For the first two-thirds of the twentieth century, Chile enjoyed perhaps the most stable democracy in South America. All of this changed in the early 1970s after Salvador Allende became president at the head of a leftist coalition that included both Socialists and Communists. His administration, which came to power by perfectly legal means, sought to carry out socialist policies that created sharp divisions among Chileans, with some embracing his plan for a “Chilean Way” to socialism while others viewed Allende as a stalking horse for an eventual Communist dictatorship. Because the electorate divided fairly evenly between enthusiastic supporters of Allende's Popular Unity (UP) government and its determined enemies, democratic resolution of this conflict was difficult. By the third year of the Allende administration the country was in crisis, with increasing levels of violence and a collapsing economy. At this point the military intervened, as it had done twice before in the twentieth century. But this time several thousand of their real and suspected enemies “disappeared” or were killed, and the armed forces remained in power for over sixteen years.

The crisis of the early 1970s and the long period of military rule that followed had a profound effect on both the ideological climate and the institutional environment. Since the early 1970s there have been two histories of Chile.

When aircraft encounter turbulent storm conditions, the principals of aerodynamic design are not suddenly suspended. In the same way the dynamic political equilibrium during a democratic transition depends on the interaction of political actors' objectives and beliefs with the institutional constraints, just as it does in more normal times, notwithstanding the emotionally charged content of objectives that include victims' quest for justice and despite sudden changes in institutional constraints. The Chilean transition is notable for its reliance on a set of temporary policy guarantees that the former military government imposed as the price of transition. These policy conditions are protected by a series of institutional checks on a powerful and democratically elected executive. If one were to simply import the state-of-the-art models of gridlock used to analyze the U. S. Congress, this arrangement would seem to provide a permanent framework for indirect military rule. However, the family of models based on the agenda-setter model of Romer and Rosenthal (1978) ignores the potential for the agenda setter, in this case the Chilean president, to exploit the valence component of policy to pry acceptance from the veto player, in this application the median member of the Senate, for policy positions closer to the agenda setter and farther from the Senate median.

In the Chilean transition the president's ability to couple high-valence policy reforms with movements in the ideological content of policy has profound implications for the long-run effects of the constitution imposed by the military government.

Of all of the institutions created by the military government, Chile's Senate is perhaps most influenced by the transition. With its provision for appointed “institutional” Senators to serve side by side with elected members of the chamber, it provides a unique window on the transition. Roll-call voting records from Senate committees make it possible to compare the issue positions of Socialists, with those of Christian Democrats, with members of the Independent Democratic Union (UDI), a party with links to the former military government, and with the positions taken by Senators appointed by Pinochet. Given the Concertación majority in the Chamber of Deputies, and their control of the presidency, the Senate, with its majority for the opposition, acts as a check on the legislative agenda of the Concertación. It is in the Senate that bills are made or broken, and it is the Senate that determines the pace at which policies change and institutions are reformed.

Opposition control of the Senate stands on two pillars: the Institutional Senators and the “binominal” electoral system. The electoral system is based on two-member districts for both the Senate and the Chamber of Deputies. The seats are apportioned according to the d'Hond system, which has the effect of guaranteeing a seat for the party list that finishes second unless its vote share drops below half that of the first-place finisher. After the 1989 elections, this left the opposition with about 42% of the elected seats in each legislative chamber.

Constitutions provide structure for two kinds of activity: solving problems about which there is consensus, and mediating conflict over policy choices about which there is not. Moreover, the structure of constitutions is not assembled behind a Rawlesian veil of ignorance. Those who write constitutions, whether they are the elected democratic representatives of a free people or the agents of an authoritarian government, are often partisans in the policy conflicts the constitution will resolve, ready and willing to manipulate the institutional structure on behalf of their policy goals. This lack of innocence produces a tension between the problem-solving and conflict-mediating features of constitutional design. The best structures for solving problems about which there is consensus delegate considerable flexibility. This is what we see in the world of commerce; when all of the stockholders of a firm share the goal of earning higher profits, they delegate considerable decision-making authority to the company's manager. In contrast, when there is conflict about policy goals, those whose grip on power may subsequently slip will seek to “lock in” concrete policy choices, denying flexibility to future decision makers who may not share their objectives.

