International Organizations and Structural Reforms


Researchers

Abstract:

Since the 1990s, countries throughout the world have embarked on structural reform projects. Many of these reform efforts have been undertaken with support from international organizations such as the International Monetary Fund, the World Bank, and the European Union. While in some places these reforms have been comprehensive and lasting, such as among many Eastern European nations, other nations have followed rockier reform paths. Argentina launched aggressive reforms, but most of the changes were reversed by later governments. Brazil's reforms have been long lasting, but were more modest to begin with. Reforms throughout Southern Europe were comprehensive and have lasted so far, but may now be at risk of reversal in Greece. Galiani, Torre, and Torrens build a dynamic model of the policy reform process in order to better understand why countries take different reform paths and how international organizations might more effectively encourage lasting reform.

In Galiani et al's model, there are three equilibrium reform paths. In the first case, countries embark on full scale, lasting reforms. In the second, they launch partial, but lasting reforms. Finally, in the third case, they enter into cycles of reforms and costly counter-reforms. The path a country follows is determined partially by its domestic institutions and the political incentives for reversing reforms, and partially by the influence of international organizations. Galiani et al argue that, while international organizations can increase the probability of countries successfully launching more ambitious reform projects, intervening too aggressively can increase the risk that reforms will be reversed in the future. Since such reversals can be very costly, it often may be better for international organizations to push for the greatest irreversible partial reform rather than a bigger reform that might trigger a backlash. Galiani et al also suggest that international organizations may wish to experiment with deliberately making the costs of reversal high or providing defensive funding for dealing with events likely to spur counter-reforms. Greece poses an interesting example of this former approach. Galiani et al's model predicts that, while Greece would have embarked on moderate to strong reforms on its own, European Union support resulted in more ambitious reforms being enacted. These more ambitious reforms carried with them stronger incentives for reversal, which were in turn held in check because reversing the reforms would incur the high costs of exiting the Eurozone. The survivability of Greece's reforms thus was put into something of a delicate balance, which has recently been called into question.

It is important for policy makers in international organizations to remember the domestic constraints on reform in the countries they seek to influence. Pushing through reforms that will only trigger a reversal in the future is counterproductive. International organizations must be adroit in facing the tradeoff between reform scope and reversal risk, potentially by moderating their own support for ambitious reforms or by engaging in other efforts to constrain counter-reform movements.

 

Citation:

Galiani, S., Torre, I., & Torrens, G. (2015). International Organizations and Structural Reforms (No. w21237). National Bureau of Economic Research.