Journal Issue

Books: Conflict or Cooperation?

International Monetary Fund. External Relations Dept.
Published Date:
January 1992
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Paul Mosley, Jane Harrigan, and John Toye

Aid and Power

The World Bank and Policy-based Lending

Routledge, New York, NY, USA, 1991, Volume 1: Analysis and Policy Proposals, xvii + 317 pp., $67.95 ($22.50 paper); Volume 2: Case Studies, xiii + 443 pp., $69.95 ($27.50 paper).

This ambitious exercise in international political economy is as much a window into the intellectual evolution of its British authors as it is an examination of the World Bank’s experience with structural adjustment lending in the 1980s. The researchers begin with the hypothesis that the intellectually arrogant but powerful Bank impresses its policy conditions on weak, unwilling borrowers, which then try their best to wriggle out of their commitments. Yet, at the end of their multiyear, nine-country case study, the authors find themselves in sympathy with many of the Bank’s purposes, endorse the direction of recent Bank efforts to correct flaws in its policy-based loans, and offer recommendations intended to improve the rate of compliance with Bank conditionality.

The authors begin by positing an inherent conflict between a World Bank wishing to maximize conditionality and recipient governments seeking to guard their sovereignty and minimize the short-term political costs of adjustment. All parties, however, share one interest for money to flow: The borrowers need the cash, while Bank staff face internal pressures to push money out the door. Hence, a bargain is eventually struck.

These bargains are unequal across countries. The Bank is found to impose tighter, more numerous conditions on poorer countries most in need of official finance. The toughness of conditions is not a function of the degree of market distortions, but of bargaining leverage. The authors stress, however, that even weak, needy nations generally can maneuver their way around actual implementation of distasteful conditions, since noncompliance has very rarely triggered cancellation of second tranche disbursement: In the end, the pressure to reach loan targets outweighs the Bank’s policy objectives. At the same time, the authors do note that some governments guilty of noncompliance will receive fewer loans in the future, especially if the country in question is small and weak.

The nine case studies (Ecuador, Ghana, Guyana, Jamaica, Kenya, Malawi, the Philippines, Thailand, and Turkey) reveal a rate of compliance with individual conditions of 54 percent, which is close to the result of a 1988 Bank survey of a much larger sample of country cases. The authors present several recommendations intended to raise the rate of success for adjustment programs. They deplore the tendency, most notable in early structural adjustment loans (SAL), to impose extravagant and naive “Christmas” lists of requirements that overload borrowers’ limited administrative capacities and render the ultimate “pass/fail” decision extremely subjective. The proposed alternative is a more carefully phased and selective conditionality.

The case studies find that policy-based loans have generally stimulated export growth, but investment has often lagged. To correct this flaw in SAL design, it is suggested that loan covenants protect the level of real government development expenditure. Moreover, Bank staff should advise the IMF on pro- investment stabilization options.

The study also urges greater sensitivity to particular country circumstances. Whereas market-oriented reforms have served to accelerate the relatively successful adjustment processes in middle-income nations, such reforms, it is argued, have only deepened poverty in African nations, where governments need to increase their activism to overcome market failures and to stimulate supply responsiveness.

The most interesting recommendations are intended to help the Bank’s natural allies—the technocrats in central banking and ministries of finance—to assemble winning, proreform coalitions. In particular, the allegiance of operational ministries should be secured by feeding them sector and project loans, while the opposition of inevitable losers can be diluted by bribing them with nondistortive compensation payments. The Bank can stiffen the technocrats’ own resolve by providing them with persuasive intellectual artillery and electronic data processing capacity.

Thus, the book’s logic, which begins as a unitary actor bargaining game, evolves into a more sophisticated model that disaggregates the domestic political economy. The initial, cynical notion—that borrowers reflexively oppose policy-based loans for fear of short-term political costs—is discarded in favor of the more empirical findings that important factions within governments have been prepared to weather storms in order to reach long-term social gains. Indeed, the notion that governments are inherently near-sighted and narrowly self-interested is more appropriate to the cynical rational choice school—an attitude that the authors themselves mock.

