Sovereignty, Developing Countries and International Financial Institutions: A Reply to David Williams

Sovereignty, Developing Countries and International Financial Institutions: A Reply to DavidWilliamsAuthor(s): Ralf J. LeiteritzSource: Review of International Studies, Vol. 27, No. 3 (Jul., 2001), pp. 435-440Published by: Cambridge University PressStable URL: http://www.jstor.org/stable/20097744 .

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Review of International Studies (2001), 27, 435-440 Copyright ? British International Studies Association

Sovereignty, developing countries and

international financial institutions: a Reply to

David Williams RALF J. LEITERITZ1

In his article Aid and Sovereignty: Quasi-States and the International Financial

Institutions2, David Williams claims that '(t)he activities of the IFIs [international financial institutions, RL] in their relations with many developing countries certainly suggest that the substance of state sovereignty does not amount to very much more

than a show' (p. 573). In my reply, I beg to differ with respect to the causes of the

changing state sovereignty in developing countries and the role of international

financial institutions, and of the World Bank in particular, in this process.3 By

offering a comparison concerning the structure of the interactions developing coun

tries have with the IFIs and private capital markets, respectively, I conclude that the

relationship between developing countries and private capital markets has more

substantial effects on the changing nature of state sovereignty in the developing world.

The IFIs and developing countries?the experience with policy conditionality

First, Williams unduly exaggerates the leverage and capabilities of the IFIs, and

especially of the World Bank (henceforth 'the Bank'), vis-?-vis developing countries.

Research on the effectiveness of aid recently undertaken at the Bank has clearly shown that policy conditionality introduced through structural adjustment lending that commenced in the 1980s has largely been a failure.4 Despite agreements between

the Bank and borrowing countries on macro-policy reforms that were deemed

necessary to accompany the loans, these reforms did often not materialize. Since the

1 The views expressed here as solely those of the author and should not be ascribed to the World Bank. I wish to thank Eulalia Sanin and Wolfgang Fengler for their very helpful comments and suggestions in writing this reply.

2 David Williams, 'Aid and Sovereignty: Quasi-states and the International Financial Institutions', Review of International Studies, 26:4 (2000), pp. 557-73.

3 However, as Stephen Krasner has sophistically shown, the violation, compromise and truncation of

sovereignty has been a central feature of international relations since the very inception of the

'Westphalian system' in 1648. See Stephen D. Krasner, Sovereignty: Organized Hypocrisy (Princeton, NJ: Princeton University Press, 1999).

4 The World Bank, Assessing Aid: What Works, What Doesn't, and Why, World Bank Policy Research

Report (Washington, DC: Oxford University Press, 1998). See also Paul Collier, 'Learning from

Failure: The International Financial Institutions as Agencies of Restraint in Africa', in Andreas

Schedler, Larry Diamond, and Marc F. Plattner (eds.), The Self-Restraining State: Power and

Accountability in New Democracies (Boulder, CO: Lynne Rienner, 1999), pp. 313-30, and Christopher L. Gilbert and David Vines (eds.), The World Bank: Structure and Policies (New York: Cambridge University Press, 2000), especially the articles by Craig Burnside and David Dollar (ch. 8) and

Jonathan Isham and Daniel Kaufmann (ch. 9).

435



436 Ralf 1 Leiteritz

necessary institutional reforms were rarely implemented in conjunction with the

disbursement of the loans, this partially explains why the supposed effects of the

structural adjustment loans regarding the growth of the domestic economy could

not be achieved. The clear message from the Bank's own research has been that

money has a big impact, but only if countries have good economic institutions and

policies. If these institutions and policies have been absent in the country, the

allocation of aid has largely been a waste of resources. This conclusion, in turn, has

led the Bank to emphasize the crucial institutional conditions within the countries

('good governance') as a prerequisite for continued or increased aid to them.5 This is

the backdrop for Williams' main contention, namely that the 'concern for

sovereignty has increasingly been 'trumped' by the international donors' commit

ment to the pursuit of 'ideal' or good political and social arrangements and

economic development within many of these (developing) countries' (p. 557).

