Research & Policy Briefs From the World Bank Malaysia Hub No. 54 February 15, 2022 The Pandemic’s Extensive Reform Agenda: How Can the Development Community Contribute? Lodewijk Smets and Richard Record The COVID-19 crisis requires policy reforms on many fronts, from debt sustainability to climate-smart recovery. This Research & Policy Brief draws on theory and empirical evidence to explore the opportunities for the international development community to support policy and institutional reform. The focus is on four dimensions of support: conditional financing, policy dialogue, analytical work, and political institutions. While budget support is important to close financing gaps, the Brief argues that high-quality analytical work and policy dialogue may be needed for sustained reform success. Although political institutions determine public policy, the Brief cautions that supporting changes in the political system may lead to unintended consequences. The Research & Policy Brief concludes with a discussion and some avenues for future research in this field. Introduction be important to close financing gaps—especially in times of crisis, financial transfers in and by themselves are unlikely to be effective In addition to disrupting lives and livelihoods, the COVID-19 in generating sustained policy change (Svensson 2000, 2003). In pandemic also laid bare an extensive policy reform agenda. There some circumstances, the budget support could even trigger is a need to build back better and greener, with climate-smart “isomorphic mimicry” (Andrews 2009), a tendency to superficially policies to support a sustainable recovery (Estevao 2020). With implement (donor-driven) reforms merely to meet conditions to more than half of all low-income countries in debt distress or at access necessary financing. In such situations, it is unsurprising high risk of it, debt concerns must be addressed (World Bank when reforms are not sustained. 2022). Furthermore, the pandemic has pushed about 100 million more people into extreme poverty (living on less than For example, from 2007 to 2012, the World Bank supported US$1.90/day) (World Bank, 2021). Making progress in eradicating anti-corruption efforts in Vietnam. The DPL series included, among poverty requires dealing with the effects of the pandemic. other reform actions, the establishment of a steering committee Relatedly, the COVID-19 crisis has shown the importance of to suspend high-level officials who had engaged in corruption and building social protection systems, to make sure no one is left the implementation of asset declaration requirements. However, behind. The pandemic has also put pressure on health and the committee was launched but abandoned. Only a small fraction education systems, leading to large human capital losses. Policies of civil servants submitted asset declarations, and the declarations are therefore needed to build more resilient and equitable health themselves were not disclosed to the public. Overall, the reform and education sectors. Finally, with an increased role of the state efforts produced only mixed results (World Bank-IEG 2015). (EBRD 2020), there is a need for good governance reforms and a While the provision of financing may not trigger sustained resizing of the public sector in a post-pandemic world. reform, there are theoretical arguments why the carrot of budget International financial institutions such as the World Bank, the support may be more effective in times of crisis (see, for example, regional development banks, and the International Monetary Drazen and Grilli 1993; Alesina, Ardagna, and Trebbi 2006). Crises Fund (IMF) play a leading role in supporting policy reform may mute political opposition and help in solving distributional (Clemens and Kremer 2016). For example, since 1980 the World conflicts, or otherwise reduce the costs of undertaking difficult Bank has supported specific policy and institutional reforms, policy reforms. On the other hand, during economic crises ranging from economic management to public sector governance, financing needs are often urgent, resulting in a possible trade-off by providing recipient governments with conditional budget between supporting critical reform and the provision of financing—called development policy loans (DPLs). Their use fast-disbursing financing (Eifert and Gelb 2006). increased markedly to respond to the COVID-19 crisis. For instance, the share of DPLs in total World Bank financing increased Cross-country empirical work suggests that crises do offer an from 24 percent in the months before the onset of the pandemic opportunity for reform. Figure 1 presents the point estimates and to 36 percent in the April–June 2020 period. confidence intervals for the impact of World Bank DPLs on the quality of economic policy, as measured by the economic This Research & Policy Brief discusses the opportunities and management cluster in the World Bank’s Country Policy and limits for the international development community to support Institutional Assessment (CPIA) database. Figure 1 (a) indicates policy reform. The focus is on four dimensions of support: that World Bank policy lending has a positive impact on the quality conditional financing, policy dialogue, analytical work, and political of economic policy in developing countries, providing evidence institutions. The Brief concludes with a discussion and some that external policy support can contribute to welfare-improving avenues for future research in this field (for more details, see reform. Interestingly, when limiting the sample to countries going Smets 