Issue 5, October 2008
|Economic Policy and Governance Reform|
Traditional aid dollars can be used to create economic and political change, but development assistance in the economic and governance reform category is different from traditional aid because its goals tend to be structural, and it is specifically given with the intention of making traditional aid simultaneously more useful and less necessary. Both governance reform and economic policy reform are aimed at increasing the accountability and democratic quality of LDC institutions, as well as making the country more competitive and conducive to market-oriented growth. This form of assistance is not without its controversy and debate, however, and many feel that developed countries have their own flaws and shortcomings, and thus have no right to impose economic and governance policies on LDCs.
Economic Policy Reform
No discussion of economic policy reform in LDCs is likely to occur without the mention of the Structural Adjustment Programs (SAPs) of the last decades of the 20th Century. Also known as “shock therapy,” these programs placed conditions on the loans given by International Finance Institution (IFIs – made up of the World Bank and IMF) to recipient countries. The intention was to push these countries to make fundamental economic and political transformations through fiscal discipline, with the ultimate goal of creating the conditions for free-market, capitalist growth.
To illustrate how this worked, take the hypothetical example of an LDC attempting to ‘modernize,’ both economically and politically. In this country, an authoritarian, often corrupt regime presides over a poorly performing, non-capitalist economy (characterized by heavy state influence/ownership of assets and a large, even bloated public sector). In order to receive desperately needed loans, the country is required to make radical changes to jumpstart its market economy and “open” the country. As was the case with most SAPs, the country is required to deregulate, abolish many public subsidies and labor rights, reduce state spending, lower tariffs, encourage export-oriented industries, and sell major public enterprises.
In order to rapidly transition an economy with faltering socialist practices into a capitalist free market, the patient was often essentially killed in order to be saved. The enticements were significant loans and the eventual integration into global markets that had historically produced such incredible growth for developed countries. The result in the short-term was almost always hardship – state sector jobs were eliminated, prices for basic goods rose as currency lost value, and private industries were opened up to often crippling foreign competition. Those with capital to purchase previously state-owned assets quickly rose to the top; others found their standard of living diminished. The transfer of assets from the public realm to privatization was often rife with corruption, as highly-placed government officials cut deals for their personal benefit and that of their cronies.
Even if the transition was smoother than that described above, the result for the country in question was likely to be a form of raw capitalism untempered by government social welfare measures. Although social welfare is used widely in donor nations, these measures were typically discouraged in SAPs. Even if they were permitted, safety net benefits require a functioning government to disburse them effectively; this is a luxury generally not found in developing nations. Instead of democracy, unfettered capitalism thus often produced oligarchy, in which elites ran the capitalist economy and the state for their own benefit.
To make matters worse, one of the main reasons LDCs subjected themselves to this process – the lure of participation in lucrative global markets – has not fully come to pass, as will be discussed further in the International Trade Policy section of this issue. This happened partly because while donor nations required LDCs to dismantle protectionist measures as part of SAP packages, they largely kept their own protectionist architecture in place, retaining their competitive edge in these markets.
Due to these factors, the potential of SAPs to create economic growth was largely unfulfilled. Not only did SAPs fail to produce significant growth, but they also left the developing world with huge debts from the loans (see the Development Aid section for information on debt relief) and a bitter taste in its mouth toward the West’s well-intentioned, but misguided reform efforts. A significant backlash ensued against externally-driven policy assistance; in extreme cases, leaders of LDCs were able to use Western institutions and experts as a scapegoat for their poor economic status.
SAPs remain a subject of great debate within the development field. Some take issue with the premise that they were wholesale failures. The World Bank continues to point to a few measured successes of SAPs among some countries who, in varying degrees, managed to reduce debt and inflation, as well as set competitive exchange rates and establish basic preconditions for growth. Some experts believe that SAPs were never really given a chance and that they were never adequately funded, correctly implemented, or given enough time to work. Others believe that SAPs were too rigid and not sufficiently inclusive of local input or adapted to varying conditions on the ground. Still others fundamentally believe that reforms cannot and should not be instituted externally from IFIs; rather, market reforms must be shaped by incentives and incremental support for indigenous innovators to take advantage of the free market on their own terms. Another viewpoint is that macro reforms require macro solutions, and that development economists from the developed world can provide valuable guidance. An entirely different group of SAP critics is composed of those who believe that the power of the market is overstated, and that LDCs were sold false hope that they would be able to create optimal market conditions, that markets would have anti-poverty effects, and that developed nations would level the playing field to allow them to participate.