Many of the findings of this valuable study have been duplicated in recent Bank self-assessments and are gradually filtering into staff practice. This book concludes with the hope that the “valuable,” “imaginative” concept of policy-based lending continue to evolve toward a “kinder, greener, gentler World Bank for the 1990s.” At which point, the authors will presumably discard their model of inherent conflict and embrace a perspective that commonly finds mutual interests between the Bank and its borrowers.

Richard E. Feinberg

President, Inter-American Dialogue

Meier Gerald M.(editor)

Politics and Policy Making in Developing Countries

Perspectives on the New Political Economy

ICS Press, San Francisco, CA, USA, 1991, xi + 369 pp., $14.95.

What is the usefulness of “the new political economy” (NPE)? This interesting book contains the papers and discussions of a conference at which economists, political scientists, and policymakers discussed the policymaking and reform process in developing countries and the relevance of the NPE. Most of the participants, especially the political scientists, were rather critical.

To be clear on what it is all about, one might quote one of the contributors, T.N. Srinivasan. He defines the NPE by “the axiom that agents behave rationally; that is, they have a consistent set of preferences over their actions, and they choose an action whose outcome is preferable to the outcome of other actions they also find feasible, given the constraints within which they act …” He also says that “no other assumptions can lead to a meaningful, testable theory, because once the postulate of rational behavior is abandoned, any outcome is a priori possible.” The “agents” refer here to those who influence or determine political decisions (i.e., politicians and bureaucrats).

So here we have an evolving body of theory that tries to show why governments do what they do, and why economists who concern themselves with the “national interest” are not listened to. Perhaps it is a reaction against the excessive naivete of some economists who have expected their advice about complicated “optimal” policies to be readily accepted.

The issues are certainly important. In particular, how does reform come about? Political scientist Merilee S. Grindle points out convincingly that the NPE is inadequate for explaining how change occurs; it explains much more why policymakers resist change. The approach of NPE is unduly pessimistic. In fact, in several Latin American countries, not to speak of the ex-socialist countries, major reforms have been taking place, and, in this reviewer’s judgment, this body of theory only focuses on rather obvious reasons why reforms are difficult, not on why they do take place. Furthermore, William Easterly points out that “the self-defeating nature of populist policies does not support a theory of rational politicians pursuing such to their political advantage and to the economic benefit of their working- class constituents.” He instead supports “economists’ rather arrogant, old-fashioned idea that policymakers often do not know enough to act in their own best interest.” Of course, one might add that politicians often perceive their own interest as the need to win the next election.

These extracts may give a flavor of the issues discussed. Apart from several expositions or applications of the new political economy, especially by Findlay and Srinivasan, and the critiques from the political scientists, there are papers more pragmatically focused on policy reforms, dealing with land reform, poverty alleviation, public enterprise divestiture, and inflation and destabilization. Several contributions come from experienced policymakers in Latin America. One, Francisco Swett from Ecuador, remarks that “it is wasteful to seek to build elaborate explanations based on self-evident truths.” Yet, one might comment in reply that the “truths” have to be built into theories if they are to make a full impact.

In an excellent final overview, the editor remarks that “the general problem for explaining ‘turning points’ is to determine what forces induce political innovations. Policy reform requires political entre- preneurship. But a theory of political entrepreneurship is not to be found in the NPE.” This remark signposts a research agenda, where, no doubt, historians and political scientists are needed as much as economists.

W. Max Corden

Jeffry Frieden

Debt, Development, and Democracy

Modern Political Economy and Latin America

Princeton University Press, Princeton, NJ, USA, 1991, x+ 280 pp., $29.95.

Karen Lissakers

Banks Borrowers and the Establishment

A Revisionist Account of the International Debt Crisis

Basic Books, New York, NY, USA, 1991, ix + 280 pp., $23.

