Abstract
This paper employs a principal-agent framework to analyze the role and design of outcomes-based conditionality in the presence of market frictions and domestic opposition. The results suggest that outcomes-based conditionality is a good option for the IMF when opposition to reforms is relatively weak and when IMF loans are unsubsidized. The only role conditionality ends up playing in this case is that of an efficiency tool to ensure efficient allocation of resources in the presence of market frictions. The benefits of outcomes-based conditionality in the presence of strong opposition are less clear, and using this conditionality as an incentive tool would require IMF financing to be subsidized.
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Notes
This view of IMF conditionality was first suggested in Dixit (2000).
This will also help ensure that IMF resources are repaid.
A formal definition of ownership adopted by the IMF is as follows: “Ownership is a willing assumption of responsibility for an agreed upon program of policies, by officials in the borrowing country who have the responsibility to formulate and carry out those policies, based on an understanding that the program is achievable and is in the country’s own interest” (IMF, 2001b, p. 8).
At the moment, IMF conditionality is already a mix of policy-based and outcomes-based conditionality. Thus, the issue is really whether the relative importance of outcomes-based conditionality should be increased.
A recent review of the 2002 Conditionality Guidelines (IMF, 2005b) suggests that this may not be the case in practice and points out the risk that conditions might be met in unacceptable or suboptimal ways.
The term “efficiency” is used here somewhat loosely. Its precise meaning is explained later in the text.
On the weakening of incentives in settings with multiple principals and multiple-task agents, see Dixit (1997). In this model, the principal can make negative marginal payments for the outcomes of tasks that are primarily of interest to the other principals, thereby obtaining insurance against those outcomes. This is true for all principals, and this overprovided negative externality leads to a weakening of incentives in the Nash equilibrium.
Government holds many unique control rights in fiscal, monetary, exchange rate, taxation, and institutional infrastructure matters that can affect the return of foreign investors.
This formulation abstracts from the possibility of default, which is central to the relationship between private borrowers and lenders. Although it may seem that by ignoring default issues, the main conflict of interest between borrowers and lenders is eliminated, in practice IMF loans have almost always been repaid with interest (Rogoff, 2002). Because the IMF is a preferred creditor, as a practical matter default is not a primary issue for the IMF. For justification of conditionality from the borrower-lender perspective, see also Khan and Sharma (2003).
The IMF levies market-related interest rates for nonconcessional financing, which is based on the SDR (Special Drawing Rights) interest rate that is revised weekly to take into account changes in short-term interest rates in the major international money markets. It charges higher interest to the borrower (the rate of charge) than the interest rate accrued to the lenders (rate of remuneration), with the difference covering the cost of IMF operations.
Under effectively market rate, the IMF charges the borrower an interest rate slightly higher than the market rate, rB = r* + θ > r*, whereas the lender is remunerated at an interest rate below the market rate, rL = r* − θ < r*, but when 8 approaches zero. Under the subsidized rate, rB = rL = r* − s.
Calculations are available from the author upon request and the results are described in more detail in Ivanova (2006).
Although it is not possible to sign the cross-partial, all of the relevant expressions in this paper can be unambiguously signed.
When the IMF loan is offered at a subsidy that is sufficiently large, the lender may be hurt by the IMF loan because the cost of the subsidy, which is borne by the lender, outweighs the benefit from the additional unit of lending that relaxes the lending constraint.
Policy a is also affected by the IMF offer T, but for notational simplicity this dependence is omitted.
I assume that the IMF cannot offer negative contributions. Perhaps withdrawing financing and thereby discouraging private lenders could be viewed as a “negative” payment, but it is hard to think of a proportionately higher punishment for higher levels of distortions that would be required in the model to introduce negative payments.
Dixit, Grossman, and Helpman (1996) provide a characterization of equilibrium in the common agency game (Theorem 1). Because the only required assumption to prove this theorem is that government utility is increasing in contributions of both principals, the proof goes through for the model presented in this paper, with the only difference being that all utilities need to be replaced by expected utilities.
Essentially, the question being asked here is, “What is the maximum average lobby’s contribution for bad policy that the IMF can outbid?” \(T_{ob\,\max }^{IMF}(\omega, \,{a_g})\) is the “maximum” schedule that the IMF is willing to contribute for good policy and therefore determines the lobby’s maximum contribution that the IMF can outbid.
I assume that the subsidy is small enough that, at least for some levels of distortions, the lender would still benefit from the IMF loan.
See, for example, the analysis in Dixit (2002) of the success of a program on performance-based organizations launched in 1993 in the United States.
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She is indebted to Charles Engel for valuable advice, support, and encouragement throughout this project. Ivanova thanks Akito Matsumoto in particular, for numerous enlightening discussions. She is also grateful for the comments of Robert Staiger, Peter Eso, Paolo Manasse, Alex Mourmouras, Nienke Oomes, and Bill Sandholm.
