INSIDE
Putting Global Governance
in Its Place
Supporting Policy Reform
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from the Outside
Illicit Financial Flows:
Concepts, Measurement,
and Evidence
Preventing More “Missing
T H E W O R L D B A N K Girls”: A Review of Policies
to Tackle Son Preference
Research
Observer
Volume 35 • Number 1 • February 2020
ISSN 0257-3032 (PRINT)
ISSN 1564-6971 (ONLINE)
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THE WORLD BANK
Research Observer
EDITOR
Peter Lanjouw, VU University Amsterdam
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CO-EDITOR
Luis Servén, World Bank
EDITORIAL BOARD
Harold Alderman, International Food
Policy Research Institute
Laura Alfaro, Harvard University
Stefan Dercon, University of Oxford
Barry Eichengreen, University of California-Berkeley
Marianne Fay, World Bank
Jeffrey S. Hammer, Princeton University
Ravi Kanbur, Cornell University
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THE WORLD BANK
Research Observer
Volume 35 r Number 1 r February 2020
Putting Global Governance in Its Place
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Dani Rodrik 1
Supporting Policy Reform from the Outside
Lodewijk Smets 19
Illicit Financial Flows: Concepts, Measurement, and Evidence
Matthew Collin 44
Preventing More “Missing Girls”: A Review of Policies to Tackle
Son Preference
Sneha Kumar and Nistha Sinha 87
Putting Global Governance in Its Place
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Dani Rodrik
Greater interdependence is often taken to require more global governance, but the logic re-
quires scrutiny. Cross-border spillovers do not always call for international rules. The canon-
ical cases for global governance are based on two sets of circumstances: global commons and
“beggar-thy-neighbor” (BTN) policies. The world economy is not a global commons (out-
side of climate change), and much of our current discussions deal with policies that are not
true BTNs. Some of these are beggar-thyself policies; others may produce domestic benefits,
addressing real market distortions or legitimate social objectives. The case for global gover-
nance in such policies, I will argue, is very weak, and possibly outweighed by the risk that
global oversight or regulation would backfire. While these policy domains are certainly rife
with failures, such failures arise not from weaknesses of global governance, but from failures
of national governance and cannot be fixed through international agreements or multilateral
cooperation. I advocate a mode of global governance that I call “democracy-enhancing global
governance,” to be distinguished from “globalization-enhancing global governance.”
JEL Codes: F53, F55
Keywords: global governance, beggar-thy-neighbor.
Introduction
In a world economy that has become highly integrated, problems always seem to
require more international cooperation and better global governance. The populist
backlash, as well as U.S. President Donald Trump’s trade policies, have added fuel to
calls made by economists, technocrats, and commentariats for more international-
ism. “[V]irtually every problem destabilizing the world in this plastic moment is global
in nature and can be confronted only with a coalition that is global . . .”, wrote the
New York Times columnist Thomas Friedman recently (Friedman 2019). Or as Ne-
mat Shafik, then the Deputy Managing Director of the International Monetary Fund,
put it in 2013, “What happens anywhere affects everybody—and increasingly so.
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doi: 10.1093/wbro/lkz008 35:1–18
So it is pretty clear that the world needs more, not less, international coordination
and cooperation” (Shafik 2013). When the European economics network VoxEU.org
solicited advice from leading economists on how address the frailties of the global
financial system in the wake of the 2008 crisis, the proposed solutions often took
the form of tighter international rules administered by some kind of technocracy:
an international bankruptcy court, a world financial organization, an international
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bank charter, or an international lender of last resort (Eichengreen and Baldwin
2008). Nationalism may seem ascendant in politics, but global governance reigns in
economics.
It is tempting to think that greater interdependence requires more global gover-
nance, but the logic requires scrutiny. On the one hand, interdependence blurs the
distinction between what is domestic and international. On the other hand, there
remains considerable institutional diversity among nations, rooted in different his-
torical, cultural, or development trajectories. This diversity reflects itself both in dif-
ferent preferences (“objective functions”) and in different perceptions of how the
world works. These in turn make it difficult for countries to agree on common
policies or rules. Today’s U.S.–China trade conflict is the paradigmatic example of
the tensions that arise in the absence of a satisfactory solution to this dilemma.1
When should global rules over-ride national differences and impose common
solutions?