Recent economic history of developing countries—particularly those in Latin America—has been characterized by mounting public sector deficits and weak monetary policies, frequently accompanied by alternate attempts to liberalize and increase controls on foreign trade and foreign exchange markets. The result has been increased external imbalances, accelerated inflation, and slow economic growth. These trends were initially masked by heavy access to commercial bank borrowing and improving terms of trade. However, as external conditions worsened, Latin America confronted a major shock in the early 1980s from which the region is only now starting to emerge.

These two books explore these issues from new perspectives. The volume by Frieden analyzes the different patterns of national, economic, and political behavior that arose in Argentina, Brazil, Chile, Mexico, and Venezuela from 1965-85. It systematically presents the different ways these countries dealt with similar external conditions. The study of the five countries reveals the importance of political pressures by special interest groups (both toward governments and from governments) in shaping economic policy and finally, the importance that economic interests have on political behavior.

The book discusses in detail how specific groups supported or forced certain policies and how the failures of economic policy led in some cases to changes in political regimes (Argentina and Brazil), or in government policy orientation (Mexico and Venezuela). Only in Chile did the reformist economic policies remain broadly unchanged even in the presence of significant criticism, because of overwhelming concern by government supporters of the need to preserve political stability. The book also analyzes how the economic interests of political forces affected the role of the public sector in economic activity. The author claims that his goals are modest, but this well-researched book can undoubtedly shed new light on understanding the forces that have brought the region closer to attaining the two hopefully consistent goals of democracy and sustained economic growth.

The volume by Karen Lissakers seeks to provide a “revisionist account of the International Debt Crisis.” It presents an entertaining description of how the onerous relationship between commercial banks and developing countries developed. The book provides a detailed account of events and protagonists, but does not attempt to present a systematic analysis of the situations. Correctly, and not surprisingly, it blames many of the problems of excessive borrowing in the 1970s not only on sovereign borrowers but also on careless lenders, aided in many cases by legislation in industrial countries that created inordinate incentives to these activities.

The author then discusses the events of the last decade, from the abrupt halt of voluntary lending, through the requirement of forced new money, multiyear agreements, the more recent debt reduction operations, and now the incipient new voluntary lending. Ms. Lissakers makes the arguable point that in the process of financial reconstruction that started in 1982, commercial banks had the upper hand, with the support of creditor governments. In fact, the banks were under considerable pressure by governments and had to pay a high price for their poor lending record, as reflected in the secondary market price for developing country debt and the impact that these operations had on the banks’ net worth.

It would have been more appropriate if this book would not have sought to provide ex-post advice on the approach taken by debtor and creditor countries, banks, and multilateral organizations, especially on the immediate need for debt reduction when the debt crisis emerged. After all, errors of judgment were made by all parties. In any event, while some of her analysis could be questioned, Ms. Lissakers correctly concludes that conditions exist for the development of effective cooperative solutions based on the newly acquired wisdom of borrowers and lenders.

Claudio M. Loser

Jagdish Bhagwati (edited by Douglas A. Irwin)

Political Economy and International Economics

The MIT Press, Cambridge, MA, USA, 1991, xi + 576 pp., $45.

This book—the fifth volume of Professor Bhagwati’s collected writings—provides an ideal bedside companion for the insomniac international economist. It offers a compendium of the Professor’s work since 1984 and covers a broad range— lectures bearing masterly overviews of his many subjects, learned articles containing important theoretical insights, succinct surveys for edited collections, thoughtful policy analysis, and jeux d’esprit. The focus of the book coincides with Bhagwati’s central concerns in recent years with the political economy of commercial policy and directly unproductive (DUP) activities. But the collection ranges widely to include a playful analysis of the economics of organized religion, further thoughts on the paradoxes of “immiserizing” growth, and important work on trade in services and international immigration. And all presented with the Professor’s inimitable style and wit. Truly a book that can be dipped into for enlightenment and distraction at all hours of the night (and day).