2020). through a deep economic crisis, the coefficient on DPL lending almost triples (see figure 1 (b)). Conditional Financing (in Times of Crisis) Policy Dialogue and Belief Change To support policy change, donor agencies typically transfer financial resources to the recipient country’s budget, conditional Budget support operations generally go hand in hand with policy on meeting certain reform actions. While budgetary support may dialogue on reform priorities. Policy dialogue has the potential to Affiliations: Macroeconomics, Trade and Investment Global Practice, World Bank Acknowledgements: The authors thank Tobias Pfutze for thoughtful comments and suggestions. Objective and disclaimer: Research & Policy Briefs synthetize existing research and data to shed light on a useful and interesting question for policy debate. Research & Policy Briefs carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions are entirely those of the authors. They do not necessarily represent the views of the World Bank Group, its Executive Directors, or the governments they represent. The Pandemic’s Extensive Reform Agenda: How Can the Development Community Contribute? related to the quality of the underlying research (see next section), Figure 1. The policy impact of World Bank Development Policy Lending in Non-Crisis vs. Crisis Countries but also to non-informative aspects. For instance, government officials appreciate policy advice more when they have had a work 0.35 history with the development institution that provides the information, Custer et al. (2015) report. This result is consistent 0.30 with the idea that shared identity matters for belief and policy Estimated impact of DPLs formation (Bonomi, Gennaioli, and Tabellini 2021). Relatedly, 0.25 non-informative but highly salient communication by authority 0.225 figures can affect beliefs, empirical evidence gathered by Bassi and 0.20 Razul (2017) shows. 0.15 In another study, Buera, Monge-Naranjo, and Primiceri (2011) 0.10 show that the way policy makers learn from the growth experience 0.078 of their own and neighboring countries determines policy choice, 0.05 more so than redistributive or political economy concerns. Seeing what works (and doesn’t) in other countries can often be very 0.00 (a) Overall sample (b) Crisis sample effective for belief change and policy reform. At the start of the pandemic, for instance, forums such as Asia-Pacific Economic Source: Authors’ own estimations based on Moll and Smets (2020). Cooperation (APEC) and communities of practice such as the East Note: Coefficient estimates and 95-percent confidence intervals presented. Higher coefficients indicate greater policy impact of DPLs. Results are based on a Asian Public Expenditure Management Network provided a useful fixed-effects regression analysis. The dependent variable is the CPIA cluster A&B mechanism for exchange of ideas on early responses to the average, an indicator that measures the quality of macroeconomic and structural policies. The variable of interest is a dummy coded 1 if a country received DPL COVID-19 crisis. financing with at least one economic policy action. The overall sample consists of 75 aid-receiving countries. The regression sample covers the 2005–15 period. The crisis However, it is important to note that information exchange and sample consists of the overall sample limited to countries with a per capita growth contraction of at least 3.5 percent (one standard deviation below mean growth). For communication do not always help in changing beliefs. Cognitive more detail on the model and estimation method, see Moll and Smets (2020). limitations and behavioral biases may prevent people from updating their beliefs (World Bank 2015). Furthermore, beliefs build commitment—or so-called ownership—on the side of the may also fulfill important functional and psychological needs for an recipient, which is a crucial ingredient for reform success (see, for individual, such as moral esteem or self-confidence, which may example, Devarajan, Dollar, and Holmgren 2001). More make them resistant to many forms of communication, Bénabou specifically, policy dialogue may build ownership for reform and Tirole (2016) forcefully argue. through belief change. Analytical Work and Research A burgeoning literature convincingly shows that the beliefs policy makers hold concerning the functioning of the economy and As indicated in the previous section, credible information may help the way they learn from past experiences influence policy choice in changing policy makers’ beliefs, which can trigger policy change. (see, for example, Mukand and Rodrik 2018). As Rodrik (2014) Such information is often generated through analytical work and notes: research—knowledge products in which development institutions such as the World Bank invest heavily. Policymakers operate under certain working assumptions about how the world works. Their worldviews shape their Hjort et al. (2021) provide recent empirical evidence on the perception of the consequences of their and others’ actions in both contribution of analytical work for policy reform. Using economic and political domains. These ideas may fall on either side experiments with Brazilian municipalities, the authors find that of some of the biggest controversies in the history of economic mayors update their beliefs when informed about the findings of thought: Does the economy work better under laissez-faire or randomized impact evaluations (IE), especially if it involves IE with planning? Are economic growth and development more rapid large samples (suggesting