The contrasting experiences of China and India are important to consider when discussing SAPs. Unlike many of today’s LDCs, they largely did not participate in formal SAP initiatives. Rather, they focused on pieces of the SAP model, most notably the export diversification component, putting their greatest asset (a large labor pool) to work in producing competitively priced agricultural and industrial goods that could be sold abroad. This produced strong results, and they followed up this diversification by establishing a favorable business climate in their countries and attracting a great deal of foreign direct investment (FDI). By contrast, many of the SAP nations became bogged down in the reform process, took on more and more debt, and scared away investors. In time, their potential markets for labor-intensive exports were dominated by India and China, and their market access was limited by international trade policy that favored developed nations.
Whether or not SAPs were an unfortunate iteration of a well-intentioned idea or a neo-imperialist travesty visited on LDCs is a subject of continued debate. Overall, there is disagreement about the design of the programs, but most would still defend the goals sought by SAPs: to produce the conditions conducive for growth via the free market. Easterly perhaps sums it up best when he says that SAPs were ill-conceived means to a correct end. Markets are a proven way to produce economic growth, and most LDCs are in need of economic and governance policy reforms to position themselves well in the global marketplace. Numerous studies, including those conducted by David Dollar and Craig Burnside, link economic reform to growth, and have shown that monetary and tax policy assistance are a critical complement to traditional development assistance in the form of aid.
To that end, after falling briefly out favor, economic policy assistance has again become a major tool for development; however, many, such as Council on Foreign Relations expert Amity Shales, believe these programs look a lot like a reincarnation of SAPs. The Growth Report, compiled by the Commission on Growth and Development, is based on the same faith in markets for growth and recommends a variety of economic policy reforms that LDCs should adopt with technical expertise and monetary support from the development community. These suggested reforms include building the capacity of local leaders to choose a growth strategy and communicate it well to the population, and working to achieve buy-in with a full disclosure of short and long-term risks and discomforts. It also recommends shoring up economic security during the time of transition toward the modern global market, including the provision of retraining, income support, and basic services for those workers displaced by reforms. Fiscal and monetary policies are recommended by the report and cover exchange rates, inflation, and the role of central banks. Investments in public health and education for workers are also recommended. It contains policy advice on mitigating the environmental impact of growth and the effects of global warming; it also includes a discussion of labor markets, and an analysis of rural/urban issues associated with growth. The report advocates more cultural and educational exchanges between LDCs and developed nations to improve the capacity of local leaders, combined with incentives to encourage migrants who are educated in the West to return to the LDCs as agents of reform.
Like its SAP predecessors, the Growth Report advocates against the adoption of wide-spread protectionist measures, but unlike the SAPs, it advocates for the provision of social welfare mechanisms to mitigate the effects of extreme poverty and recognizes the merit of some agricultural subsidization for LDC producers in the short-term. Overall, it looks to the China and India model and seeks to set LDCs on the path of “labor-intensive growth strategies” and “structural change under competitive pressure.”
The Growth Report acknowledges the barriers put up by developed countries’ own protectionism and does not advocate that LDCs should have to comply with the same carbon emissions standards as industrialized nations. Many economists hope that assistance in implementing these economic reforms in LDCs will bear the fruit that SAPs were supposed to produce. Its emphasis is on long-term horizons; it is now the job of the development community to negotiate ways to encourage these reforms in less destructive, more realistic, and sustainable ways. Whether these reforms go far enough or too far, whether they should be conceived by IFIs or on the ground, and how they should interact with other types of development assistance (especially aid and international trade policy) will clearly be the new (and old) debate. It is encouraging to many that current proposed economic reform assistance packages do a better job of recognizing the myriad of fronts on which LDCs need to fire in order to generate growth. From investing in human capital to attracting financial capital and building social capital, the pieces of the growth paln are not as effective if addressed in isolation from each other; in the same vein, policy reform is not as effective when not combined with other tools in the development assistance arsenal. As Greg Mills has pointed out, the education of 400,000 Kenyans means little if less than 10% of them can find jobs upon leaving school.