Consider the following policies: educational policies; highway speed limits; gasoline
taxes; agricultural subsidies; import tariffs on cars; and tax havens.
In an economically interdependent world, each one of these policies produces
spillovers—or cross-border externalities—to other nations. The last three policies are
typically considered international, and subject to global governance. The first three
are normally considered “domestic” policies, but they too have global implications.
Educational policies can shape a country’s comparative advantage and will thereby
influence its (and other countries’) terms of trade. Highway speed limits and gasoline
taxes affect the domestic demand for oil and therefore the price of oil on world mar-
kets. The presence of cross-border spillovers does not seem like a sufficient condition
for global governance.
In fact it is not at all clear how the dividing line that is conventionally drawn be-
tween the two sets of policies is actually drawn. Should we focus on the magnitude of
cross-border spillovers? This is an empirical matter requiring case-by-case analysis.
For example, taxes on gasoline in the United States and Europe likely have far greater
impact on world markets than auto tariffs in small or medium-sized countries. Should
we ask instead whether there is harm to other nations? But export subsidies on farm
products are beneficial on net to the rest of the world since they deteriorate the sub-
sidizing country’s external terms of trade and improve the terms of trade of the rest
of the world. Perhaps we should focus on the stated objective of policy—domestic
versus international? Yet educational investments are often justified on the grounds
2 The World Bank Research Observer, vol. 35, no. 1 (2020)
of increasing a country’s global competitiveness, making them as international in
this sense as trade policies. None of these criteria does a good job of explaining why
the first set of policies is “domestic” and the second is “international.” The muddle
of global governance is that many policies have become “internationalized” through
happenstance or the operation of political lobbies, rather than on account of princi-
pled distinctions.
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The canonical cases for global governance are based on two set of circumstances.2
The first occurs when there is global public good (GPG). The classic case is carbon con-
trol policies in the presence of climate change. The second is represented by “beggar-
thy-neighbor” (BTN) policies. A BTN policy is one that produces an income transfer to
the home economy from the rest of the world while producing global inefficiency as a
by-product. Exploiting monopoly power in a rare metal on global markets by restrict-
ing sales abroad would constitute an example. Both of these circumstances provide
impeccable arguments for global governance establishing and enforcing guidelines
on what countries can do on their own. However, their relevance to the burning pol-
icy issues of the day is much more limited than is commonly realized. As I will show
below, the world economy is not a global commons, and virtually no economic policy
has the nature of a global public good (or bad). And while there are some important
BTN policies, much of our current discussions deal with policies that are not true
BTNs. Subsidies, industrial policies, employment-protecting tariffs, non-tariff mea-
sures that target health or social concerns, poor financial regulations, inappropriate
(excessively austere) fiscal policies, or national Internet walls are neither GPGs nor
BTNs. Some of these are beggar-thyself policies; others may produce domestic ben-
efits, addressing real market distortions or legitimate social objectives. The case for
global governance in such policies, I will argue, is very weak, and possibly outweighed
by the risk that global oversight or regulation would backfire.
None of this is to suggest that we live in a Panglossian world where all policy is for
the best. The policy domains I have just lifted are certainly rife with failures. When
large countries make serious policy mistakes—as in the case of the United States with
lax financial regulation in the run-up to the global financial crisis of 2007–2008—
other countries pay a price as well. My argument is that such failures arise not from
weaknesses of global governance, but from failures of national governance. These
failures cannot be fixed through international agreements or multilateral cooper-
ation. External constraints may in fact aggravate domestic failures of governance,
insofar as they empower particular distributional coalitions at the expense of the
broad publics. At the end of this paper, I advocate a mode of global governance that
I call “democracy-enhancing global governance.” Unlike “globalization-enhancing
global governance,” democracy-enhancing global governance would leave most pol-
icy domains to national regulation, with global oversight restricted to procedural
safeguards—such as transparency, accountability, the use of scientific/economic
evidence—intended to reinforce democratic deliberation.