Second, Williams seems to suggest that the Bank is simply imposing its conditions

on the borrowing countries without giving the countries a voice or authority in the

process. I disagree with Williams that the Bank does only pay lip service to the

participatory role of the borrowing country as he implicitly suggests.6 Indeed the

traditional notion of sovereignty as the sole authority of national governments over

their 'internal affairs' has long been rendered obsolete, or as some observers argue, it

has de facto never really existed in the first place.7 However, it became quite clear

from the research on aid effectiveness that 'country ownership' of any national

development strategy supported by international donors is a fundamental pre

requisite for the success of development assistance. Hence, the Bank would shoot at

its own feet in the figurative sense (and deliberately forego loan repayments) if it

does not take into account the needs and opinions of the borrowing countries?and

not only of their national governments. The participation of civil society actors at

large in the formulation, implementation and supervision of national Poverty Reduction Strategy Papers (PRSPs) has come to the forefront of the Bank's strategy as part of the recently started enhanced debt relief initiative for Highly Indebted

Poor Countries (HIPC).8 The Bank pursues the involvement of civil society groups within the PRSP process sometimes even against the articulated interests of the

country government.

Official versus private flows to developing countries

Third, as Williams rightly points out, much of sub-Saharan Africa is heavily relying on Official Development Assistance (ODA) as part of its income. Private capital

5 Joseph E. Stiglitz, The World Bank at the Millennium', The Economic Journal, 109: 459 (1999), pp.

?511-91, and Devesh Kapur and Richard Webb, Governance-related Conditionalities of the

International Financial Institutions, G-24 Discussion Paper no. 6 (New York and Geneva: UNCTAD,

2000). 6

'(T)here is now not very much left of the idea of a sphere of 'internal affairs' over which governments have sole authority. The IFIs are prepared to intervene in almost all aspects of economic, political, and social life'; Williams, 'Aid and Sovereignty', p. 573.

7 Krasner, Sovereignty: Organized Hypocrisy. See also the review of this and other recent books on the

concept of sovereignty by Daniel Philpott, 'Usurping the Sovereignty of Sovereignty?', World Politics, 53:2 (2001), pp. 297-324.

8 For more on the PRSP process see http://www.worldbank.org/prsp/.



Developing countries and IFIs: Reply to David Williams 437

markets have largely ignored most sub-Saharan countries in Africa. Not even

Africans themselves trust their countries: 37 per cent of Africa's private wealth is

held outside of the continent?compared to just 3 per cent in Asia.9 The important role of the Bank as the main provider of investment resources in those countries

should therefore not come as a surprise to anybody. But what about the rest of the

developing world, especially the middle-income countries in Latin America and East

Asia? These countries, among them the biggest borrowing countries of the Bank, China and India, have indeed had the option of borrowing capital from private investors and, most importantly, they are attractive for foreign direct investment.

They have used this option much more intensively in the past decade vis-?-vis a

decreasing lending volume from the Bank and other donors.

Looking at the long-term aggregate net resource flows to developing countries in

1999, official flows (including grants) amounted to US$ 46.4 bn, roughly 18 per cent

of all net resource flows. In contrast, private flows to developing countries were US$ 215.6 bn or 82 per cent of all aggregate net resource flows in 1999.10 The ratio

for China, for example, was US$ 2.0 bn in official flows and US$ 40.7 bn

in private flows. For comparison, Sub-Saharan Africa received only US$ 7.7 bn in

private flows, but US$ 10.5 bn in official flows.11

The structure of the relationship to the IFIs and private capital markets and the effects on state sovereignty in developing countries

Fourth, in order to highlight my main criticism concerning Williams' one-sighted

analysis, I would like to compare the relationship between the IFIs and the develop

ing world with the relationship between private capital markets and the latter.

Research has shown that welfare states in the developed world, especially in Western

Europe, have retained quite a significant amount of autonomy vis-?-vis financial

markets.12 However, states in the developing world are not that 'lucky', that is, they are exposed: much more 'unprotected' to financial markets and their demands.

Agreements between the IFIs and developing countries as well as collaborations

between the latter and private capital market actors must deal with the risk of non

compliance. Private capital market actors usually take the approach of ex ante

demands on borrowers. By requiring prior concessions, a party to the agreement may improve the expected outcome by enough to compensate for the risk of a

breach'. In dealing with developing countries, '(financial markets resort to a

combination of higher risk premia, greater collateral and shorter duration agree ments to address the risk of non-compliance'.13 The so-called country risk premium

9 Wolfgang Fengler, Politische Reformhemmnisse und ?konomische Blockierung in Afrika. Die

Zentralafrikanische Republik und Eritrea im Vergleich (Baden-Baden, Germany: Nomos, 2001), p. 66. 10 Private flows are composed of foreign direct investment, portfolio equity, bonds, and trade-related

lending. 11 The World Bank, Global Development Finance: Country and Summary Data 2001 (Washington, DC:

World Bank, 2001). 12

Geoffrey Garrett, Partisan Politics in the Global Economy (New York: Cambridge University Press,

1998) and Layna Mosley, 'Room to Move: International Financial Markets and National Welfare

States', International Organization 54:4 (2000), pp. 737-73. 13

Kapur and Webb, Governance-related Conditionalities, p. 1.



