conditionality when donor and recipient preferences vary

CONDITIONALITY WHEN DONOR ANDRECIPIENT PREFERENCES VARY

HOWARD WHITE 1 and OLIVER MORRISSEY2�1Institute of Social Studies, The Hague, The Netherlands

2CREDIT and Department of Economics, University of Nottingham, UK

Abstract: An extensive literature evaluates the content of conditionality, but the design

of conditionality has received less attention. This paper presents a general framework of

conditionality, which allows donor and recipient preferences for policy reform and aid

to vary, in which previous contributions are incorporated as speci®c cases. The general

approach allows for conditionality as bargaining between donors and recipients: cases

where donors impose conditions on unwilling recipients; cases where recipients are

willing but unable to implement all conditions; and situations where recipients and

donors are clearly in con¯ict. Ex ante conditionality is shown to be ine�ective in pro-

moting reform in all cases and often counter-productive, either inhibiting the reform

e�orts of sincere governments or undermining its own credibility by encouraging donors

to condone slippage. # 1997 by John Wiley & Sons, Ltd.

J. Int. Dev. 9: 497±505 (1997)

No. of Figures: 4. No. of Tables: 0 No. of References: 13.

1 INTRODUCTION

While the impact of policy conditionality has been of major concern in developmenteconomics since the early 1980s, the theory of conditionality has received less atten-tion. One notable exception is the literature on credibility of reform (eg. Rodrik, 1989;Casella and Eichengreen, 1996). Another strand of the literature starts from theimplicit assumption that conditions are imposed by donors and accepted, usuallyunwillingly, by recipients. Mosley (1991; Mosley and Hudson, 1996) models condi-tionality as a bargaining game between recipients and the donor. An alternativeapproach posits that recipients can be studied as agents implementing the conditionsdesired by donors, who are the principals (Killick, 1995, 1997). A possibility notexplicitly explored in this literature is that the recipients may wish to execute economic

� Correspondence to: Oliver Morrissey, Economics Department, University of Nottingham, UniversityPark, Nottingham NG7 2RD, UK

Contract grant sponsor: Ford Foundation, CREDIT research programme; Contract grant number:940±1427

CCC 0954±1748/97/040497±09$17.50# 1997 by John Wiley & Sons, Ltd.

Journal of International Development: Vol. 9, No. 4, 497±505 (1997)

reforms, and need ®nancial assistance to do so, but are unable to implement allconditions. The aim of this paper is to provide a framework within which thesealternative approaches to conditionality can all be accommodated.

The structure of the paper is as follows. Section 2 outlines a simple typology ofdonor and recipient utility for loans and reforms; donors are assumed to always desirereforms, but may or may not derive utility from increased lending; recipients areassumed to always desire aid, but may or may not desire reform. This gives rise to fourcases. We then introduce conditionality, the e�ect of which depends on which caseprevails, but generally it is either impotent, unnecessary or counter-productive.Sections 3±6 discuss each case in turn. Section 7 concludes.

2 DONOR-RECIPIENT PREFERENCES AND CONDITIONALITY

Assume that both donors (D) and recipients (R) are willing to o�er/accept combina-tions of economic policy reform (P) and aid ®nancing (F). Both have utility functionsof the general form U � U�F;P�, denoted UR and UD for recipients and donorsrespectively. Assuming that R always desire aid (UR

F > 0) and that D always desirereform (UD

P > 0) we can identify four cases:

Case 1: UDP > 0 UD

F > 0 URP > 0 UR

F > 0

Case 2: UDP > 0 UD

F > 0 URP < 0 UR

F > 0

Case 3: UDP > 0 UD

F < 0 URP > 0 UR

F > 0

Case 4: UDP > 0 UD

F < 0 URP < 0 UR

F > 0

This is the typology we use to explore conditionality. In the ®rst case both partiesfavour reform and ®nancing and both maximize utility by having as much as possibleof both aid and policy reform. In the second case, both want to spend the aid budgetbut R does not favour reform. Case 3 represents the situation where donors do notlike lending more. In the fourth case D do not want to lend more, and R do not wantto implement reforms. Before addressing each case in more detail we can introduceconditionality (White and Morrissey, 1997, provides a fuller discussion).

