August 23, 2005
World Bank and IMF: Indicators of Investor Opportunity or Red Flags of Investor Risk?
by William Baue
Two academic papers produce empirical evidence that World Bank and International Monetary Fund loan
conditions stipulating market reform may prove counterproductive and fuel backlash.
World Bank (WB) and International Monetary
Fund (IMF) loans often come with conditions that
borrower countries reform their regulatory policies. Examples include privatizing state-owned
industries such as telecommunications or electricity. Do borrower country reactions to the reforms
influence the overall effectiveness of WB and IMF efforts?
This was not
amongst the research questions Wharton
School Management Professor Witold Henisz and his colleagues asked
themselves in preparing to write a pair of recent papers. At least initially, they were searching
for regulatory designs that were more robust or rigid, according to Prof. Henisz.
field research comprising more than 300 interviews in 14 countries over 12 weeks spread across two
years of real time, we stumbled across stories of local hostility to IMF-imposed reforms frequently
enough that we wanted to see if there was anything behind them other than rhetoric," Prof. Henisz
told SocialFunds.com. "To our own surprise, we found quite a bit of meat, so we shifted the focus
of our research from the question of how to better design local regulations to how to better design
the reforms behind those regulations."
Prof. Henisz and his colleagues designed two
empirical studies to test their reformulated hypotheses. One study,
entitled The Worldwide Diffusion of Market-Oriented Infrastructure Reform, 1977-1999,
examines market reform in the telecommunications and electricity industries in 71 countries and
territories between 1977 and 1999. The second study, entitled
Deinstitutionalization and Institutional Replacement: State-Centered and Neo-liberal in the
Global Electricity Supply Industry, examines 1,056 private electricity projects in 83 countries
from 1989 to 1999.
Interestingly, the redirected research reveals that WB and IMF
stipulations might be counterproductive, making it more likely that governments will reject market
reforms and renew state control. These findings carry important implications for investors using
the involvement of multilateral organizations such as the World Bank and IMF as a proxy for reduced
"A naïve investor might see a WB or IMF program as a stamp of approval
and rush into a country after the signing of such an agreement," said Prof. Henisz. "A more
sophisticated investor should recognize that, while a country that has consented to undertake
reforms at the behest of or with the consultation of the Bank and Fund is frequently a better
locale for investment than a country that has spurned the advice of multilaterals, multilateral
presence is not a panacea for political, regulatory, or social risk."
"In fact, in some
important respects, reforms associated with Bank and Fund involvement actually may have higher
risks of retrenchment than otherwise similar reforms adopted independently," he added.
other words, the degree to which the World Bank and IMF exert coercion to enact market reforms
versus allowing countries to choose this course of their own accord is a key determinant of success
in the eyes of investors.
Prof. Henisz and his colleagues necessarily ground these
findings in their historical context. The 1952 passing of the first amendment of the IMF charter
allowed the agency to use its lending power to coerce borrower countries to adopt political
policies in line with its ideology. Before the end of the '50s, IMF Managing Director Per
Jacobsson cautioned against imposing programs against the will of recipient countries.
Such impositions were rare for the next few decades but became increasingly frequent with the
1980s rise of neo-liberalism, which "proposes to reduce the role of politics and the state in the
economy so that markets may function unhindered," according to Prof. Henisz and colleagues. By
1993 the World Bank codified neo-liberalism by requiring market reform in its loan terms.
While neo-liberalism may appear to be the most efficient solution on paper, its implementation
on the ground is a different story, with local actors playing a significant (and under-appreciated)
role in the ultimate acceptance or rejection of reforms introduced from the outside.
"Investors should recognize that economically optimal reforms may generate political and social
backlash--there may be a cost in terms of efficiency for the sustainability of a reform effort,"
explains Prof. Henisz. "You may need to continue cross-subsidies or continue state involvement in
certain social programs in order to engender political support for reform."
extrapolates the implications of these findings vis-à-vis World Bank and IMF critiques.
"On the one hand, our findings suggest that the Bank and Fund have not gone far enough in
recognizing the importance of local context for the successful adoption of their reforms," said
Prof. Henisz. "On the other hand, our results fall far short of an indictment of Bank and Fund
involvement--it is quite possible that some or even the majority of consumers in these countries
are better off than they would have been in the absence of reforms."
Prof. Henisz, who has
worked for the IMF and consulted for the World Bank (as has co-author Bennet Zelner of the Haas School of Business), hopes to use the
studies to initiate dialogue with both institutions to raise awareness of the importance of "local
ownership" of reforms.
"We would welcome the opportunity to work with the Bank and Fund to
develop metrics of 'local ownership' or 'fit with the local institutional context' and test various
mechanisms of obtaining that buy-in or fit," Prof. Henisz stated. "As well, we would be
interesting in establishing the link between that buy-in or fit and the performance of the