For the policymaker, the most interesting and relevant sections of the book may be those related to the political economy of commercial policy. Here there are two persistent themes. One is that the case for free trade is alive and well. Bhagwati provides a spirited rebuttal to those who dare to believe that advances in modeling increasing returns and strategic competition in international trade have weakened the arguments for free trade. The Professor recognizes that, as in other circumstances where perfect competition does not rule and markets fail, protection can under certain conditions be shown to improve on free trade. But he argues strongly that, in a world of uncertainty and limited information, in which lobbyists push for sectoral advantages, and foreign governments retaliate in response to aggression, mutual and symmetric access to each other’s markets should remain a fundamental guiding principle.

Bhagwati’s second theme may be more disquieting to the reader, that in understanding policymaking one needs to move beyond the idea of a “puppet” government responding precisely to the benign economist’s directions, to that of a “clearing house” government that responds to pressures from interested parties. These responses give rise to the possibility of the DUP activity, which can generate profit for the protagonist without producing any good or service with any value for consumers or producers. Lobbying for protection or other means of creating artificial monopolies are typical DUP activities.

Charles Collyns

Warwick McKibbin and Jeffrey Sachs

Global Linkages

Macroeconomic Interdependence and Cooperation in the World Economy

The Brookings Institution, Washington, DC, USA, 1991, xi + 277 pp., $36.95 ($16.95 paper).

Reading through this book brought me back to my graduate school days when I took an applied course in macro modeling. At the time, the professor relied on a series of books by Pindyck, Chow, and others that ran the gamut from model building to optimal control. This book could prove to be a very useful addition to the field of applied econometric modeling since it covers every one of these topics. (After writing this review, I discovered that the authors sell a user-friendly PC version of this model that enables one to replicate much of the quantitative analysis of the book.)

The authors systematically take the reader through the process of applied macroeconomic model building, starting with theory and ending with sophisticated policy analysis. In addition, they provide the reader with three very useful appendices that include the equations and parameters of the model, a set of tables of policy multipliers that can be used for “back of the envelope” policy analysis, and finally a set of algorithms that can be used to solve rational expectations models with strategic game behavior.

For those readers who might already be turned off by a book that they perceive is nothing more than a description of a model and its multipliers, they will find that this book is much more and serves several other purposes. It contains an excellent overview of two theoretical areas. Chapter 2 starts with a concise presentation of the simple Mundell- Fleming model, followed by several useful extensions that include debt dynamics, rational expectations, and the supply side. One of the most readable discussions of the theory of policy coordination, including the issue of time inconsistency, is contained in Chapter 7.

In addition to these theoretical sections, the book is integrated with a theme, namely, explaining the large fiscal and external imbalances that existed in the 1980s. The authors hypothesize that the large current account imbalances are the result of identifiable macro policies rather than trade policies.

The McKibbin-Sachs global model belongs to the rational expectations (RE) class of applied macroeconomic models that have recently gained increasing popularity. As with other RE models, the authors are able to analyze, and even highlight, the importance of policy announcements as well as current policy settings in explaining much of the major movements in economic variables in the 1980s.

The authors rely on a variety of methods, primarily computable general equilibrium techniques, to estimate their model. Forecasting with RE models is not very straightforward since it depends on the future and unknown paths of all exogenous variables. The authors introduce a technique for tracking history, that while original, is not very convincing, since it depends on some very restrictive assumptions, including limiting expectations errors to two variables and a very arbitrary monetary policy regime. A comparison to other methods, such as stochastic simulations, might have made this analysis more convincing. The authors include a variety of standard simulations (i.e., fiscal, monetary, oil prices, and LDC transfers) but the most interesting simulation chapter includes a lengthy analysis of the dramatic decline in the value of the dollar (hard landings) and policies that might correct world imbalances.

Anyone who has a serious interest in dynamic international macroeconomic model building, and probably those who are already involved in the area, need to read this book. It is the best available reference on “how to correctly build a model.”

Steve Symansky

E. Roy Weintraub

Stabilizing Dynamics

Constructing Economic Knowledge

Cambridge University Press, Cambridge, MA, USA, 1991, x + 177 pp., $39.50.