Yet even the most guileful partisans will perceive some cost in fully constraining future decision makers. Future politicians constrained from increasing spending on public health cannot expand medical subsidies as a way to redistribute income to the poor, but neither can they raise spending to combat an unforeseen epidemic.

Introduction

In this chapter I distinguish between aid transfers and aid relationships. The traditional literature on the economics of aid focused on the resource transfer. Aid relaxed constraints on economic performance, either by increasing savings or by increasing foreign exchange. There was no relationship between donor agencies and recipient governments. Aid, in this analysis, was indistinguishable from a government-owned oil well.

I consider three aid debates in which the central issue is the relationship between the donor and the recipient. The first of these is policy-based lending, or ‘conditionally’. This relationship has been criticised both as intrusive and ineffective (although these two criticisms sit together uncomfortably). The second debate is on ‘aid dependency’. This criticism is that the aid relationship is intrinsically undermining of national capacities, analogous to the weakening of household capacities in the syndrome of welfare dependency. The third debate is around the suggestion that aid is missing an opportunity for a coordinating relationship. By focusing upon individual nations aid has, it is argued, missed its comparative advantage in the financing of coordinated development at the supra-national level, such as region-wide transport systems.

I discuss these three debates in turn.

Policy conditionally

Although policy conditionality became established only during the 1980s, the idea that international public resources should be used to induce policy reform has a long history. Its origin lies in Fund crisis programmes. For example, in one of the largest IMF programmes ever undertaken, in 1976, the British government was provided with finance on condition that it changed economic policies.

Introduction

For a large number of developing countries, particularly in Africa and Latin America, the 1980s are remembered not terribly fondly as the decade of debt and ‘structural adjustment’. In many of these countries, the term is closely associated with the International Monetary Fund (IMF) and the World Bank. More recently, though, during the ‘emerging markets’ boom of the mid-1990s, structural adjustment – a set of policy reforms aimed at restoring internal and external equilibria to a crisis-hit economy, whilst simultaneously seeking to increase the efficiency with which its productive resources are allocated – seemed consigned to textbooks of the economic history of the 1980s, along with the debt crisis that preceded it.

With the onset of the East Asian, Russian and Brazilian balance of payments crises during 1997–9, however, the topic generated renewed interest. Other chapters in this volume will address the Asian crisis specifically. This chapter looks back at the World Bank's experience with structural adjustment programmes during the 1980s – since the first Structural Adjustment Loan (SAL) was launched in February 1980. We discuss the causes and the nature of the process of adjustment, and consider its main policy components in turn. We also review the evidence on the performance of the programmes during the 1980s. Where appropriate, we draw some lessons for the different – yet related – systemic crises and reforms of the late 1990s.

Section 2 briefly reviews the causes and nature of the processes of stabilisation and structural adjustment in the 1980s.

Introduction

From the ‘Wapenhans Report’ (World Bank, 1992b) to the Strategic Compact of 1998, the World Bank has over the past decade closely examined how to achieve its development objectives more effectively. This is more difficult for the World Bank than for many private sector actors since the Bank is more than a development agency (see Hopkins et al. chapter 11 in this volume). It is also multilateral institution which must represent and implement the will of the governments who are its members. For this reason, the Bank's ability to undertake and fulfil its economic purposes depends on a number of political forces. The institution requires the ongoing support of its most powerful members, while yet satisfying ‘an increasingly vocal and demanding senior shareholder’, the Bank must also retain its status as a technical and multilateral agency which requires the support of all its other members (see Feinberg et al., 1986).

