Aid and the Political Economy of Policy Change

Tony Killick

• Publisher: Routledge
• Year: 1998
• eBook ISBN: 9781134662449
• Topic: Business
• Subtopic: Business General
• Index: Business

This volume looks at the effectiveness of conditionality in structural adjustment programmes. Tony Killick charts the emergence of conditionality, and challenges the widely held assumption that it is a co-operative process, arguing that in fact it tends to be coercive and detrimental to development objectives. Through detailed case studies of twent

1: THE PRACTICE AND JUSTIFICATION OF CONDITIONALITY

The task of this chapter is to set the scene for what follows. We first trace the spread of conditionality in recent years and then briefly describe the modalities of conditionality. This leads to a discussion of the meaning and nature of conditionality and is followed by examination of the arguments in legitimation of the principle of applying conditionality. The chapter concludes by providing brief prima facie reasons for thinking that conditionality is not working well—and why, therefore, it seemed worthwhile to write this book.

I: The spread of conditionality

It is only a modest exaggeration to say that in the 1970s the only substantial policy conditionality applied to developing country governments in search of assistance was that of the International Monetary Fund (IMF). The World Bank was yet to move far into ‘policy-related’ lending and the same was true of other donor agencies. Moreover, the Fund conditionality of that time was designedly of quite limited scope, confined to a few macroeconomic policy variables such as the exchange rate and domestic credit.

Since then, however, the position has been transformed. First the scope of IMF conditionality has been greatly extended (Killick, 1995b:22–7). It began to take trade liberalization measures much more seriously. It increasingly insisted on delving below aggregate targets of budgetary deficit reductions to examine the specific revenue and expenditure measures envisaged to produce these outcomes, which it has rightly been observed ‘unobtrusively introduces microconditionality’ (Polak, 1991:40).

The Fund’s move into ‘structural’ conditionality has had three thrusts:

1. to increase the role of markets and private enterprises relative to the public sector, and to improve incentive structures;
2. to improve the efficiency of the public sector; and
3. to mobilize additional domestic resources.

This has broadened the content of its conditionality into such areas as the reduction or elimination of public subsidies and the removal of price controls, with the pricing of petroleum products and agricultural producer prices particularly frequent targets. The operation of the market mechanism has also been promoted through the liberalization of trade and payments; and the realm of the private relative to the public sector has been extended by numerous requirements for the privatization of public enterprises. The efficiency of the public sector has additionally been promoted through stipulations requiring some chronically inefficient public enterprises to go into liquidation. Improved domestic resource mobilization has been promoted by tax measures, and by provisions for the reform and strengthening of the financial sector, including the recapitalization and restructuring of banking institutions and de-control of interest rates.

Evidently, then, the previous principle of restricting IMF conditionality to a few macroeconomic variables has been abandoned in favour of a far more ambitious agenda. By contrast, once it got started in the business of policy conditionality the World Bank was never anything other than ambitious. Indeed, one of the first internal evaluations of its structural adjustment lending experiences criticized its staff for attempting too much, for being too unselective in the policy stipulations they wrote into programmes, and that has been a recurring theme in later evaluations.

If we take together the Bank’s (increasingly rare) economy-wide structural adjustment programmes and its (still numerous) sectoral adjustment programmes, the aggregate coverage of its policy conditions is enormous, extending to all economic sectors and to the very wide range of policy instruments that can be deployed within these, as may be judged from the distribution of the 117 adjustment operations in being at mid-1994, shown in Table 1.1.

Of course, at any one time a borrowing government will only be confronted with conditions relating to some sub-set of the possible total. Nevertheless, the range of stipulations can be extraordinarily large, as is suggested by the not unusual example of Uganda, a country still trying to rebuild its public administration after the ravages of prolonged civil war. An unpublished Bank report sets out a total of eighty-six specific policy commitments for 1991–2 to 1993–4, of which seventy-nine should have been undertaken or initiated in FY 1991–2 alone. That this was not an extreme case is suggested by information showing that the average number of conditions per adjustment loan in 1989 was fifty-six (see Table 1.3), having risen steeply during the decade.