that policy makers value high-quality under free trade or under protection? Each of these positions work). More importantly, the authors go on to show that municipal presumes a particular model of how the economy works and leaders in Brazil were more likely to implement a tax reform after therefore has different implications for political behavior (Rodrik being provided a research note that reported on the effectiveness 2014, pp. 192-193). of the tax reform. The above indicates that beliefs matter for policy choice. A Sound evidence about the costs and benefits of policy reform related line of research shows that beliefs can be influenced can also be used to reduce uncertainty regarding the winners and through policy dialogue. Della Vigna and Gentzkow (2009) review losers of reform (Majumdar and Mukand 2004). For example, in the empirical literature on persuasion and conclude that the early 1960s, the business community in the Republic of Korea persuasive communication is at least somewhat effective in fiercely opposed trade liberalization because it was difficult to influencing behavior, especially if it involves personal contact determine in advance which sectors would win and which sectors (which currently is often lacking due to forced teleworking, would lose, Fernandez and Rodrik (1991) report. This finding potentially weakening the persuasive power of policy dialogue suggests that providing evidence about the distributional impacts once the face-to-face element is removed). of policy change may help to unlock the status quo. Receivers of information tend to respond more positively when Due to capacity constraints, many countries may lack the they are more uncertain and when the information conveyed is capacity to generate the evidence necessary to design sound credible. The COVID-19 pandemic has dramatically increased policies. When countries lack such technical expertise, external uncertainty, therefore raising the importance of policy dialogue as agents may provide assistance. For instance, a World Bank analysis an instrument for supporting reform. Credibility of information is contrasting Malaysia’s highly competitive mobile telecommunications 2 Research & Policy Brief No.54 Box 1. Malaysia’s Need for Speed: How a Study and (TM). In December 2017, TM had a 90 percent market share. This Policy Reform Helped Unleash Ultrafast Internet made Malaysia the most concentrated fixed broadband market in the Asia-Pacific region for any country with a population larger Over the past decade, Malaysia’s internet market has been marked than one million people. by slower growth compared to most of its regional peers. This lag has been especially noticeable in terms of the adoption of fiber Policy reforms undertaken in Malaysia’s telecommunications internet services, which are essential for the sustained sector in 2018 had a significant and positive impact. Based on the development of any digital economy. Malaysia has not only lagged study findings, the government implemented a number of in comparison with more advanced economies, but also among regulatory actions. These policy actions caused the prices of fixed middle-income comparators. broadband services to drop and triggered a shift in consumer demand. Within three months, multiple service providers A World Bank study helped to identify policies to promote announced new broadband subscription plans that included faster Malaysia’s digital economy (World Bank 2018). It found that this speeds at lower prices. As Malaysia’s average fixed broadband lag was at least partly due to limited competitive pressure in the speeds tripled in just over a year, the study and associated reforms market, marked by the dominance of incumbent Telekom Malaysia helped Malaysia close the gap with leading countries. market to that of Portugal and Venezuela proved to be particularly For example, while elections are regarded as a mechanism to make convincing to support digital economy reforms (see box 1). governments accountable, in contexts without complementary institutions, supporting the introduction of democratic elections There is also increasing evidence to suggest that participatory may lead to negative outcomes. Collier and Vicente (2012) show analytical work is more effective. Country experiences in Malaysia that in such environments voter intimidation, ballot fraud, and and Vietnam have shown that civil servants are more likely to buy violence are used as strategies to affect voter turnout and in to reform proposals if they take part in analytical work (such as influence electoral results. public expenditure reviews, tax diagnostics, and growth analyses) and fully understand the evidence base associated with different Discussion and Conclusion policy choices. The old adage of never letting a crisis go to waste certainly holds in It is important to note, however, that it is not always the context of COVID-19. The pandemic has triggered an increase straightforward to generate high-quality evidence about policy in budget support financing, providing a stimulus for significant effectiveness. Deaton (2010) notes that for empirical research to policy experimentation, and has offered enduring lessons in be useful for policy analysis, it needs to be embedded in theory. In domains such as health systems preparedness, scaling of social some reform areas theory is well established and backed by broad protection, and digitalization of public services, to name just a few. expert consensus. An example is macroeconomic stabilization (Khemani 2017). The large evidence base in this area may explain That