EC-OECD Seminar Series on Designing better economic development policies for regions and cities Development assistance and conditionality: Challenges in design and options for more effective assistance 28 April 2017 Anwar SHAH Brookings Institution, Washington, DC Background information This paper was prepared as a background document to the OECD-European Commission Seminar on “Conditionalities for More Effective Public Investment” held on 28 April 2017 at the OECD Headquarters in Paris, France. It sets a basis for reflection and discussion. About the Project This seminar is part of a five-part seminar series in the context of an EC-OECD project “Designing better economic development policies for regions and cities”. Other sessions in the series addressed the use of: contracts for flexibility/adaptability, performance indicators, financial instruments, and insights from behavioural science. The outcome of the seminars supports the work of the Regional Development Policy Committee and its mandate to promote the design and implementation of policies that are adapted to the relevant territorial scales or geographies, and that focus on the main factors that sustain the competitive advantages of regions and cities. The seminars also support the Directorate-General for Regional and Urban Policy (DG REGIO) of the European Commission in the preparation of the impact assessment for the post-2020 legislative proposals and to support broader discussion with stakeholders on the future direction of the delivery mechanisms of regional policy. Follow us on Twitter: OECD SMEs, Regions, Cities (@OECD_local) © OECD 2018 *Email: [email protected] This work is published under the responsibility of the Secretary-General of the OECD. The opinions expressed and arguments employed herein do not necessarily reflect the official views of the OECD or of the governments of its member countries or those of the European Union. This document and any map included herein are without prejudice to the status or sovereignty over any territory, to the delimitation of international frontiers and boundaries and to the name of any territory, city, or area. 2 DEVELOPMENT ASSISTANCE AND CONDITIONALITY: CHALLENGES IN DESIGN AND OPTIONS FOR MORE EFFECTIVE ASSISTANCE © OECD 2018 Acknowledgements This paper has been prepared under the guidance of Dorothee Allain-Dupre, OECD. The author is grateful to Peter Berkowitz, European Commission; Dorothee Allain- Dupre, OECD; Saleh Nsouli, former director, IMF; Professor Massimo Florio, University of Milan; William Tompson, OECD; Andrea Mairate, European Commission; and David Rinaldi, Centre for European Policy Studies; as well as all the participants at the OECD “Seminar on Conditionalities for More Effective Public Investment”, held on 28 April 2017 in Paris, France, for helpful comments on an earlier draft. The views expressed here and any errors are those of the author alone and may not be attributed to the OECD, the European Commission, or the Brookings Institution staff and directors. DEVELOPMENT ASSISTANCE AND CONDITIONALITY: CHALLENGES IN DESIGN AND OPTIONS FOR MORE EFFECTIVE ASSISTANCE © OECD 2018 3 Table of contents Introduction: Objectives of development assistance, rationale for and taxonomy of conditionality 7 Rationale for conditionality .................................................................................................................... 9 Conditionality and the donor – Recipient government relationship ..................................................... 10 Program design and conditionality: Conceptual perspectives ........................................................... 13 Game theory .......................................................................................................................................... 13 Public choice perspectives .................................................................................................................... 17 Fiscal federalism perspective ................................................................................................................ 18 New Public Management perspectives ................................................................................................. 23 Political economy perspectives ............................................................................................................. 26 New institutional economics perspectives ............................................................................................ 28 A synthesis of conceptual perspectives ................................................................................................. 30 International development assistance: Evolving perspectives on donor-recipient relations and on conditionality of assistance ........................................................................................ 33 Evolving landscape on the conditionality of development assistance .................................................. 33 Outstanding issues and views ............................................................................................................... 37 Lessons on the conditionality of development assistance .................................................................... 41 Note .......................................................................................................................................................... 47 Annex A. IMF, World Bank and EU/EC experience with conditionality .......................................... 48 References ............................................................................................................................................... 54 Tables Table 1. Responses to donor conditions for reductions in public sector employment ..................... 11 Table 2. Payoff matrix in a two-player game................................................................................... 14 Table 3. Examples of approaches to improve incentives ................................................................. 16 Table 4. Taxonomy of grants and their potential impacts: A stylised view ..................................... 19 Table 5. Traditional and output-based (performance-oriented) conditional grants ......................... 21 Table 6. Principles and better practices in grant design ................................................................... 22 Table 7. Sources of capital financing would differ by type of investment and fiscal capacity of the recipient government ................................................................................. 23 Table 8. On making the dog wag its tail: The NPM perspectives.................................................... 24 Table 9. Comparison of two alternate results-based accountability approaches ............................. 25 Table 10. Implications of conceptual perspectives for loan/grant conditions: A synthesis ............................................................................................................................. 32 Table 11. Good practice principles for development policy lending by the World Bank ................................................................................................................................... 35 4 DEVELOPMENT ASSISTANCE AND CONDITIONALITY: CHALLENGES IN DESIGN AND OPTIONS FOR MORE EFFECTIVE ASSISTANCE © OECD 2018 Figures Figure 1. Decision tree for country administrators............................................................................ 14 Figure 2. Donor loan conditions for a country with conflicting administrative goals ....................... 15 Figure 3. Results-based chain: Application in education .................................................................. 24 Boxes Box 1. An output-based transfer for school finance: An illustrative example .................................. 21 Box 2. The road to hell is paved with good intentions: Selected examples of development assistance that did not work as intended ...................................................... 37 DEVELOPMENT ASSISTANCE AND CONDITIONALITY: CHALLENGES IN DESIGN AND OPTIONS FOR MORE EFFECTIVE ASSISTANCE © OECD 2018 5 Introduction: Objectives of development assistance, rationale for and taxonomy of conditionality Development assistance in this paper is more broadly defined to include grant and loan assistance within and across sovereign territorial limits by governmental and non-governmental actors and agencies. Such assistance is motivated by altruistic, economic, political, military and humanitarian considerations. It is used to advance wide-ranging objectives such as minimising risks for loan repayment, efficiency, equity of the public sector, overcoming infrastructure deficiencies, promoting growth, facilitating poverty alleviation and good governance, combating terrorism, support for a specific ideology, influence peddling, and economic and political imperialism. The provision of such assistance is more often than not conditional as even unconditional assistance almost always carries some explicit preconditions and implicit conditions. Conditions are imposed as part of lending or grant assistance unilaterally or by mutual agreement of the donor and the recipient. These conditions form contractual terms of such assistance which bind the recipient to expected actions or results as a quid pro quo for receiving such financial assistance. These conditions can vary from being very vague to extremely clear and precise. They may impose formal binding requirements