Rodrik 3
The Analytics of Economic Interdependence:
The Case for Global Governance
It helps to have an explicit framework to discuss the issues that arise in the presence
of spillovers and to distinguish among different kinds of problems. Let us denote the
home country by h, and the generic foreign country by j, with associated policies (ac-
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tions) ah and a j . We express the utility functions in the form uh = uh (ah , i=h ai ) and
u j = u j (a j , i= j ai ). The reader may want to think of these functions as “indirect”
utility functions where all the relevant resource and political constraints have been
substituted in. As written, these utility functions capture the ideas that well-being at
home and abroad is affected not only by a country’s own policies, but also by (the sum
total of) policies of foreign countries. That is,
∂ uh (· ) ∂ u j (· )
= 0, = 0.
∂a j ∂ ah
These spillovers could be negative or positive, depending on the policy in question.
When countries act independently, maximizing their own utility and disregarding the
effects of their choices on other countries, we have the standard result that the re-
sulting (Nash) equilibrium will be inefficient. Policies with negative spillovers would
be over-supplied, and policies with positive spillovers will be under-supplied. Pigovian
taxes and subsidies that enable the internalization of these cross-border externalities
are obviously impractical in this context.
There are two benchmark cases where all countries could be made better off
through global rules that discipline a. I take them up in turn.
Global Public Goods (GPGs)
Suppose in addition to their direct, domestic effects, home and foreign policies jointly
contribute to provide a global benefit (or damage), G, which is non-rival and from
which individual countries cannot be excluded. We write utility functions as
uh = uh (ah , G ) , u j = u j a j, G ,
G = = 1.
i γi ai , i γi
The weights γi can be thought of capturing the relative size of each country, so that
for an identical set of a’s, the contribution of each country to G is proportional to its
size. When countries are small (γi ≈ 0), they overlook the effect of their policies on G.
Let’s look at the home country:
duh (· ) ∂ uh (· ) ∂ uh (· ) ∂ G ∂ uh (· )
= + = when γh ≈ 0.
dah ∂ ah ∂ G ∂ ah ∂ ah
4 The World Bank Research Observer, vol. 35, no. 1 (2020)
Since the effects on G are systematically discounted, a global public good will be
under-provided and a global public bad will be over-provided. The best known exam-
ple of this is greenhouse gas (GHG) emission, a global public bad in view of climate
change. Policy here consists of controls on GHG. Since such controls are costly at the
domestic level ( ∂ ∂uh ( · )
ah
< 0) while providing benefits only in terms of G, countries will
have the incentive to minimize these controls. A global agreement that capped do-
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mestic GHG emission levels would leave all countries better off, assuming countries
are sufficiently similar or the caps are appropriately calibrated to individual country
circumstances.
When commentators describe the world economy as a “global commons” or free
trade as a global public good, they have a similar argument in mind. But this is a
misleading analogy. Economic policies that are beneficial to the world economy also
tend to be beneficial for the home economy; they are primarily private, rather than
public goods.
First, consider trade policy. It could well be that open trade policies contribute to
a global public good: the benefits from trade may increase with the number of coun-
tries that practice free trade. But the relevant question is whether a country that dis-
regards this external benefit would have the incentive to pursue globally sub-optimal
trade policies. For a small country, the answer is no. Free trade is the optimal policy
for domestic reasons, regardless of other countries’ policies. In other words, ∂ ∂ uh ( · )
ah
= 0
when tariffs and non-tariff barriers are set to zero, and u = u (ah , G ) is maximized
h h
at free trade. (I will take up the large country optimal tariff case later.) This is very dif-
ferent from the GHG case where ∂ ∂ uh ( · )
ah
< 0, and the home country wants to set GHG
controls (ah ) at their lower limit. Countries trade not to confer benefits on their part-
ners, but to reap the domestic gains from trade. And when they forsake those gains
from trade, the problem is not with lack of global governance; the much larger failure
lies at home, with domestic governance.
Much the same logic applies in many other policy domains where good economic
policy is its own reward. Consider financial markets. Prudential financial regulation
ensures that financial intermediaries do not take on too much risk and financial in-
stability is kept in check. When financial centers pursue appropriate policies they en-
hance financial stability and soundness for the global economy as a whole. But these
centers have all the incentive in the world to adopt such policies since they will be the
first to bear the costs of financial crises. The 2008 global financial crisis may have
been due to lax financial regulations in the United States. But these policy mistakes
did not originate from the U.S. government’s lack of concern for the global economy.
Rather, they were the result of a series of misjudgments with respect to the domestic
consequences of financial liberalization. U.S. regulators did not require greater cos-
mopolitanism; they needed a better sense of the national interest.