said, while budget support remains an important why support for economic reform has generally been found to be instrument to close financing gaps—especially during crises—and successful (see Smets and Knack 2016). In other reform acquire a seat at the policy dialogue table, financial transfers in areas—such as public sector governance—local context and and by themselves are unlikely to generate sustained reform. behavioral norms play an important role, making it crucial to Two other ways to incentivize policy reform include accession customize policy support and the evidence backing it. This implies to a club and aid tournaments (Mattli and Plumper 2002; Zinnes that transplanting best practices to other cases may not always be 2009). Regarding the former, the carrot of accession to the World a good idea (Rodrik 2008; Pritchett, Woolcock, and Andrews Trade Organization (WTO) proved to be a particularly effective 2013). It has also meant that policy reform progress in those driver of regulatory reform in Cambodia and Lao PDR. Both sectors has been more difficult to achieve (see Smets and Knack countries attached high-level policy objectives to gaining 2018). membership and temporarily increased the convening power of trade ministries in support of politically challenging reforms. In aid Supporting Change in Political Institutions tournaments, aid budgets are pooled and committed to a group of Policies are not only determined by beliefs and preferences, but countries, with disbursements taking place based on the also by the constraints provided by political institutions (North and countries’ relative performance. While such a proposal may seem Knight 1997). A large body of theoretical and empirical literature hard to implement, some elements are already present in the convincingly shows that broad political representation promotes World Bank’s financing model for low-income countries. investments in the common good, regardless of who holds power. As the development community acquires a seat at the policy This in turn incentivizes political leaders to build fiscal capacity and dialogue table, it is important to understand the beliefs that policy implement growth-enhancing policies (Besley and Persson 2011). makers hold and find ways to influence beliefs. This may involve Given the importance of inclusive political institutions, the exploiting the non-informative dimensions of influencing: that is, a donor community may make resources available to support common work history or the persuasive power of trusted experts. changes in the political system of recipient countries. For instance, Furthermore, development agencies often organize study tours to Africa’s third wave of democratization in the early 1990s was expose policy makers in recipient countries to new environments heavily supported by the development community (van de Walle and possibilities. Recent research by Stegmann (2018) indicates 2001). that such approaches may indeed help in transforming beliefs. However, supporting political change without taking into These factors have implications for who takes a seat at the account general equilibrium effects can be counterproductive.1 policy dialogue table. Policy discussions are often led by technical 3 The Pandemic’s Extensive Reform Agenda: How Can the Development Community Contribute? experts. Such competencies are essential, but they need to be political engagement can not only hold political leaders more complemented with a different set of skills that allow participants accountable but can also improve the incentives and norms of to gauge beliefs and tap into the non-informative dimensions of elected officials and the electorate. influencing. Therefore, it is essential that reform teams need not only include topical experts, but also persons with the proper “soft Finally, there is a need for further research on this topic. First, skills“. it is necessary to more deeply investigate the highlighted dimensions to influence policy reform. For instance, while In addition to the appropriate skills, the development advances have been made to elicit beliefs in laboratory settings, community also needs to bring sound evidence to the table about finding out the views of policy makers during policy discussions the costs and benefits of policy reform. Analytical work and may not be straightforward. Second, in addition to the dimensions research may help in shifting the policy maker’s mindset. It could discussed in this brief, other factors also influence policy choice. also reduce uncertainty about the distributional impacts of For instance, cultural traits are related to policies and institutions reform. Credible evidence, however, needs to be based on (Alesina and Guiliano 2015). Political unrest—fueled by an high-quality research designs, while the resulting policy emotional reaction to unfair treatment—influences policy prescriptions need to be adapted to the local context. This (Passarelli and Tabellini 2017). Legitimacy and citizen requires donors to dedicate sufficient resources to research and communication play an important role in the success of reforms analytical work, including an understanding of the political (Khemani 2017). Relatedly, the interplay between media markets economy within which reform options are considered (World Bank and political competition shapes public policy (Stromberg 2004). 2017). Identity politics can determine voter behavior and policy choice Given the importance of inclusive political institutions, it may (Mukand and Rodrik 2018). 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