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
R A L F J. L E I T E R I T Z 1

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-à-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 J. 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.
F577–97, 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-à-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-à-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, ‘(f)inancial 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 ökonomische 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 J. 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-à-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-à-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 J. 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).