Implementation Uncertainty and the Design of IMF Conditionality

Martin S. EdwardsWhitehead School of Diplomacy

Seton Hall University

The Limits of Conditionality

40% of International Monetary Fund lending programs are suspended for noncompliance

Program suspension has real costs for both IMF and the borrowing state

To what extent is the IMF to blame for the failings of conditionality?

Question

How does the IMF design loan programs if it does not know ex ante whether the borrowing state will honor its promises?

The Argument:

IMF devises conditionality both prospectively and retrospectivelyConditionality is front-loaded in states with

approaching elections and federal statesConditionality is front-loaded in states with a

history of poor program implementation.

Does Implementation Uncertainty Matter for the IMF? Joseph Stiglitz (2002:52): “Sometimes conditionality was

even counterproductive, either because the policies were not well suited to the country or because the way they were imposed engendered hostility to the reform process.”

Stanley Fischer (1998): “We don't need to form very sophisticated judgments about the political forces in (those) countries. We basically have to form a judgment on whether the government will do what it says it will do in an overall satisfactory way.”

Forming international agreements

Variations in the form of international agreements are responses to uncertainty Escape clauses / renegotiation are ways to adjust

agreements

Agreements made under high transaction costs look different than those in which parties face low transaction costs Ex ante commitments can be used to make promises

more credible

Assumptions

Fund faces uncertainty about borrower commitment

Program causes domestic dislocation Renegotiation costly for IMF Renegotiation costly for borrower

If I’m right…..

Expect more conditions in states with a higher level of implementation uncertainty.

But these conditions should be imposed on states ex ante. IMF imposes conditions (prior actions) in

order for Executive Board to approve program

What shapes implementation uncertainty? Approaching elections

We know that electoral cycles are common in developing countries, and that elections often coincide with program interruptions

Federalism Economic adjustment more difficult in these states

Past performance Failed programs lead to changes

Expectations

Prospective Programs with approaching elections are more likely

to have prior actions than those in which elections are not approaching

Federal states more likely to have prior actions Retrospective

Programs negotiated in the wake of a suspended program are more likely to have prior actions than those negotiated following a successfully completed program.

Cases

Random Sample of 38 States under Programs from 3rd qtr 1997 to 2nd qtr 2003.Asia (7 states), Latin America (8), Africa (11),

Eastern Europe (12)183 agreements initiated in this time periodStates required to submit new memoranda as

part of program review process

Dependent Variable

Count of fiscal prior actions for each agreementRange: 0-12

Prior actions are those policy measures that are prerequisites for review by Executive Board

Examples of Fiscal Prior Actions

Measures adopted to reduce wage bill Cambodia 99q3: freeze on new hiring for civil service

Measures to increase revenue Russia 99q3: Delay law on VAT reduction Pakistan 01q1: Mandated increases in rates for electricity and

gasoline Measures to reduce expenditure

Armenia 98q4: Publish decree detailing govt plan to reduce expenditures by 7 billion dram.

Passage of Fund-compliant budget by legislature

Why Fiscal Prior Actions?

Have to look at prior actions to ascertain whether Fund incorporates implementation uncertainty Looking at performance criteria makes causal chain unclear

Fiscal criteria serves as “most likely” case Electoral cycles manifest themselves through higher levels of

spending Federal states esp. prone to fiscal problems Noncompliance stems most frequently from fiscal shortfalls

Independent Variables

Policy Stance Lagged budget deficit / GDP (-)Lagged growth of expenditures / GDP (+)Lagged growth of reserves (-)Lagged GDP (-)

Type of Agreement Dummy for PRGF/ESAF (+)

US influenceLagged US foreign aid / GDP (-)

Independent Variables

Approaching elections (Dummy) Is an executive election six months away?

Federalism (Dummy)

Status of past program (Dummy)Did the Fund interrupt the program for

noncompliance?

Research Design

Confront substantial missing data problemsMissingness on fiscal variables approaches

40% of sample Used multiple imputation (King et al 2000)

to address missing data

Research Design

Empirical Test is a negative binomial modelAppropriate because data are countsDistribution of count dictates model

specification Population averaged to address panel

heterogeneity

Change in Total Reserves t-1 -0.00025**(9.102 E-05)

GDP t-1 -2.43 E-06(1.008 E-05)

Budget Deficit / GDP t-1 0.0114(0.0159)

Change in Expenditure / GDP t-1 0.0022 (0.0013)

PRGF Dummy -0.1651(0.2652)

US Foreign Aid / GDP t-1 0.3860(0.5012)

Approaching Elections 0.7242*(0.3591)

Prior Program Noncompliance 0.8669***(0.2581)

Federalism 1.061*(0.5360)

Number of Performance Criteria 0.0879 (0.0504)

Dummy for Ukraine Program 2.6957***(0.2711)

Constant -0.6510 (0.3481)

Change in Total Reserves t-1 -8.510

GDP t-1 -1.685

Budget Deficit / GDP t-1 1.509

Change in Expenditure / GDP t-1 1.199

PRGF Dummy -.403

US Foreign Aid / GDP t-1 1.288

Approaching Elections 2.572

Prior Program Noncompliance 3.338

Federalism 4.571

Number of Performance Criteria 2.816

Dummy for Ukraine Program 2.256

Substantive – Discrete Change

Robustness Checks

Results hold in the presence of the followingControls for Quota in IMFControls for DemocracyTrade OpennessChanges in Exchange Rate level

Results unchanged with nine-month window.

Summary

IMF does not lend “in the dark”Expectations about electoral horizons affect

program designPrograms look differently in federal statesExpectations about program compliance

affect program design

A Further Question to Consider

Do prior actions make a difference ex post? In fiscal performance? In the probability of program suspension?