Development Policy Lending, Conditionality, and Ownership: A Dynamic Agency Model Perspective

Abstract

Is the World Bank's Development Policy Lending likely to enhance ownership and have greater effectiveness than structural adjustment? We specify a dynamic common agency model in which a government considering economic reform faces domestic opposition from interest groups. The dynamic specification, which is original in the context of policy reforms supported by the International Financial Institutions (IFIs), is essential to allow the strength of special interest groups to arise endogenously during the reform process. We show that conditionality may alter the country's political equilibrium and lead to higher social welfare. However, under certain circumstances which depend on country-specific circumstances, conditional assistance could lead to lower social welfare. Thus, for conditionality not to be inconsistent with ownership, its design must be appropriate to the country circumstances and directly affect the domestic political constraint.