The World Bank and the IMF engaged in a game of incentives across the global stage in the late 20th century, with the idealistic mission of sparking long-term economic growth in the Global South and emerging markets.
Between 1980 and 1994, the International Monetary Fund (IMF) and the World Bank collectively issued twelve adjustment loans to Zambia alone, under the loose objectives of spurring economic growth and mitigating inflationary impacts on international trade. The country, much like many who were part of the IMF and World Bank’s “client base”, was a typical “low-capital, hence high-returns” trope, one that perfectly played into the institutional incentive model. It seemed an unquestionably symbiotic relationship for all parties involved: Zambia would receive cash infusions on a regular basis to jumpstart and expand its economy in any way it would see fit, while the aforementioned institutions would reap high returns and the emotional currency of helping an infrastructurally disadvantaged country and its people.
Some “back of the cocktail napkin” math bolsters this model: with capital appropriately invested and spread evenly across all economic sectors, technological growth increases productivity and efficiency alike, inflation retards as liquidity reserves are tapped for infrastructure projects and imports, and the given country looks well on its way towards a previously unachievable level of economic growth. Unsurprisingly, the utopian scenario we see described above is far from what we see happen on a regular basis. Zambia is one of a multitude of countries where these adjustment loans have had negligible, if not perverse, effects on GDP growth, while sapping these goodwill organizations of millions of dollars. Between 1985 and 1996, Zambia ailed from inflation of 40% or above in all but two years . This consistent breakdown between the “expected” and the “actual” was naturally alarming to the IMF and the World Bank, but with the success stories of Ghana (1.4% GDP per capita growth after initial -1.6% growth pre-loans) and, particularly, South Korea (6.7% per capita growth) , among a limited number of others, driving the institutions forward, the adjustment loan strategy was one that persisted for quite some time. WIth the benefit of hindsight and the impressive work of William Easterly in his book “The Elusive Quest for Growth”, we are able to take a magnifying glass to what exactly didn’t work, why it didn’t work, and help us come to conclusions about what can be done differently in the years to come.
Greta Thunberg and Adjustment Loans
First, a crash-course on adjustment loans. Let’s say, somehow, I end up in custody of Greta Thunberg, and, being the considerate father I would be, am worried about her slipping grades as she sails to and fro, across the Atlantic, saving our beloved planet. I strike a deal with her: for every hour she spends studying, I will plant two trees, and for every “A” she receives on a test or paper, I will plant 10 trees. I’m not Ecosia but I’m earnestly trying. Having considered the incentives that are most valuable to each of us, her grades for me, and the environment’s well-being for her, I have created a package that addresses the central economic tenet of “people respond to incentives”. As our deal continues to mature, I amend it slightly to meet the new standards set as time passes. Perhaps, I will get away with planting fewer trees for every hour spent studying, or will require a more significant accomplishment, perhaps an “A” in a class, to donate a certain sum to a conservation society of Greta’s choice. This is the “adjustment” part of the “adjustment loan” notion; to refocus, this is the ability that the World Bank and the IMF reserve to wean a given country into a particular pattern of behavior or tendency, or my strategy of forming The Great Thunberg into a bona-fide “student athlete”, if you will. Lastly, the term “loan” implies an obligation to pay back the issuing party, something that’s a little less straightforward in our “Greta Thunberg is my daughter” universe. Perhaps, this will be Miss Thunberg compensating my monetary contributions in buying each tree, or it’ll be her, even more graciously, reserving a certain percentage of her starting salary to pay me back for my initial investment into her education, even if those dividends are paid in appleseeds and quinoa. How dare she! In our original, this will, of course, be the recipient paying back in full, often with interest, the IMF and/or World Bank, signaling a high degree of economic independence and the completion of the IMF/ World Bank’s initial mission.
Loan Package Buffering and Similar Struggles
WIth pertinent terms cleared up, we can backtrack slightly in the realm of economics and focus on two rather simplistic concepts: economic growth and inflation. While almost out of place in a discussion that seems to be tiers more technically complex, most basely, all the IMF and the World Bank are attempting to do, in 9 out of 10 cases, is to lower inflation to a reasonable benchmark, and then encourage economic growth through liquid stimuli. The important caveat here is that the money, in theory, only follows policy change. Without the government’s provision of a comprehensive economic roadmap that is to the institution’s liking, the adjustment loan cycle cannot begin . As such, we cannot point to institutional fecklessness as a reason for the shortcomings of their projects; instead, their follow-up, or in many cases, lack thereof, can be more telling of why countries, even after their tenth round of stimuli, still find themselves in a stagflationary pit.
To return to our Zambian case study, where inflation was hovering near 40% for the better part of a decade, the IMF agreed upon the script that inflation, empirically, created bad incentives for growth. These initial adjustment loans, then, had the aim of lowering inflation in order to create better incentives for growth and increase productivity and let the Solow model do its work to help countries reach their steady state equilibrium. However, among the countries with triple-digit inflation that sought out the aid of the IMF/World Bank, half experienced inflation decrease while the other half saw inflation continue to rise, even as money kept pouring into their coffers. A 50% success rate, in these cases, seems to be moreso the product of luck than skill or effectiveness.
Another failed inflation-lowering project took place in Russia, following the first-ever introduction of the free market on January 1, 1992. As prices were freed and inflation shot into the thousands as part of Boris Yeltsin’s “shock therapy” economic programming, the IMF and World Bank failed to have adjustment loans ready to allay the dramatic increase in inflation; given the urgency of the moment, the central Russian government was forced to haphazardly print money left and right to finance credits to state enterprises, only pushing inflation north and complicating the job of the IMF and World Bank .