Similar arguments can be made for fiscal policy, tax policy, and regulation in gen-
eral. Excessive austerity can be damaging to the world economy, but the costs are
Rodrik 5
borne first and foremost at home. Inappropriate tax policies or poorly designed regu-
lations hurt the home economy in much greater measure than they affect other na-
tions. In all these areas, policies that sustain a healthy global economy are—or should
be, with appropriate domestic governance—in the national interests of each country.
The extent to which global governance can help fix domestic governance problems is
a different question, to which I will turn later. The point for now is that most standard
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economic policies cannot be considered to be GPGs.
Beggar-Thy-Neighbor Policies (BTNs)
Beggar-Thy-Neighbor policies provide benefits at home only to the extent that they
harm other countries. Additionally, they generate global inefficiency, a deadweight
loss. A well-known instance in trade policy is the so-called optimum tariff, whereby
a large country can manipulate its terms of trade by restricting its imports (or ex-
ports). Since other nations face similar incentives, in the end all (or most) countries
end up worse off by engaging in destructive trade practices (Johnson 1953). This type
of problem represents the second canonical case for global governance. Distinguish-
ing between BTN and non-BTN policies can be useful in practice to ascertain the limits
of desirable international rules. For example, my colleagues and I have proposed an
approach to U.S.-China economic relations that centers on drawing a bright red line
around BTNs (U.S.-China Trade Policy Working Group 2019).
A two-country example follows, with home (h) and foreign (f ). We write util-
ity functions as the sum of two components, a regular part that depends only
on own policies, w i (ai ), and a second part that captures the pure transfer compo-
nent of the policy T (ah − a f ), with T (0) = 0. We assume without loss of general-
ity that the derivative of T (· ) is positive. The full utility functions for h and f are
expressed as:
uh = w h ( a h ) + T a h − a f
u f = w f ( a f ) − T ah − a f .
Note that the transfer component is zero-sum: whatever home gains from its policy
comes at the expense of losses to foreign, and vice versa. The first-order condition for
home is:
duh (· ) ∂ w h (· ) ∂ T (· )
= + = 0.
dah ∂ ah ∂ ah
T (· )
Since ∂∂ > 0, optimality requires ∂ w (· )
h
ah ∂ ah
< 0 in equilibrium. Under the standard
assumption of concavity of utility functions, the implication is that the level of ah is
higher than what it would be in a situation without the transfer, or BTN component
(figure 1).
6 The World Bank Research Observer, vol. 35, no. 1 (2020)
Figure 1. The Equilibrium Level of ah in BTN Equilibrium
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Source: Author.
Assume for simplicity that the two countries are identical. Then the analogous first-
order condition for f implies that ah = a f and T (· ) = 0. In equilibrium, neither coun-
try is able to extract transfers from the other. But in attempting to beggar each other,
they are both driven to inefficiently high levels of ah and a f . This is exactly what hap-
pens in the optimum tariff case.
Another example would be the use of mercantilist currency policies. Assume there
is generalized unemployment, and both countries would benefit by running a trade
surplus. Each country tries to undervalue its currency or follow other policies to im-
prove its trade balance. But one country’s trade surplus is the other country’s trade
deficit. In the end, such efforts offset each other. Neither country ends up with higher
employment, but both suffer the incidental costs of mercantilist policies.
Since BTNs are negative-sum policies, there is a strong presumption that they
should be restrained using global rules. Note that in the two examples I have used
above, it is also the case that both countries are better off when their policy auton-
omy is restricted (by placing ceilings on ah and a f ) compared to when they have full
autonomy. Subject to the usual caveats about commitment, these are the relatively
easy cases for global governance.3
But there are other cases of BTN policies where one or more of the countries would
be worse off in the cooperative equilibrium. (Side payments from the beneficiaries to
the losing country would rule out such a possibility, but these are difficult to imple-
ment in a global context.) In the optimum tariff game I discussed, in the presence
of asymmetry it is possible for one of the countries to prefer the Nash equilibrium
to the cooperative equilibrium: a larger country gains more from manipulating its
terms of trade than a smaller one, and has more to lose from international disciplines.
The example of a global cartel, mentioned in the introduction, is another example.