438 Ralf 1 Leiteritz

refers to the possibility that borrowers in a country default. It indicates a general level of uncertainty in a given country that affects the value of loans or investments.

The parameters for accessing a country's risk premium 'depend on the variability of

the nation's terms of trade and the government's willingness to allow the nation's

standard of living to adjust rapidly to changing economic fortunes'.14

The country risk premium is determined through an analysis independent of

promises of future changes through the government, but is instead done as an

evaluation of the existing political and economic situation in the country. No

process of formal or direct interaction between international rating agencies and

national governments takes place in assessing a country's risk premium. However, the resulting rating grade is the fundamental criterion upon which investment and

loan decisions of private capital market actors are based.15

In contrast, in negotiations between a borrower country and the Bank the

outcome of the interaction is endogenous to the process. To deal with the risk of

non-compliance and in the absence of market mechanisms?for example, risk

premia?the IFIs have adopted the approach to 'structure the agreement itself in

ways that reduce the level of risk, often through stipulations that restrict a party's freedom of action'.16 That means, however, that the country government has in fact

the opportunity to directly influence the costs of debt. While the interest rate and

the repayment schedule of Bank loans are usually predetermined, the terms and the

scope of the conditionalities attached to the loans are not. In addition, an agreement with the Bank signals an increased creditworthiness of the country to financial

markets, thereby possibly reducing its risk premium. Consequently, official develop ment assistance has the potential to attract increased private investment flows to

developing countries under favourable circumstances.

Given the different nature of the interaction with both groups of actors, I argue

that, other things being equal, governments in the developing world prefer to borrow

from the IFIs than from private investors. Borrowing from the IFIs is much cheaper than from the private capital market as the IFIs do not (and for broader public

purposes cannot) use the concept of risk premia. It should be pointed out in this

regard that the Bank operates with two so-called 'loan windows' for developing countries. 'Loans' to developing countries through the International Bank for

Reconstruction and Development (IBRD) are made below private capital market

interest rates. On the other hand, 'credits' are made through the 'soft loan window'

of the Bank, the International Development Agency (IDA), which makes conces

sional loans to the world's poorest countries at virtually no interest rate. However,

private investment flows to countries which receive loans through the Bank's IDA

window have been very low and these countries are thus practically forced to rely on

official flows. IBRD-borrowers, on the other hand, could go directly to the private

capital market where they would not need to pay heed to the various conditionalities

attached to the loans from the Bank.

Yet the absence of formal negotiations and hence of immediate influence over the

outcome of the interaction delivers developing countries largely into the will of 14

Alan C. Shapiro, Multinational Financial Management, 6th edn. (Upper Saddle River, NJ: Prentice

Hall, 1999), p. 616. 15

Timothy J. Sinclair, 'Passing Judgement: Credit Rating Processes as Regulatory Mechanisms of

Governance in the Emerging World Order', Reviews of International Political Economy, 1:1 (1994),

pp. 133-59. 16

Kapur and Webb, Governance-Related Conditionalities, p. 1.



Developing countries and IFIs: Reply to David Williams 439

financial markets.17 On the other hand, in formal interactions with the IFIs

developing countries can indeed influence the outcome of the negotiation?and even

more important the implementation of the agreements?in their perceived favour.18

Private capital markets are somewhat less patient with the country at hand. The

risk premium representing the cost of borrowing can only be reduced after the

institutional reforms ('structural adjustment') are implemented. Seen from the

perspective of governments, such a process renders the results of the interaction with

private capital markets more severe?but also somehow less visible to outsiders?for

state sovereignty in developing countries than the interaction with the IFIs. Whereas

the promise of institutional reforms has largely been sufficient in interactions with

the IFIs, only the up-front delivery of these reforms matters for the reduction of the

country's risk premium in financial markets.

What explains the fact that private flows to sub-Saharan Africa are as negligible as they are? Quite simple, private investors do not find the institutional infra

structure in place to expect any positive returns on their investments.19 This, on the

other hand, does not provide the country government with any kind of recourse to

negotiate the terms of engagement with private market actors other than to rely on

institutional reforms perceived as necessary to attract higher private flows to the

country. In other words, the change in state sovereignty appears as the voluntary decision of the government not directly influenced by any outside force such as the

Bank. I argue that these 'real reforms', when undertaken, run much deeper than any

agreements?malleable as they have been in many cases?between the country

government and the Bank and that these domestic changes create much more signi ficant and, above all, sustainable inroads towards a changing concept of state

sovereignty in developing countries.