Even this account does not do full justice to the broadening of conditionality which has occurred over the last decade.¹ Measures to reduce poverty, or to alleviate the social costs of adjustment, have featured increasingly, with even the IMF changing tack to take a more active interest in this area. Policies for the protection of the environment have also begun to feature increasingly, particularly among some bilateral donors. Other policy causes promoted by bilateral conditionality include reduced military spending, enhancement of the position of women and human development.

Table 1.1 Subject coverage of World Bank conditions, 1994

Source: World Bank, 1995a:115.

Various pressures have contributed to this explosion. Much of it has come from publics in the industrial countries, weary of the seemingly insatiable appetite of developing countries for aid and alarmed by media stories of corruption. Some, perhaps surprisingly, has come from NGOs who, while often highly critical of IFI-style conditionality, have not shrunk from advocating their own nostrums—to enforce protection of the environment, or of the poor, or of women, etc. Partly in response to these changing public attitudes but due also to their growing reluctance to aid developing countries in economic difficulties, government representatives on the Executive Boards of the IFIs have also exerted large pressures for conditionality, asking of proposals for new adjustment credits ‘what policy changes are we buying with this money?’.

Also underlying this question are the intellectual influences, as well as practical experiences, which led to a growing belief that past government policy interventions in developing countries had often had malign effects and that aid applied within a distorted policy framework was likely to be wasted. The gradual fading of colonial guilt brought further changes in relations between the metropolitan powers and their former colonies. The demise of communism in Eastern Europe and the former USSR was a further important influence. By altering foreign policy objectives and devaluing the security-cum-foreign policy motive for aiding strategically placed countries, the ending of the Cold War brought further changes in relationships between donors and many recipients, increasing the self-confidence of the former and making them bolder in pressing their views.

Table 1.2 IMF and World Bank adjustment lending, 1980–94 (average new credits and commitments per annum)

Source: World Bank, 1992a, Annex 1, and Annual Reports, 1993, 1994; IMF Annual Report, 1994, Table II.1.

Notes:

^a Includes EFF, SAF and ESAF credits

^b In SDR billions

^c In US$ billions

These figures relate to the respective fiscal years of the two agencies.

These views were not, of course, confined to the economic sphere. There has also been a powerful move to link aid with the promotion of ‘good governance’ (accountability, transparency, the rule of law, the prevention of corruption, etc.), the observance of human rights and the promotion of multi-party democracy. There has been a growing use of conditionality in these areas, particularly by bilateral donors but also by the World Bank (which has tried, with only mixed success, to limit its stipulations in this area to the tenets of good governance).²

Table 1.2 shows the rapid growth in policy-oriented adjustment lending by the Bank since the early 1980s, with the number of new loans increasing five-fold during the 1980s, although there has been some reduction since. The trend is less clear in the case of the Fund but by the last period shown it was making an unprecedented large number of high-conditionality (i.e. excluding structural adjustment facility (SAF)) structural adjustment loans.

In addition to the growing number of governments entering into structural adjustment arrangements with the IFIs, the number of policy stipulations per credit has also been increasing (see Table 1.3).

In the IMF, the tendency towards proliferation is most obvious with its ESAF programmes. The range of policy conditions in these is considerably wider than in traditional stand-bys. There has been extensive use of preconditions but additional evidence on proliferation can be seen in the averages of the number of performance criteria per programme presented in Table 1.4.

Table 1.3 Average number of policy conditions per World Bank adjustment loan

Source: World Bank, 1992a, Table A2.3.

Note:

^a Legal in the sense that their observance is required if a loan tranche is to be released, i.e. similar in status to IMF performance criteria.

Table 1.4 The growth of performance criteria in IMF programmes

Source: Polak, 1991:14.

The substantial use of conditionality by bilateral donors is quite a recent development, although it has some history in the case of the USA and has never been entirely absent among other donors.³ So far as adjustment conditionality is concerned, the bilaterals have mostly contented themselves with ‘piggy-backing’ on the conditionality of the IFIs, although with varying degrees of enthusiasm. The UK has gone furthest, with the USA, Germany and the Netherlands also firm supporters but with France, Japan and the European Union slower to come fully on board.