This chapter examines the relationship between political pressures exerted on the Bank and its independence. In particular, the chapter analyses the characteristics of the Bank which enhance its autonomy so as potentially to counter-balance the Bank's reliance on the support of its largest shareholder. The characteristics examined include the Bank's financial structure, its research and expertise and the rules governing its lending operations. The chapter notes that by the end of the 1980s all the above had become subject to political influences, thus challenging the Bank's status as a multilateral and technical agency.

Introduction

Foreign aid has a strong positive effect on growth in low-income countries with good policies; it has no measurable effect in countries with severely distorted policy regimes (Burnside and Dollar, 1997). While that result is consistent with other econometric and case study work on aid, it leaves open a number of important questions. How exactly docs one measure ‘policy’? Is the finding robust to different measures of policy? And does it hold for other outcomes of interest, such as poverty reduction or improvement in social indicators? Spurring growth in the developing world is one stated objective of foreign aid; but the most commonly cited objective is poverty reduction. In general, poverty reduction and growth go hand-in-hand, but it is still possible that foreign aid has been successful at mitigating poverty but not had much measurable effect on growth.

This chapter has several objectives. First, we revisit our basic results on aid, policies and growth – starting with our model and reviewing the empirical evidence. Second, in doing that we broaden our indicator of ‘good policy’ to include more micro or institutional dimensions. Third, we also examine the effect of foreign aid on infant mortality, an issue of interest for two reasons. First, infant mortality is an important social indicator in its own right. Second, changes in infant mortality provide indirect evidence about whether the benefits of development are reaching the broad mass of the population.

The main findings of the chapter are as follows. The impact of aid on growth is conditional on the quality of policies. We get stronger results using the broad measure of policy that includes institutional features.

The World Bank (henceforth ‘the Bank’) is an institution whose objective is the promotion, world-wide, of sustainable economic development and poverty reduction. It pursues these objectives through lending, through the production of research and economic analysis and through the provision of policy advice and technical assistance. The purpose of this book is to critically examine the rationale of this institution and to describe the policies which it currently carries out, in order to examine whether its objectives are best served by its current mix of activities.

Our intention is not just to look backwards, but to examine future options and to advocate choices among them. It has often been said that the Bank lacks a coherent vision, and that, as a consequence, it suffers from a dysfunctional proliferation of objectives. We agree. In response to this, we argue that the Bank should be organised around a vision of itself as a ‘Knowledge Bank’. To some extent, this has already happened. But it has only partly happened; making it really happen would radically transform the Bank's priorities, and its activities in the field, way beyond any changes currently in train. In particular, far less manpower would be devoted to analysing loan proposals and outcomes, and far more would be devoted to giving advice about development strategies and to providing help with their implementation.

The Bank recently celebrated its fiftieth anniversary. It has always been controversial.

Introduction

Almost all commentators note the multiplicity of the World Bank's functions and objectives. Oliver's (1971, 1975) accounts of the Bretton Woods and subsequent negotiations demonstrate differences of opinion, both between the Americans and the British, and also within the US administration itself, about what the World Bank should do, going back to the very origins of the organisation. Gavin and Rodrik (1995: 329) state that the debate surrounding its creation was about what it should do, not just how it should do it. Naïm (1994) accuses the current structure of generating goal congestion. We argue that the World Bank's strength arises from complementarity among these functions, and that conditionality is the cement that generates this complementarity. We see the World Bank's objectives as being closely aligned with the interests of borrowing countries, and view Bank conditionality, which we interpret in a broad sense, as a mechanism for helping governments realise some of these objectives. We suggest that this view of conditionality meshes well with the ‘Comprehensive Development Framework’ or CDF approach to development assistance which the Bank is now promoting.

The World Bank: a functional analysis

The World Bank is a large and complex organisation comprising a set of imprecisely focused institutions with overlapping responsibilities. It may be analysed in terms of these institutions or alternatively in terms of the economic functions it fulfils. In this chapter, we focus on the Bank's functions and ignore the institutional embodiments of these functions that we have discussed in Gilbert et al. (1996).