However, not only the sheer difference in available financing resources of private and public institutions explains why governments in developing countries which are

faced with a choice between both of them have drastically expanded their exposure to private capital markets. At least part of the reason can also be found in the

changing conditions the Bank has attached to its loans over the past decade or so.

These increased standards, that is, the so-called safeguard or 'do-not-harm' policies, are supposed to take account of environmental and social aspects of big develop

ment projects. Notwithstanding the overall favourable terms of Bank loans vis-?-vis

private financing sources, some developing countries?usually from the middle

income group of countries?that have the ability to borrow from private capital markets might have reduced their engagement with the Bank due to the perceived

17 Layna Mosley arrives at a similar conclusion in her empirical analysis of financial markets and their

influence on government policy choices, focusing on the government bond market in developed democracies. She claims that financial markets have a broader influence in the developing world

based on the 'importance of default risk to investors' collection of information' and because 'default

risk is salient in emerging markets'; Mosley, 'Room to Move', p. 766 (quotes from original). 18

Williams concedes this fact when he writes that 'developing country governments have been able to

resist implementing its loan conditions, and they have dissembled, bargained, dragged their feet, and

generally, where they wished, tried to maintain some semblance of control over the process of

political and economic reform'; Williams, 'Aid and Sovereignty', p. 571. 19

However, as Paul Collier has pointed out, the main reason for the low supply of private investments

in Africa has to do with the fact that African governments are not trusted by investors' despite high returns on current investments. In other words, Africa faces a credibility problem vis-?-vis private investors, which according to Collier is due to the fact that 'governments have lacked effective

agencies of restraint'; Collier, Learning from Failure, pp. 313^4.



440 Ralf I Leiteritz

'strings' on their sovereignty beyond fiscal and monetary conditions. In contrast to

the 'traditional' forms of conditionality and their supposed effects on the growth of

domestic economies, the application of safeguard policies is not aimed at benefiting

private investments. These policies or conditions are rather intended to protect the

rights and demands of marginalized groups, people and natural resources in

developing countries as part of Bank loan agreements.

Consequently, governments faced with a choice of creditor rely increasingly on

borrowing from private capital markets irrespective of the comparatively unfavour

able pricing conditions. The relatively recent introduction of safeguard policies for

Bank loans might have contributed to this development as governments have come

to value the direct benefits of 'traditional' conditionality for higher private flows, but

have been reluctant to accept the newer social and environmental conditions for

Bank loans.20

Conclusion

In sum, the analysis of David Williams would lead the observer to locate the

primary causes for the changing concept of sovereignty in developing countries

largely or only in their interactions with the IFIs. However, this change does not take

effect solely based on agreements between the IFIs and developing countries as

Williams has it. As has been shown, policy conditionality as applied by the Bank did

not lead to significant and sustainable institutional reforms in most countries. On

the other hand, such reforms are the prerequisite for any successful collaboration

with private capital markets. Hence, assuming that such institutional reforms

constitute the essential element of what Williams calls the 'loss of effective control over the national economic project' (p. 573), the relationship between private investors and developing countries plays a more important role than the outcomes

of interactions with the IFIs.

A rather extensive literature now exists suggesting that private actors and their

allies in the public realm are the drivers of globalization and therefore of changes in

state sovereignty not only in the developing world.21 These studies contradict

Williams' utterly narrow focus on the IFIs as the sole cause of 'compromised state

sovereignty' [Stephen Krasner] in developing countries. In addition, it seems that not

only the Bank itself, but even its fierce critics have overestimated the role of the IFIs

in changing the internal dynamics of developing countries. I wonder how Williams

explains that the worst and most inefficient regimes, particularly in Africa, have

remained in power and have continued to impede the development of their countries

for such a long period of time, given their alleged 'loss of the effective control over

the national economic project'.

20 The most recent and highly publicized of these instances was the Western Poverty Reduction Project in Qinghai, China. This project eventually did not receive funding from the Bank due to its

non-compliance with various safeguard policies. As a result and after it voluntarily withdrew the

application for a Bank loan, the Chinese government announced it would finance the project with its

own resources. See Robert Wade, 'A move for the good in China: The World Bank has been unfairly criticised over the Qinghai resettlement project', in Financial Times, 4 July 2000, p. 15.

21 Susan Strange, The Retreat of the State: The Diffusion of Power in the World Economy (New York:

Cambridge University Press, 1996) and A. Claire Cutler, Virginia Haufler, and Tony Porter (eds.), Private Authority and International Affairs (Albany, NY: State University of New York Press, 1999).



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Sovereignty, Developing Countries and International Financial Institutions: A Reply to David Williams