One last note on economic policy reform concerns land ownership in LDCs. Some in the development community believe this issue is critical, while others believe it is overstated and potentially culturally-destructive. What many in the West do not realize is that in many developing countries, not only is land inequitably distributed, but it is also often held without official title. From a mud hut to several acres of subsistence-farmed lands, people who occupy these properties often have no way of gaining official title to them. This means that they lack a critical economic asset: collateral or credit needed for seeking a loan, which closes most traditional banking channels to them (See the Microfinance section for information on alternative banking channels). If people don’t have legal control of their land, there is less incentive to expand and improve the capacity of that land. This is an area of reform that many believe could have tremendous impact on developing societies’ growth. Yet there are others who believe that IFIs and Western reformers tread on sacred ground with regard to cultural, familial, and societal practices of communal ownership in developing societies. A similar controversy exists over the introduction of insurance to developing economies. Finding ways of providing insurance for crops, property, and business ventures in LDCs, some believe, holds a great deal of promise and could enable would-be entrepreneurs to achieve a level of protection and risk management in their endeavors. However, others like Stephen Marglin, have pointed out that such market solutions “often substitute impersonal relationships” for collective and reciprocal systems of cooperation, and thereby harm communal core values that often celebrate dependence of community members on each other for help in times of crisis. He writes, in his article “Development as Poison,” that “once this interdependence is undermined, the community is no longer valued; the process of undermining interdependence is self-validating.”
Good governance goes hand in hand with economic reforms, for it is the government that needs to preside over the newly emboldened marketplace and to take care of those for whom the market cannot be the solution. Governance affects decision-making with respect to all types of development assistance: how to use aid, how to attract foreign investors and negotiate beneficial trade agreements, how to make the most of technology, and how to use bilateral and multilateral connections to prevent and mitigate conflict and achieve economic stability. In short, governance presides over how to get the needs of the country met, domestically and internationally and how to avoid the traps and cycles that impede development.
Yet, governance can be a trap in and of itself – the poorer a country is, the worse its governance tends to be, for a variety of factors. Poverty often means that leaders themselves are not well-educated or connected to the outside world and that they are more susceptible to corruption; poverty can mean that their constituents are largely concerned with subsistence living and lack capacity for oversight, opposition, and reform movements. These obstacles in turn create a cycle for the future, as the leadership makes poor decisions that impede economic growth.
However, leadership is but one component of governance. An enlightened and beneficent leader is necessary, but not sufficient, for good governance; even the best-intentioned leaders often fail when they preside over broken systems. Moreover, regime change is not necessarily an effective solution to bad governance; poor governance usually runs deep and is entrenched in a country’s institutions and in the ruling elite. Removing Saddam Hussein did not fully address the poor leadership that had afflicted the Iraqi government; effecting real change in Zimbabwe means more than simply removing Robert Mugabe. Holding a democratic election does not always mean that true democracy will result. Experts generally agree that governance reform must address dynamics, norms, and policies broadly and deeply throughout a country’s social, ethnic, and political infrastructure. Assistance from the outside world to governments in LDCs must help leaders strike a balance between lack of authority and overwhelming authority, between garnering the support of elites and serving the population as a whole. Reform assistance must help to create accountability and rule of law if it is to have any impact on poverty and development. Please see the Democracy Around the World 2008 issue of the World Savvy Monitor for a thorough discussion of governance and its relation to a country’s economic growth.