Collier and Gunning (1996) suggest four objectives for conditionality: (1) patern-alism, where donors believe they know what is best for the recipient; (2) bribery, topersuade recipients to do something they would not otherwise do, corresponding toCases 2 and 4 above; (3) restraint, the recipient agrees on reforms (Cases 1 and 3), butthe donor puts conditions in place to prevent policy reversal; and (4) signalling, anindication to other donors and the private sector that the reform programme is sincere(suited to Cases 1 and 3 where recipients also want reform). We add two more to thislist, both of which may apply even if the recipient also favours reform: (5) monitoring,when donors want to disburse their aid where it will do most good conditionality canprovide a mechanism to ensure that aid is going to the `right' countries; and (6)supportive, some reforms may need ®nancing. The objectives and e�ectiveness ofconditionality will vary between the four cases we have identi®ed.

In our terminology, conditionality is the linking of disbursement of F to the extentof P, which we can represent as a linear function F � �1=C�P, where the inverse of theconditionality coe�cient, C, is taken so that any tightening of conditionality is anincrease in C. The function may also be written as P � CF , so that tightening

J. INT. DEV. VOL. 9: 497±505 (1997) # 1997 by John Wiley & Sons, Ltd.

498 H. White and O. Morrissey

conditionality rotates the `conditionality function' anticlockwise in (F;P) space. Thisrepresentation will be used for illustrative purposes in discussing each case.

3 CASE 1: SHARED PREFERENCE FOR LENDING AND REFORM

As illustrated in Figure 1, the indi�erence (utility) curves for R and D are negativelysloped: both reforms and money are `goods', so these are the usual downward slopingshape. However, the slopes ofUR andUD need not be the same so that the curves maycross. Assuming a maximum aid allocation to the country (F�) determined by thedonor and a maximum feasible reform programme (P�) determined by R, the utilitymaximizing solution is trivially at point e. This is not Pareto optimal, but improve-ment is not possible on account of the implied `budget constraint' (as indicated by P�

and F�).In practice, the feasible limits of reform are di�cult to identify; one simple problem

is that a government may be unsure how much reform to attempt because it facespolitical and administrative constraints (Haggard and Webb, 1993; Morrissey, 1995).There is a growing literature on the political economy of reform with models wheregovernments desire reform but are constrained (e.g. Frey and Eichenberger, 1994).Rodrik (1989) has a model in which governments can liberalize fully and rapidly;nevertheless, to convince private agents that reforms are permanent, the governmentmust over shoot on reform. In this model conditional aid may be counter-productive:uncommitted governments will reform to receive aid, but will then backtrack;liberalizers, who were willing to reform even without aid, will be unable to distinguishthemselves from the uncommitted. Conditionality will not solve this problem.

Where there is shared agreement by R and D for F and P there can still be a role forconditionality (as restraint, signalling, monitoring and support), represented as a ray

P

F

P = CF

P = CTFUD

f e

UR

F*FD0

P*

PD e'

Figure 1. Mutual shared preferences, case 1.

# 1997 by John Wiley & Sons, Ltd. J. INT. DEV. VOL. 9: 497±505 (1997)

Conditionality when Donor and Recipient Preferences Vary 499

from the origin (P � CF ) in Figure 1. This will pass through e and ensure the joint-utility maximizing equilibrium only if the donor correctly identi®es P� as theattainable level of reform. If conditionality is too tight (P � CTF) so donors relatedisbursement F� to an unattainable level of reform (PD), believing that an outcomeat a point such as e0 in Figure 1 is possible, the ®nal outcome would appear to be apoint such as f , implying a loss in utility for donor and recipient alike (relative to e).If the recipient had agreed to PD, not realizing it to be unfeasible, then it is forced intoa position of unavoidable slippage. The donor can raise utility for both parties byignoring the slippage and disbursing the funds anyway (moving back to point e), butthis raises a credibility problem as other recipients will take it as a signal that thedonor is not serious about conditionality. In Case 1, ex ante conditionality,disbursing funds on the promise of an agreed programme of reform, is therefore adangerous business which does nothing to enhance the probability of reform.