Introduction

My years as Director of the World Bank's Research Department from 1993 to 1997 gave me ample cause to contemplate the issue raised in the title of this chapter. In most institutions that are engaged primarily in operations – whether it be production or, as in the case of the World Bank, lending – some staff inevitably view research and other analytical work as a luxury. Budget reallocation brings calls for a reevaluation of such ‘frills’. These circumstances require that the research programme be kept active and effective. In this chapter, I spell out why the World Bank should be involved in development research and, wherever possible, illustrate how it has lived up to its potential. Evidence shows that on the whole the effort has been a success, and widely recognised as such.

Economics tells us that the creation and dissemination of knowledge has the key attributes of a public good. Knowledge is non-rivalrous because my use of a piece of knowledge does not preclude its use by others. Thomas Jefferson put this well when he said: ‘He who receives an idea from me, receives instruction himself without lessening mine; as he who lights his taper at mine, receives light without darkening me.’ Knowledge is also non-excludable – it is often difficult for the creator of knowledge to prevent others from using it. As is well known, these two attributes result in undersupply – individuals and firms will under invest in the creation of knowledge because they receive only a small part of the total benefits to society, but they bear the full costs.

Introduction

Recent literature, much of it deriving from World Bank research, has reached strong conclusions about the conditions under which official development assistance (ODA) can make a positive contribution to poverty reduction and other development objectives. These conclusions, if correct and broadly accepted, would have a profound impact on development assistance practice, especially when combined with effective commitment by donors to the DAC target of halving absolute poverty by 2015.

This chapter examines, in the light of this literature, experience with one specific instrument, the Sector Investment Programme (SIP), that the World Bank has taken the lead in promoting as a way of increasing aid effectiveness, especially in Africa. This initiative, coordinated with other bilateral and multilateral agencies through the UN Special Programme for Africa (SPA), has been part of a broader interest in the concept of what are now generally termed Sector-Wide Approaches (SWAps). Several bilateral agencies, notably in the Nordic countries (see for instance DANIDA, 1996; SIDA, 1995), have explicitly incorporated the principles of the sector-wide approach into their development assistance policies.

Section 2 briefly reviews the findings of recent analyses of aid effectiveness, focusing on five issues: policy environment, ownership, fungibility, conditionality and institutional capacity. Section 3 discusses the SIP instrument and the broader SWAp concept and examines how SIPs were intended to improve aid effectiveness. Section 4 summarises experience with application of the SIP concept in practice, focusing on the agriculture sector in Africa.

Introduction

Since 1960 nearly $1.7 trillion (measured in 1995 dollars) in foreign aid has flown from rich to poor countries – much of it as project assistance. As the leading project lending agency, the World Bank has, along with other donors, begun asking questions about whether this assistance is as effective as possible in promoting economic growth and reducing poverty. One source of concern has been whether aid projects actually finance what they are intended to, or whether development assistance earmarked for critical social and economic sectors directly or indirectly funds unproductive expenditures including those on defence. What has aid financed in developing countries? What is the evidence on the ‘fungi-bility’ of aid? What are the implications of aid fungibility for donors in assessing the impact of their assistance programmes? These are the issues this chapter addresses. In section 2, we first define aid fungibility and then analyse its consequences. Section 3 provides a review of the literature on fungibility of foreign aid and reports some results. The review examines the evidence – both cross-country and country-specific – on the link between foreign aid and the recipient country's public spending. In section 4 we develop a link between fungibility and a donor agency's lending strategy. Moreover, in the light of the empirical findings on aid fungibility, we draw lessons for donor assistance and make recommendations for designing better lending instruments. In this section, we also provide a blueprint of a new lending instrument – a public expenditure reform loan (PERL) and discuss its strengths and potential shortfalls. Section 5 provides some concluding remarks.