Overall, then, there has over the last one-and-a-half decades been an explosive growth in the use of conditionality, which has left few developing country governments untouched (see Table 1.5). Note the special concentration on sub-Saharan Africa: the extent to which policies in that region are under the direct influence of the IFIs and bilateral donors is without historical parallel. In enquiring into the effectiveness of conditionality we are therefore examining a phenomenon of no little importance.

II: The modalities of conditionality^{2 4}

In formal terms, conditionality of the type considered here refers to a mutual arrangement by which a government takes, or promises to take, certain policy actions, in support of which an IFI or other agency will provide specified amounts of financial assistance. However, the various policy requirements do not all have equal status.

Table 1.5 Regional breakdown of IMF and World Bank adjustment programmes, 1994

Source: World Bank, 1995a: 112; and IMF Memorandum, 6 February 1995, using World Bank country classifications.

The most binding are preconditions, or 'prior actions' as the IFIs prefer to call them. These are policy actions agreed in the course of a credit negotiation but which must be undertaken before the agency will present the credit agreement for the approval of its Board. These are quite extensively used by the Bank, as the figures in Table 1.3 show, and by the IMF. However, only a limited set of policy changes is amenable to this type of treatment. If there is not to be inordinate delay, prior actions must relate to actions over which those parts of government with which the IFI has been negotiating have direct control and which they can undertake quickly. The actions must be quite unambiguous, in the sense of being precisely specified and readily monitored.

In the context of a crawling peg regime, the exchange rate is a classic example of an instrument that passes these tests and, indeed, devaluation has probably been the most common prior action stipulated by the IMF. A specified change in some other price directly controlled by the Treasury has similar qualities, as do changes in tax rates, or in commodity subsidies. Policy shifts that have to be mediated through other levels of government, or those which are more qualitative in nature, or which involve institutional reforms which can only be implemented gradually, are clearly unsuitable for treatment as preconditions.

Once an agreement is worked out and any preconditions have been implemented, the way is clear for the government to draw upon the supporting line of credit. However, only very exceptionally will all the agreed amount become available ‘up front’, upon signature of the agreement. Any leverage which the lender (or giver) may have over the recipient government’s policies wanes rapidly once the money has changed hands. The IFIs therefore usually only release their credits in instalments, or ‘tranches’.

In the case of the IMF, stand-by credits are normally made available in quarterly tranches, while credits from its Enhanced Structural Adjustment Facility (ESAF) are normally subject to six-monthly tranches, although these terms can be varied according to country circumstances (there have even been instances of monthly tranching). The leash on World Bank structural adjustment credits is usually somewhat longer. Two tranches (i.e. an up-front payment plus one further instalment) are the general rule but three or four are not uncommon. Tranches are not necessarily of equal amounts, nor equidistant in time. Where it is desired to exert maximum leverage over a government, a credit may be ‘back-loaded’, with a large proportion payable in later tranches. Where there is high confidence in the intentions of a government and it needs finance urgently, there may be ‘front-loading’, with a large proportion of the credit being paid up-front. Both IFIs can vary tranching arrangements in these ways.

This brings us back to the hierarchy of policy conditions. After preconditions come certain trigger actions—what the IMF calls performance criteria and the Bank benchmark criteria or legal requirements (see Table 1.3). It is compliance with these which trigger governments’ continuing access to the next outstanding tranche of the credit. IMF performance criteria typically include ceilings on the expansion of domestic credit, or on credit to the government, minimum levels of foreign exchange reserves and maxima on non-concessional foreign borrowings. Exceeding a ceiling or falling below a floor will normally result in the withholding of the next credit tranche until the government can come back into compliance or new targets can be agreed. The benchmark criteria of the Bank are more varied, depending on the nature of the credit in question, but commonly relate to such measures as trade liberalization, financial sector reforms, the composition of public expenditures, various aspects of agricultural policy and the reform or privatization of public enterprises. All should have the quality of being precisely defined and readily monitorable.