The track record of the developed world in assisting LDCs with governance reform is fairly bleak. The fact that Mobuto Sese Seko, Idi Amin, Charles Taylor, Pervez Musharraf, and Robert Mugabe all received significant development and other types of aid from bilateral and multilateral donors in the developed world bears this out. Certainly incentives have been tried, pressure placed, and much consulting done, but to little avail. Both carrots (more aid, preferential trade deals) and sticks (sanctions, threats to withdraw aid or intervene militarily) have been used to try and effectuate governance reform. Despite this, many believe that the OECD and others have not fully followed through on threats related to in-country governance in LDCs, especially when it comes to developing nations that are considered strategic to the interests of developed nations. In key geo-strategic states, the developed world has often claimed it has few choices, that the stakes are too high, and the potential for instability too great for them to place significant reform pressures on certain leaders, no matter their governing style or capacity.
A way in which some current pro-good governance initiatives are different from their predecessors is in the specific nature of conditionality. United States Millennium Challenge Accounts (MCAs) are one such area viewed with promise by many experts. MCAs condition loans and grants on basic good governance requirements, among them representative decision-making and transparency/anti-corruption measures. The idea has great ideological support, but to date, is hamstrung by lack of funding. Only a portion of the intended budget has been disbursed through MCAs. Furthermore, there are those who feel that application of these guidelines has been uneven in the administration of the funds, and that difficulty in monitoring compliance will only increase as more money is disbursed. The fact remains that conditionality is difficult to implement well. It is a lesson learned the hard way that promises to meet conditional requirements are not the same as actual follow through on these promises. Many recipients of conditional aid have pocketed the money and failed, for reasons of malice or ineptitude, to make the required reforms, and the international donor community has historically had little redress in such circumstances.
A micro approach that has been proposed to create incentives for good governance is grants for good leaders, often delivered by the private sector. For example, Sudanese billionaire Mo Ibrahim has established a foundation that will award the Achievement in African Leadership Prize. The world’s largest leadership prize (at $5 million, it is three times the amount of the Nobel Prize) will go to a democratically-elected leader of a Sub-Saharan African nation who receives high marks on a performance scale measuring quality of governance in areas such as security, rule of law, economic opportunity, and political freedom. His hope is that the prize will serve as an incentive for leaders to govern honestly and beneficently and to leave office when their tenure is up (any attempt to stay in power beyond elected terms will disqualify candidates). The effort is chaired by former UN Secretary General Kofi Annan and will also include a $200,000 grant for the winner to use in philanthropic ways.
Beyond positive incentives for good governance, some also advocate using negative pressure to stem bad governance. Economic sanctions used for this purpose have had varying levels of effectiveness. Many believe that the shaming or exclusion of corrupt, ineffective, or predatory leaders would be more effective if it were extended to their participation in regional and multilateral institutions, acting as both a punishment and incentive for reform. Yet, with such an approach so unevenly practiced (no one has yet to be kicked out of the African Union, ASEAN or United Nations), this has had limited effect. The International Criminal Court seeks to pursue a similar naming and shaming (and ultimately indicting) approach, but yet again, it has had limited success to date.
Alongside efforts to transform existing bad governments with incentives or threats, a completely different realm of governance reform assistance exists to empower opposition leaders and reformers. Instead of focusing on the villains, many believe that developed countries can better impact governance in LDCs if they bypass existing governments of LDCs and aid courageous and often downtrodden indigenous reformers. Many contend that those seeking change should stop attempting to reform the corrupt and the inept leaders of the ranks of the LDCs, and instead, start supporting the opposition in a significant fashion. They argue that this does not necessarily need to be through cash grants, but could be in the form of technical assistance, training, and on-the-ground protection and facilitation for reformers.
These are the very measures Peter Uvin believes aid agencies and other external players should have helped put in place as Rwanda’s governance problems began to come to light in the 1980s and early 1990s. The same measures could be beneficial in any country with poor governance and an aspiring reform or opposition faction: free press, freedom of assembly, election monitoring, empowerment of civil society watchdog groups, and encouragement of lawyers, judges, and police officers to uphold the rule of law. Finding the moderates and helping them to spread their message and garner the support of the people for locally-driven reform and even regime change is a more low-profile development assistance activity, but one that most believe may have the most chance of success in addressing issues of governance and economic policy.