4 CASE 2: PARTIES CONFLICT ON PREFERENCE FOR REFORM

A number of previous models start from the assumption that D and R share aninterest in spending the donor's budget (i.e. both have increasing utility in F), but arein con¯ict regarding implementation of economic reforms, so that R desires lessrather than more P. This case is represented in Figure 2, similar to the representationemployed by Mosley (1991) and Bird (1995). Donor utility increases as higher P isobtained for a given F, as in Case 1. For recipients, on the other hand, more P is onlyacceptable if accompanied by more F , so the indi�erence curve is positively sloped(and curves lower to the right represent higher utility). This situation may be moti-vated by the recipient's appreciation of the costs of reform (as in the model of Casellaand Eichengreen, 1996) or that ®nancing is necessary to support some reforms, suchas retrenchment or liberalization of the foreign exchange market.

Mosley (1991, p. 7) argues that the donor ®xes its funding allocation to each R,represented by F� in Figure 2, and posits that possible outcomes lie between points aand b. Given the implied budget constraint (F� and P�), R0s utility is maximized atpoint c, that is (F�; 0) D0s utility is maximized at (F�;P�), at point a (where de®ningP� as maximum attainable is our assumption). Hence the ®nal outcome will liebetween a and c, but where along that line is the outcome of the bargaining processbetween donor and recipient. The ®nal outcome will not be a Pareto optimum, as theutility lines cross with no possibility of a tangent.

In this case donor and recipient alike may play games to enforce their preferredposition. On the part of the donor, conditionality is the key to their bargainingstrategy. Donors exploit F as a bargaining instrument to elicit a commitment topolicy reforms by R: tightening conditionality will move the intersection of theconditionality function up the vertical line from F� toward point a in Figure 2. As therecipient is willing to o�er PR, by assumption, and there is a maximum at P�,conditionality tries to force an outcome along ab; let us assume the donor aims for d.Of course, having agreed to a set of conditions, the recipient can always move theactual outcome back down towards b by slippage, and so obtain a higher level ofutility. This would then force the donor to point d 0 if conditionality is fully enforced(where lower F indicates punishment of slippage by with-holding). But point b yieldshigher utility than d 0, so the donor may increase joint utility by disbursing the funds



anyway. Whilst utility is increased in the single period game shown here, the donorfaces a credibility problem; again, ex ante conditionality is ine�ective (this also appliesin the two period game of Mosley and Hudson, 1996; see White andMorrissey, 1997).

5 CASE 3: PARTIES CONFLICT ON PREFERENCE FOR LENDING

This case di�ers from Case 1 as donors want to restrict lending (UDF < 0), perhaps

because they `need to safeguard against default to protect the quality of donorshareholder's assets invested in them [and to permit] maximum new lending of re¯owsfrom past loans' (Killick, 1995 p. 216). Assuming that R desires reform, this case isillustrated in Figure 3. The recipient desires more P and F ; higherUR represent higherutility for R and display the usual negative slope. Donor utility increases with lower Ffor a given P; higher UD imply higher utility andUD are positively sloping. Hence D'sutility is maximized at point c, which is (0;P�) on UDmax, and R0s utility is maximizedat a point like b, (FR;P�) where it gets as much funding as possible for the maximumattainable reform. The bargaining outcome will be between these two points, at apoint like a (which will exist).

If donors want to restrict lending they can use tight conditionality as a way ofminimizing disbursement, that is achieving an outcome nearer to point c in Figure 3.Although slippage is not expected as the recipient also wants reform, setting condi-tionality too tight can mean that maximum attainable reform is achieved, but not theplanned aid disbursement. In this case conditionality may fail in its monitoring,

Figure 2. Con¯ict over policy reform, case 2.



signalling and support roles. For the ®rst two of these it may seem that the recipient isnot committed to reform, when in fact it is. Furthermore, the amount of feasiblereform may be limited by an insu�ciency of aid funds (failure in the support role),resulting in an outcome even further down the left of the conditionality function thanpoint d 0, which unintentional slippage has an adverse e�ect on R's utility and anambiguous one on D's utility (it depends on the shape of UD ).

6 CASE 4: CONFLICT BETWEEN PARTIES

This ®nal case is represented in Figure 4. Donors prefer more P for a given F , hencehigher UD represent higher utility; recipients, however, prefer less P for a given F , solower UR represent higher utility. This ®nal case is clearly one of con¯ict as D and Rdi�er over both policy and aid. Using an argument analogous to that of theEdgeworth Box, equilibrium would be on the locus of tangency points illustrated bythe contract curve (BB0) in Figure 4; in this case, as at a, the outcome will be a Paretooptimum. There is no indication of where, along BB0, the parties will settle: D wantsto be in the north-west but R wants to be south-east. Two features of this case may benoted: (i) the outcome is unlikely to attain either maximum disbursement (F�) ormaximum feasible reform (P�); and (ii) the contract curve shows that higher equil-ibrium levels of F are associated with lower P (and vice versa). Donors may useconditionality to achieve a point along BB' a�ording them higher utility, whereasrecipients may use intentional slippage to move the outcome in their favour.

