improvement in developing countries’ policies. Better macroeconomic policies and greater openness have improved the economic environments of these countries. Inflation fell significantly during the 1990s, macroeconomic management improved, exchange rates were more stable, and trade barriers were reduced. But on the other hand, there was little progress in governance, controlling corruption, and the quality of institutions worldwide—as measured for instance by the governance component of the World Bank’s CPIA index—and significant variation across countries. As a result, adjustment was, by and large, a failure. None of the top 20 recipients of repeated adjustment lending over 1980-99 were able to achieve reasonable growth and contain all policy distortions (Easterly 1985). About half of the adjustment loan recipients showed severe macroeconomic distortions regardless of cumulative adjustment loans. Adjustment lending has almost no positive effect on economic growth and little on living standards. This is a conclusion reached by several internal World Bank (OPCS) reports.<sup>7</sup> Despite good intentions, adjustment lending by the World Bank does not have a good record. To be sure, it includes a number of success stories. But it also includes cases where adjustment programs were misguided or simply not followed. Heavy reliance on conditionality was usually ineffective in the sense that a large number of conditions did nothing to strengthen borrower “ownership” of the reforms. While the focus on improving poor policies was understandable, the design of adjustment programs paid inadequate attention to governance and institutional problems, which were major constraints on the investment climate. Moreover, there was little emphasis on mitigating the social costs of adjustment and even less on equity issues. This lack of specific attention to poverty issues, understandably, attracted heavy criticism.

Although conditionality can support policy changes, it cannot persuade reluctant reformers. The number and frequency of conditions attached to adjustment loans and standby agreements from international financial institutions have little to do with successful policy reforms. Case studies have shown that effective policy reform generally emerges from domestic political consensus— and conditionality from donors does not help, and sometimes hurts, consensus building. There can be exceptions in the cases of ‘‘stroke-of-the-pen’’ reforms, such as exchange rate adjustments, where only a small number of decision makers need to be convinced of the benefits of a policy change. But even in these cases, policy reforms risk reversal if they do not command broad support.

# **The Importance of Institutions**

The neoliberal “get prices right” view of the world persisted until the early 1990s as World Bank economists struggled to provide useful advice to post-communist transition countries such as Poland, Hungary, the former Soviet Union and China—a group of countries with characteristics that were fundamentally different from those of developing countries. It soon became clear that economists did not have ready-made answer to the problems of transition economies and this helped the evolution of ideas about development. Thankfully, positive progress was made in at least three areas throughout the 1990s and 2000s. First, institutions and the political economy of

> 7  See Adjustment Lending Retrospective, June 15, 2001; Review of World Bank Conditionality, September 2005; Conditionality in Development Policy Lending, November 15, 2007; and Development Policy Lending Retrospective, October 27, 2009.

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