Kenneth Roth of Human Rights Watch concurs, suggesting that the World Bank begin to support the work of indigenous reformers on the ground by basing the conditionality of Bank aid and loans not on ad hoc or unspecific guidelines, but rather on the widely-known Universal Declaration of Human Rights. He writes that the Bank “can enhance development and growth by promoting freedom of expression and association, the availability of information, collective bargaining, political participation, and access to justice.” He notes that Bank programs that have done so include “participatory budgeting, accountability to local stakeholders for service delivery programs, and efforts to enhance the voice of marginalized groups.”
But Whose Economic Policies, Whose Governance?
As always, there is another side to these issues. What seems like a good idea – helping to reform the economies and governance of LDCs with Western expertise – is complicated by the fact that many believe developed countries could use economic policy and governance reform themselves. The current economic meltdown in the US mortgage-backed securities market is a prime example. As this issue is being written, the US is trying to negotiate a solution to the crisis brought on, at least in part, by faulty government regulation and oversight of Wall Street’s economic practices. This issue impacts those far beyond the borders of the US; some believe that the blame for a global recession, should it come to pass, should be leveled at the US government for not managing its economic affairs more prudently. This only adds to the bitter taste among some LDC leaders about externally-driven reform efforts aimed at their countries by what they see as the “hypocritical” developed world. Similarly, in addition to bilateral donors, IFIs are under attack for questionable practices and governance in their ranks. The controversy over internal World Bank policies that forced the resignation of Director Paul Wolfowitz is an example of what many perceive as the generally anti-democratic nature of IFIs, whose governance is disproportionately dominated by officials and decision-makers from the developed world.
The question becomes, given its own failings, is the developed world qualified or morally justified in forcing the issue of economic policy and governance reform in LDCs? The issue is a sticky one. Many believe that, yes, OECD donors and IFIs give a great deal of aid to LDCs and therefore have implicitly earned the right to have a say in what happens to those funds as they are channeled through in-country economic and political infrastructure. If this means imposing policy reforms and attaching strings, then so be it. Others argue that OECD donors and IFIs possess neither the right nor the correct expertise to intrude on an LDC’s economic and political sovereignty. Yet, the inescapable fact is that good economic policies and good governance matter in LDCs as much, or more, than they do in other places. Research has proven that good use of aid and economic growth are both related to market reforms and effective leadership. What is to be done?
The answer is complicated and involves improvement in the developed and developing worlds alike. First, most believe that the OECD and other bilateral donors, as well as IFIs, must develop and adhere to international norms and standards for fiscal responsibility, transparency and good governance. It is also thought that they must become more inclusive and democratic in their ranks, model what they preach, and address the issues of aid corruption and fragmentation that originate with them and their sins of omission and/or commission. Second, most believe that development assistance in the form of incentives and technical assistance for LDC infrastructure reforms must be conceived with more local input from indigenous players. In terms of both morality and effectiveness, most believe any mandated policy reforms imposed or pressured on LDCs should be designed with local, widespread participation. Finally, most agree that clear standards should be established to determine who should be required to initiate economic and political reforms in order to qualify for other types of development assistance. Likewise, enforcement should be pursued with equal vigilance everywhere. A comprehensive effort is generally seen as needing to address both structural and governance deficits around the world and issues of equity and backlash between LDCs and their developed world donors.
A last interesting wrench in the equation is how China’s dramatic economic rise has become a factor in the way in which LDCs see their own potential development trajectories. China, beginning with the economic reforms of the late 1970s, is the development success story of the century, lifting hundreds of millions out of poverty in three decades (though significant poverty does still exist among its large population). The fact that Chinese leaders were able to do this without incorporating many of the social and political reforms advocated by the West for LDCs is significant. It certainly has caused some in LDCs to think that democracy may not be the ultimate answer, or even a necessity. Furthermore, with the Chinese ready to lend, grant, and invest money in LDCs (especially those with energy resources), with no strings attached regarding governance, the attempts at governance-reform by OECD and others are being undermined.
Another key issue is that even if LDCs do make economic and governance reforms that are designed to enhance their participation in the global market to achieve growth, this is hardly the last barrier they will encounter. Becoming market-ready is one thing; being able to fully reap the benefits of the market is another. International trade policy matters a great deal, as will be shown in the next section.