Evaluating Structural Adjustment: A Dissenting Opinion

Introduction

The International Monetary Fund (IMF) and World Bank (WB) have come under heavy scrutiny for their structural adjustment programs. These programs, which feature loans conditional upon neoliberal economic reforms, have been implemented countless times in numerous developing countries since the 1980s. Recently, these loans have been criticized for failing to provide the promised economic growth and for adversely affecting the poor. Today, it has become expedient for politicians to blame IMF and WB programs as the source of their country’s past and current economic woes; railing against the policies of the IMF and WB has become a common theme of Latin America’s resurgent populist leaders. Yet, the truth of the matter is that the IMF and WB’s structural adjustment programs are not solely to blame for the economic plight that hit many developing countries. Structural adjustment could still be a sound policy; it simply needs to be revised in light of its multiple problems.

Misplaced Criticism
One of the primary complaints against structural adjustment policies is that they disproportionately harm the poor. Critics claim that by forcing governments to cut spending, the poor lose critically needed social welfare programs. While this is indeed one of the negative effects of adjustment policies, its criticism is shortsighted. Oftentimes, structural adjustment loans are given to countries with extreme budget deficits, which are the primary cause of runaway inflation. To combat this inflation, which in many loan-receiving countries can top 100 percent a month, most adjustment loans require cuts in government spending. Though cuts in spending hurt those who rely on welfare programs, runaway inflation poses a much greater risk to their livelihoods. When faced with hyperinflation, most people seek to place their assets into unaffected areas, such as real estate, gold, and foreign investments. This transfer of assets is relatively easy for the upper and middle classes to accomplish. The poor, on the other hand, are often unable to shift their assets into unaffected areas due to their relative lack of access to the appropriate tools for doing so.¹ As a result, the poor bear the brunt of hyperinflation, often losing their entire life savings in the process. Therefore, while cuts in government spending impose difficulties on the poor, they are merely temporary and pale in comparison to those caused by hyperinflation.

Mismatched Incentives
The real problem with structural adjustment loans is the lack of proper incentives. While structural adjustment loans are conditional on neoliberal economic reforms, the IMF and WB typically fail to enforce the provisions of their loans. In the past, governments that continued to run high budget deficits after initial loans from the IMF and WB continued to receive loans. The same is true for countries with continually corrupt governments, high black market premiums, negative real interest rates, and inefficient state-owned enterprises. Consider the example of Mauritania. From 1982 to 1989 Mauritania had an average black market premium of over 100 percent. The black market premium is the percentage by which the exchange rate of the currency in the black market is above the official exchange rate set by the government. It acts as a tax on exporters since they have to purchase inputs at the black market exchange rate but can only sell their products at the official exchange rate. Adjustment loans typically carry conditions that the official exchange rate be one at which exporters can be competitive. Yet despite Mauritania’s high black market premium, the WB and the IMF gave Mauritania six adjustment loans between 1982 and 1989. Other donors followed their example, and as a result Mauritania received an average of 23 percent of GDP per year in grants and official lending over this period. What happened in Mauritania is a typical pattern in IMF and WB lending. Countries with bad policies received just as much official lending as countries with good policies. Where, then, is the incentive for countries to have good policies?

Because countries that receive adjustment loans have no incentive to adjust, most do not. The whole idea of structural adjustment loans is for countries to gradually wean themselves off aid by establishing a solid foundation for growth through neoliberal economic reforms. Why then do the reforms, given their importance, go unenforced? According to William Easterly, a Professor of Economics at New York University and former Senior Advisor at the Macroeconomics and Growth division of the World Bank, donors face the wrong incentives for disbursing aid. He states:

“Most donor institutions are set up with a separate country department for each country or group of countries. The budget of this department is determined by the amount of resources it disburses to recipients. A department that does not disburse its loan budget will likely receive a smaller budget the following year. Larger budgets are associated with more prestige and more career advancement, so the people in the country departments feel the incentive to disburse even when loan conditions are not met.”

This problem is compounded by the fact that donors have a legitimate humanitarian concern for the poor. This makes any threat of cutting off aid to misbehaving countries implausible.² Recipient countries know this and therefore often ignore calls for reform. Furthermore, many recipient countries perfect the ability to appear as if they were reforming. Using various accounting gimmicks and other budget tricks, governments can make it seem as if they are reducing inflation, cutting the deficit, or accomplishing some other item on the list of mandated reforms. One common example is to reduce expenditures today in return for a future liability. In 1991, Egypt switched from subsidizing its state-owned enterprises (SOEs) to guaranteeing the bank loans made to these enterprises. While this appeared as a deficit reduction on the government’s balance sheet, in reality it just delayed the payment until Egypt’s SOEs defaulted on their loans. According to Easterly, “all of these stories show that countries can improve in the short run and appear to be meeting the loan conditions, when in fact they are only postponing the problem. So in the future, they get new adjustment loans to deal with the now larger problem of adjustment.” Additional examples include many of the “victims” of IMF and WB oppression: Argentina, Venezuela, Ecuador, and Peru.