As economically devastating as this weak-handed attempt was, the political aftermath, arguably, was worse: the loss of credibility of reformers and public frustration at savings and pension plans being hard-hit and depreciated by astronomically high inflation amalgamated to severe disillusionment in capitalism and the free-market economy, looking to pivot back to the system of communism the country had just so triumphantly left in the history books. More generally, the communism-to-capitalism transition was one the IMF and World Bank had taken on rather comprehensively, issuing 143 total adjustment loans to 24 ex-Communist economies, and again, to mostly negative effect.
By 1998, several years after this project began, cumulative inflation rose to 61 thousand percent, cumulative output declined 41%, and the percent of the population living on less than $2 a day rose from 1.7% to 20.8% . To speculate whether or not inflation or growth would have been lower without the World Bank and IMF’s help would be an interesting exercise for another day, but, when our optic is mere effectiveness, there is little doubt that, here, adjustment loans proved to be inadequate tools.
Game of Incentives
Why, though? William Easterly argues that misaligned incentives, the same incentives that, for Easterly, are the basis of economics, are to blame. As he acutely states, “[…] lenders face incentives that cause them to give loans even when the conditions of the loans are not met. Recipients face incentives that cause them not to make reforms even when they get conditional loans.”  For the IMF, World Bank, and other such supranational organizations looking to provide indiscriminate help, the steady alleviation of poverty is their Northern Star. For as long as the plight of the bottom 10% of the country is much worse than the plight of the average ten-percenter, they would continue to provide the country with money, even if appropriate policy changes aren’t being devised and implemented. For the more sadistic/strategic countries, such an incentive means that, the poorer the country, the more money they will receive, in effect encouraging the country at hand to hold their poor “hostage”, shaking as much money out of their pockets as possible until the IMF/ World Bank give up their heroics.
Another incentive issue ties the size of the loan packages disbursed from a given department of the donor organization to next year’s department budget, thus promoting larger deal sizes, even in places where they may not be most appropriate. On the recipient’s end of the loan channel, incentives are equally perverse. Understanding that only future policy change is important to donor organizations, countries often present a grisly state of affairs and an optimistic and ambitious roadmap to success, only to backslide and misappropriate their loan.
When they are called back in for a “status update”, they present the same grisly picture, and a promise to keep striving for change, and the donor organization, still primarily concerned with helping the poor, acquiesces and continues another round of adjustment loans. Moreover, as these are loans that do warrant a repayment of some form at their maturity, the final incentive issue we will look at today is the recipient’s frequent inability to pay back the previous loan, and ask for another, larger loan to be provided to service their preexisting debt. Out of benevolence and, more realistically, the fear of political backlash regarding non-performing loans that have the potential to cut into budget allowances, new loans are issued, swords are rattled, and the process repeats. The umbrella dilemma, though, is that the recipient party knows well the donor organization’s incentives, and is able to methodically use them to take the driver’s seat at the negotiating table. Adjustment loaning conditional on reform, as many economists came to realize, was simply the wrong way to go about investing in low GDP countries.
Playing a Numbers Game
What the IMF and World Bank are trying now is a more past-centric approach, assessing the performance of a country’s economy in years prior and agreeing to provide a loan if they deem this upward trajectory probable in the coming years. With this new directive, countries with the best growth rates and credit are those who qualify for the largest future adjustment loans, lessening the impact of emotional pandering and relying on a no-frills emphasis on quantitative values. In this model, as per Easterly, “[…] a poor country that has no black market premium on foreign exchange, low inflation, free market interest rates, a reasonably low budget deficit, institutions to protect private property and the sanctity of contracts, and strict anticorruption policies should get a lot of aid.”  With tighter regulations and more hawkish administrative oversight, countries are now held to a standard of consistency and quality capital appropriation they had previously trampled all over, stratifying the applicant pool to elevate those with the strongest claims for growth to the top and engage with riskier markets in a more controlled manner. With incentives properly aligned and harmonious, we should expect to see more metaphorical trees “planted” in the years to come, and a steady increase in per capita income and GDP among the countries serviced by the World Bank and IMF. Until then, godspeed Greta, keep studying and I’ll keep planting!
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 “Republic of Korea: Selected Issues.” Republic of Korea: Selected Issues. International Monetary Fund, May 2019. https://www.imf.org/~/media/ Files/Publications/CR/2019/1KOREA2019002.ashx.
 Dooley, Michael P., and Jeffrey A. Frankel. Managing Currency Crises in Emerging Markets. Chicago, IL: Univ. of Chicago Press, 2003.
 Stiglitz, Joseph. “The Ruin of Russia.” The Guardian, April 9, 2003. https://www.theguardian.com/ world/2003/apr/09/russia.artsandhumanities.
 Roaf, James, Ruben Atoyan, Bikas Joshi, and Krzysztof Krogulski. “25 Years of Transition: Post-Communist Europe and the IMF.” 25 Years of Transition: Post-Communist Europe and the IMF. International Monetary Fund, October 2014. https://www.imf. org/~/media/Websites/IMF/imported-flagship-issues/external/pubs/ft/reo/2014/eur/eng/pdf/erei_ sr_102414.ashx.
 Easterly, William. The Elusive Quest for Growth: Economists Adventures and Misadventures in the Tropics. Cambridge, MA: MIT Press, 2002.