. They were buying Treasuries and other government
agency bonds with money they borrowed for next to nothingat the Fed’s Discount Window. So in the end, isn’t the problem that Washington policymakers and their European counterparts blinked—they were too passive in dealing with arestructuring of the banks?
Zoellick: That certainly captures the mood of the moment.
I’m not sure how constructive beating up on the banks is. My
worry is that the “teach them a lesson” model will become
very complicated and ultimately very costly and unworkable,
and still probably won’t catch the next problem.
A senior Fed official, talking about what’s going to bedone to fix the mortgage securitization process, said theoriginators have to hold part of the mortgages they originate. That makes economic sense. But what about the structure of the mortgage banking industry? It’s very thinly
capitalized. Companies go out of business at the end of acycle, then open again somewhere else. So you can requirethem to hold 10 percent, 20 percent, whatever. But if they
face losses that exceed the thin capital, they’ll shut down,then they’ll reopen. That solution won’t work unless one
changes the industry structure to require well-capitalized
mortgage originators.
Let’s take mortgages one step further. Americans wantthirty-year fixed-rate mortgages. The United States has tried
to fund them with savings and loans, and we learned thatthat doesn’t work very well. So Fannie and Freddie played
a role, with a better asset-liability match, but the drawback
of a single-industry company, by law. Policymakers andthe public have to ask the question, if we want thirty-year,
fixed-rate mortgages that borrowers can prepay without
penalty, then who will hold that asset, how will they judge
its quality, and what guarantees are available? I’m a big
believer in markets and in institutions. I want to know how
markets relate to institutions. I don’t think we’ve yet reconciled supposed public preferences in the housing markets and institutions.
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TIE: In the past, even though there were always imperfections, you could still get some clearing process that worked
within the system of incentives roughly in place. Now we’ve
thrown a safety net over the entire financial system. We’ve
created an incentive system in the financial sector to run
this stuff up to bubble-like levels. Aren’t we where we aretoday because of all the subsidies to banking, and because
the regulators were asleep?
Zoellick: Clearinghouses that work under stress are usefuldevices. In general, I believe banks need capital and liquidity requirements, but I realize there’s debate about exactly
how these should work. We have to come up with a manageable way to allow banks to fail. I tend to believe it’s better to separate supervisory authority from monetary
authority, although the two need to interact. In my experience with central bankers, the prestige is with the monetaryside, and supervision takes second or third place.
TIE: Politicians want just the opposite. They want to keep
piling responsibility on central banks. But central bankers
regard bank supervision as sort of the plumbing—as in,“I’m worrying about the business cycle, don’t bother mewith the plumbing.” They punted. And now we haveanother whole layer of banking regulation because central
bankers tried to make the excuse that they didn’t have thepower to deal with the mortgage mess in the first place.
Zoellick: I agree.
TIE: To what extent does the entire world now prefer aweak currency for trade purposes? The normal problem ofa weak currency—rising inflation—is unlikely given thehuge slack in the global economy. Is the world about to see
a protectionist outbreak?
Zoellick: I don’t think we’re there yet with weak currencies. There will be pressures, but in general I expect we’ll
have flexible exchange rates and independent central banks
seeking to adapt in a world with monetary turmoil. This condition suggests possibly a bigger structural challenge ahead.
The United States will remain the principal reserve currency,
but we have to prepare for a world where there are going to
be multiple reserve currencies. I wrote about this earlier inthe year in the Financial Times. Most emerging markets are
moving to rely on flexible exchange rates, and we need tohelp them to develop the institutional structure, the domestic currency bond markets, and the prudential tools so thatthe current monetary turmoil doesn’t drive countries to either
financial protectionism or to other types of protectionism.
The World Bank has tried to monitor trade barriers
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The United States will remain theprincipal reserve currency, but we haveto prepare for a world where there aregoing to be multiple reserve currencies.
Organization has also published information about whether
or not barriers are permitted under the WTO rules. The number of protectionist steps has actually been down a bit until
recently, in part because countries have been facing inflation, especially in food prices, so their own self-interest is tokeep barriers to imports down. We need to watch whether
they now take protectionist actions as their manufacturingsectors come under pressure.
TIE: To what extent should we believe the data coming out
of China? The official number for inflation is 6.5 percent,but analysts in Japan say it is probably closer to double
that. Is the potential for a hard landing a lot greater thanconventional wisdom suggests? You have to use proxies toreally understand what’s going on in China. For example,
export orders to China have collapsed at Germany’s
Daimler. Are you worried that the China story will turn sour?
Zoellick: The good news is that the Chinese acknowledge
that inflation is their major short-term issue. When you ask
Chinese outside of Beijing—the mayors and the party secretaries—whether their actual inflation is a little higher than
the recorded numbers, they say perhaps yes, but I’m notoverwhelmingly worried. The Chinese, given the nature of
their financial system, have a series of regulatory and othertools to squeeze inflation, and they are squeezing it. They’reworried about food prices, and also about the social implications of inflation. With new leadership in 2012, theChinese are keenly focused on the problem. It won’t all bepretty, but I think inflation is a manageable issue.
A bigger issue is this idea that China’s going to bailout the world. Forget that. The Chinese are focused on
restructuring their own economy for continued and broadbased growth in years ahead. They should be. And soshould others.
TIE: Thank you very much.

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