Another issue that is frequently involved in structural adjustment loans is the problem of moral hazard. Moral hazard is when a party that is insulated from risk behaves differently from the way it would behave if it were fully exposed to the risk. Moral hazard arises when an individual or institution does not bear the full consequences of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to bear some of the consequences of those actions. Moral hazards frequently arise with IMF and WB loans. According to Easterly, “borrowers have little incentive to repay when they see the debts periodically forgiven.”³ With no incentive to plan for future payments, recipient governments can simply ignore the adjustment reforms required of them and use the money as they wish.

What Could Have Been and Can Be
What is most upsetting though, is the thought of what could have been. In countries where adjustment loans were actually followed with meaningful adjustment, significant economic growth was achieved. Between 1980 and 1994, the IMF and WB gave numerous adjustment loans to Ghana, Mauritius, Thailand, and Korea, each of which enacted significant reforms as laid out in their agreements. Their per capita growth rates for this time period were as follows: Ghana (1.4%), Mauritius (4.3%), Thailand (5.3%), and Korea (6.7%). A 1998 World Bank report confirmed “that aid has been highly successful in reducing poverty in countries with sound economic management and government institutions” and that “the low-income countries with large debts are the ones that had particularly poor policies during the 1970s and 1980s.”

In light of these findings, it is painfully apparent that what is wrong with adjustment loans is not their method for establishing sustainable growth, but rather the fact that both sides – donors and recipients – have historically failed to live up to the conditions of the loans. Fixing this requires establishing the correct incentives. The best way to do this is to tie aid to countries’ past performance, not future promises. The better a country’s policies are at creating sustainable growth, the more aid per capita it receives. This is this opposite of current aid strategies which decrease aid as income rises, thus creating a negative incentive towards becoming wealthier. If aid were given to countries with the best policies, the incentives for donors and recipients would finally match.

Final Thoughts
It should be noted however, that structural adjustment is not a sound policy for every country experiencing economic difficulties. IMF and WB involvement typically results in protests and demonstrations that can uproot weak governments and plunge a country into chaos. Between 1977 and 1991, seven out of the eight state failures or collapses had a high share of time operating under IMF programs in the ten years preceding their collapse.⁴ Of course, prior to collapsing these governments were already weak and inept, so it is difficult to gauge how much blame the IMF deserves. Nevertheless, IMF involvement in these countries brought about more harm than good regardless if one looks at whether the governments upheld their end of the loan agreements. Simply put, these countries were too fragile to withstand the shock of IMF adjustment programs. Easterly states:

“The IMF should have been more careful imposing its comprehensive reforms on such fragile political systems. At best, the IMF doing a program in these countries was like recommending heart-healthy calisthenics every morning for patients with broken limbs. The IMF feels its mandate requires it to help any and all countries in financial difficulty. However, the Planners’ mentality in which the IMF applies the same type of program to all countries is ill matched to such ill societies. In retrospect, it would have been better if the IMF were not involved at all in these cases.”

There is no doubt the IMF and WB deserve blame for the failure of their adjustment loan policies. Mismatched incentives and a one-size-fits-all mentality severely limited the prospects of the policies from the start. Worst of all, in many cases the programs caused more harm than good. Yet, the fault is not all theirs; many of the recipient countries are also to blame. By failing to adjust, recipient governments took loans designed to establish a base for sustainable growth (and thereby pay for themselves) and turned them into simply another liability to be paid off in the future. Success stories where countries received loans, adjusted their economies, and experienced strong economic growth prove the programs can work under the correct circumstances. Structural adjustment loans are still viable policy tools, they simply need to be revised in light of their past failures.

Footnotes

1. The poor, especially those in rural areas, have significantly less access to financial institutions that allow the transfer of assets. More than one billion people lack access to basic financial services, depriving them of the means to improve their incomes, secure their existence, and cope with emergencies.

2. This is commonly referred to as the “Samaritan’s dilemma.”

3. Recent debt cancellation has been quite high. In 2005 the G8 gave 100 percent debt forgiveness (worth $40 billion) to 18 low-income countries.

4. Afghanistan collapsed in 1977 after spending 46 percent of the previous ten years under IMF programs. Angola, 1981, 0 percent. Burundi, 1995, 62 percent. Liberia, 1986, 70 percent. Sierra Leone, 1990, 59 percent. Somalia, 1991, 74 percent. Sudan, 1986, 58 percent. Zaire, 1991, 73 percent.