This book is about the crown jewel of economics—the theory of equilibrium. It offers a behind the scenes look at the making of mathematical economics and its subsequent glorification using rhetoric imported from the history of science. In its pages, the dispassionate reader will discover a sense for the foundations of the discipline that is deeply sobering. Weintraub is not attempting to topple any idols, but inadvertently he does direct our attention to the instability of some pedestals.

He traces the evolution of the concept of equilibrium from its primitive state in Hicks’ Jacobian matrices to its next reincarnation in the hands of Samuelson, who introduced the notion of dynamism via the mathematics of Lotka, Gibbs, and Wilson. Then, over two score pages, we edge toward Liapunov theory, which provided Arrow, Hurwicz, and Block with the conditions to assure the stability of equilibrium. The story ends with the Godelian challenge posed by Scarf and Gale who devised models, with well-defined competitive equilibrium states, which fall short of stability.

Weintraub insists that economics adapts the use of mathematics for its own clarification. But instead of a fruitful interplay between two powerful and well- matched disciplines, what we witness is the fashioning of economic terminology around mathematical techniques. The entire process is distinctly unheroic. Instead of a thunderous intellectual debate leading to the emergence of useful economic theories that are rigorous and “scientific” to boot, we observe economics backing into mathematics with disregard for its social relevance.

Weintraub does us a service by revealing how economics has attempted to become a rigorous discipline by using notions current in the history of science to validate its credentials. His pages are peppered with references to Lakatos and Popper. In fact, there is a virtual smorgasbord of quotes and references not just from the history of science but also from the works of literary critics, who are inventing novel ways of “reading texts.” But after one has closed the book and the many contending voices have faded away, the realization dawns that the persistent romance economists have had with the likes of Popper and the apparent budding flirtation with the literary avant garde, is appallingly sterile. Alas, the foundations of economics on which so many talented minds have expended so much effort are no deeper in spite of hermeneutics or the incessant debates over methodological fine points.

One emerges from Weintraub’s book relieved to find that the economics we practice is alive and well and works whether “gross substitutability” conditions apply or not. Stabilizing Dynamics is not an easy read as it is stitched together from articles published earlier, but the determined reader will acquire a revealing perspective.

Shahid Yusuf

Alberto Giovannini and Colin Mayer (editors)

European Financial Integration

Cambridge University Press, Cambridge, MA, USA, 1991, xxi + 348 pp., $49.50.

L Alan Winters and Anthony Venables (editors)

European Integration

Trade and Industry

Cambridge University Press, Cambridge, MA, USA, 1991, xviii + 241 pp., $54.50.

These volumes contain the proceedings of two conferences organized by the Centre for Economic Policy Research (CEPR) in 1990. The volume edited by Giovannini and Mayer contains an excellent collection of studies on the impact of European economic integration on the continent’s—and the world’s—banking, financial, and capital markets. The book highlights the importance of the liberalization of international trade in assets, which, in contrast to trade in goods, as the editors note in their introductory essay, had not been at “centre stage in the postwar international arena.” A particularly adept piece of evidence for this assertion is an insightful reference made to the Articles of Agreement of the IMF, which require members to make their currencies convertible only for current account transactions. From this perspective, this volume not only illustrates the questionable logic of this provision—after all, neither the efficiency of free trade nor the effectiveness of controls depends on the nature of the transaction—but also provides ample evidence of its obsolescence.

The companion volume, edited by Winters and Venables, contains studies that explore the consequences for trade and industry upon completion of the internal market in the European Community. These explorations focus on three sets of issues surrounding “Europe 1992”: the consequences for real incomes, factor markets, and external economic relations.

In sum, the papers in these two volumes address issues of great interest both for scholars and policymakers. Their publication is timely in that they underscore the challenges confronting Western European countries, which, though they may appear less dramatic, are no less difficult than those facing their Eastern neighbors.

Manuel Guitian

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