The third, and least binding, of the policy provisions within an agreement comprise the residual element of commitments contained in the overall programme but which are neither preconditions nor trigger criteria. Such policy commitments are often quite numerous but, since there is no direct linking of their implementation to access to finance, the degree of IFI leverage over them is fairly slight. It is not completely absent, however, for it may well be that implementation of some of these measures is important for the success of the programme. In principle, the IFIs can punish governments which take a casual attitude to the execution of these residual provisions by withholding credits in the future, or drawing up tighter conditionality provisions in any future agreements.

The trigger and residual conditions just described (but not usually the prior actions) are formalized in letters addressed by the borrowing government to the IFI in question, called ‘Letters of Intent’ by the IMF and ‘Letters of Development Policy’ by the World Bank. These letters will usually also describe the economic background to the credit in question and its objectives.

Trigger conditions have the defect of creating an inflexible strait-jacket for economies subject to sudden shocks, to say nothing of miscalculations on the part of those who draw up the programmes. The IMF’s performance criteria have been particularly criticized along these lines. Both IFIs have developed techniques for reducing this inflexibility, however. Both, for example, are willing to grant waivers (which, however, have to be approved by their Boards) in the case of minor departures (or more substantial variations resulting from external shocks) from trigger conditions, although their willingness to do this varies from country to country and over time (see Killick, 1995b, Chapter 5 for a discussion of this in relation to the Fund).

There are also ‘review clauses’, which are intended to give IFI staff the ability to judge progress with a programme on the basis of the overall record, rather than simply in terms of compliance with trigger criteria. Increased use of review missions has been an important development for the Fund in recent years. Six-monthly review missions have become more or less standard practice in both stand-by and medium-term programmes, with the purpose to assess progress with a programme over the preceding half-year and to reconsider or determine performance criteria and other provisions for the following half-year. As such, they reduce the Fund’s reliance on predetermined quantitative indicators and facilitate the modification of programmes in the light of changing circumstances. Bank missions are also supposed to assess overall programme progress, although a Bank report stated that this requirement is rarely taken seriously and sometimes ignored, with reviews tending in practice to concentrate on compliance with the legal trigger criteria (World Bank, 1991:60). It is similarly unclear how much difference the introduction of more review missions has made to the de facto flexibility of the IMF.

There is also cross-conditionality. This refers to a situation in which access to one agency’s finance is made conditional upon compliance with the stipulations of a second agency. There is a good deal of this, although this is not always formally stated and sometimes denied. A well-known (although nonformal) example is the requirement of the World Bank that for a country to be eligible for a structural adjustment credit it must also have an agreement with the IMF, and remain in compliance with that agreement, or in some other way obtain the imprimatur of the Fund for its macroeconomic policies. Another example is provided by the practices of the Paris Club. This is the forum through which mainly OECD creditor governments co-ordinate their responses to debtor-country requests for relief on the servicing of official bilateral credits. The Paris Club has adopted the principle that a debtor government must have a programme with the IMF in order to be eligible for debt relief.

Bilateral aid agencies also make extensive use of cross-conditionality, commonly linking their programme aid to the conditionality of the IFIs. In such situations, the tasks of monitoring and enforcement are effectively delegated to the staff of the IFI...

Table of contents

• COVER PAGE
• AID AND THE POLITICAL ECONOMY OF POLICY CHANGE
• TITLE PAGE
• COPYRIGHT PAGE
• PREFACE
• LIST OF ABBREVIATIONS
• 1: THE PRACTICE AND JUSTIFICATION OF CONDITIONALITY
• 2: WHAT HAS ADJUSTMENT CONDITIONALITY ACHIEVED?
• 3: CONDITIONALITY AND ADJUSTMENT IN SOUTH EAST ASIA AND LATIN AMERICA
• 4: THE ‘OWNERSHIP’ PROBLEM
• 5: THE MODEL, THE RESEARCH, SOME RESULTS
• APPENDIX: THE SELECTION PROCEDURES FOR THE COUNTRY SAMPLE
• 6: REWARDS, PUNISHMENTS AND THE INFLUENCE OF NATIONAL POLITICS
• 7: ALTERNATIVES TO CONDITIONALITY
• MASTER TABLE
• BIBLIOGRAPHY