P

F

P = CF

P = CTF

UD1

d'

UDmax

F*0

bP*

d

a

UR1

c

UR2

FR

Figure 3. Con¯ict over lending, case 3.



We can interpret P � CF as the terms of trade line, hence the donor sets CF andthis ®xes the outcome. Tighter CF permits more P for given F thus R must accepthigher P to gain F . However, if the conditionality function is tangential to UR to theleft of BB0 then the recipient will increase their utility by moving down the condi-tionality function (i.e. slippage) to this point of tangency (e.g. from b to a point suchas b0 in Figure 4). As this condition is more likely to be satis®ed the tighter theconditionality, it follows that the tighter the conditionality the more the slippage! Asdonor utility is lowered by this slippage they have an incentive to prevent it, by settingC so that the conditionality function is tangential to UR on the contract curve, unlessthis point is at such a low level of P that they are better o� to set a higher C and acceptthat there will be some slippage. The important point is that conditionality plays nouseful role in supporting reform, and punishing slippage will tend to undermine therecipient's ability to implement reform (insofar as aid is supportive).

7 CONCLUSIONS

We have presented in this paper a simple framework for examining conditionalitybased on alternative assumptions about donor and recipient attitudes to aid andpolicy reform. From a theoretical point of view the advantage of this analysis is that itprovides a general case of existing analyses of conditionality. The analysis has ratherworrying conclusions for proponents of conditionality as policy conditionality is

P

F

P = CF

P = CTF

UD1

b

UDmax

F*0

B'

P*

a

UR2

FD

PD

PR

UD2

B

UR1

b'

URmax

FR

Figure 4. Con¯icting preferences, case 4.



shown to be ine�ective in promoting reform (which calls into question a basic tenet ofthe analysis of Gilbert et al. 1997) and to have undesirable consequences in nearlyevery case (unless the donor wants to reduce its spending), such as inhibiting thegenuine reform e�orts of governments sincere about liberalization and sending wrongsignals to the private sector. These problems are compounded by the fact thatrecipients may have an incentive not to implement agreed reforms and that donorswill raise their own utility by disbursing funds regardless of the slippage.

The need and the nature of conditionality will di�er substantially from case to case.This is perhaps our most important point, apparently simple as it appears: condi-tionality designed under one scenario will not be e�ective under another. Condition-ality designed for Case 4, to discourage slippage as a strategy, will have undesirablee�ects in a Case 1, where a country may be punished for unintentional slippage, ratherthan being supported in implementation. The obvious implication is to take care to®rst establish which case applies. Many of these problems could be reduced by adopt-ing ex post conditionality rather than ex ante as at present. Unfortunately, currentdiscussions on reforming conditionality are moving to link smaller scale disburse-ments to smaller packages of policy reform, i.e. more detailed ex ante conditionality.

Ex post conditionality may be based on performance measures rather than inputs,thus side-stepping the whole debate on what are appropriate policies, but thisapproach also is not without problems. First, there could be donor arbitrarinessabout what constitutes acceptable performance. Second, recipients may miss aperformance target because of external shocks or unavoidable implementationproblems. In both cases, the recipient faces uncertainty about the receipt of aid whichcan undermine the sustainability of the reform programme. What our analysissuggests is that if donors really want to maximize the amount of reform, they should®rst identify the recipient's preferences and capabilities over reform and then o�ersupport (both in building preferences and implementation capacity). The only con-structive roles for conditionality are monitoring and support.

ACKNOWLEDGEMENTS

This is a revision of the paper presented at the DSA 1996 Annual Conference,University of Reading, 18±20 September 1996; we are grateful to participants forcomments. Oliver Morrissey is grateful to the Ford Foundation for support for aCREDIT research programme (Grant 940-1427), of which this work is part. Geo�Reed provided useful comments but should not be implicated in the outcome. A fullerversion can be found in White and Morrissey (1997).

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conditionality when donor and recipient preferences vary

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