Rodrik 7
Suppose a number of exporters of a key commodity have cartelized and are facing
a large number of small importers. A cooperative equilibrium that prevented them
from exercising monopoly power would definitely leave the cartel members poorer. In
this instance, there is no incentive for these countries to join any global governance
scheme.
A second, similar example is that of pure tax havens. A pure tax haven is a ju-
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risdiction that applies a very low corporate tax rate for the sole purpose of enabling
international corporations to engage in tax evasion. This represents a BTN policy be-
cause it undermines the tax base of countries and shifts the global tax burden towards
labor, a poorer group, without stimulating physical investment. Pure tax havens shift
paper profits to low-tax jurisdictions, not physical capital (Tørsløv, Wier, and Zucman
2018). In this case too, global governance that prevented tax competition would leave
some countries, namely the pure tax havens, worse off. They would be deprived of the
revenues they generate by attracting a very large base of paper profits at very low tax
rates. An analogous case can be made for personal income or wealth tax havens. A
global registry that would identify ultimate owners of bank accounts in all financial
jurisdictions would assist tax administration and collection and benefit most coun-
tries of the world, but the tax havens would lose out.
Whether they make all countries better off or not, the demands that BTN policies
make on global governance are rather limited. That is because relatively few policies
fall under this rubric. In fact, I have mentioned here all the straightforward examples
of BTN economic policies I can think of: optimum tariffs, international monopolies or
cartels, trade-balance mercantilism, and pure tax havens (for corporate and personal
income).4 Perhaps U.S.-China competition in digital technologies opens new areas of
BTNs, but the vast majority of economic policies that are contentious and come under
international scrutiny are not BTNs, even though they are frequently presented as
such—just as the global economy is often misleadingly viewed as a global commons.
The Weak Case for Global Governance:
Policies that are Neither GPGs Nor BTNs
Consider the following two policies: R&D subsidies in a country that imports
technology-intensive goods; and; an import ban on goods produced with slave labor.
Both policies create negative cross-border spillovers. The first improves technological
capabilities in the home economy and can be expected to have an adverse terms-of-
trade impact on the rest of the world. This is because as the country becomes better at
producing technologically advanced goods, its demand for imports of such goods fall.
The second policy has a direct adverse economic impact on exporters of slave-made
goods. In both cases, current practice is that such policies are not regulated interna-
tionally. Countries are free to do what they please in both domains. My guess is that
8 The World Bank Research Observer, vol. 35, no. 1 (2020)
this conforms to the intuition of most analysts with respect to what constitutes an
appropriate dividing line between domestic and international spheres of regulation.
I will argue in this section that a large number of policies that global policy makers
do try to bring under global governance are precisely of the same nature as one or
the other of the two examples just mentioned. In particular, they have the following
characteristics: (a) they either do not create global inefficiency; (b) or when they do,
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it is the domestic economy that bears the direct economic costs.
Technology subsidies are in category (a), assuming there are knowledge spillovers
(even if these spillovers are purely domestic). The reason global governance is not
believed to be appropriate in this instance is presumably that there is an economic
justification for the policy in question, and the presence of cross-border spillovers is
not grounds on its own for limiting what each nation can do independently. The im-
port ban is in category (b). The reason for allowing a country wide latitude in this
case is different: an import ban might be economically inefficient, but it is the home
country that pays the economic price for it first and foremost. Effectively, the home
country trades off the economic cost against the value of upholding a moral stan-
dard against slavery. It does not seem fitting for an international organization or a
global governance regime to second-guess the appropriateness of this tradeoff.
Yet many other policies that are routinely internationalized are no different. I will
examine them below.
Non-BTN Policies: Enrich-Thy-Neighbor Policies
Enrich-Thy-Neighbor policies produce positive aggregate effects on the rest of the
world and are yet contentious globally. This seems paradoxical, and it is. There is
one significant category of policies that fit this description: subsidies on exportables.
Whether they be on agricultural products or manufactured goods, export subsidies
are considered to be a no-no internationally. This is puzzling since export subsidies
are an economic “gift” to the rest of the world. True, some foreign countries may
lose, but this does not alter the fact that the aggregate effect on the rest of the world
is positive.5
Formally, consider a world with two foreign countries, f and g. Denoting the policy
of the home country as ah as before, their utility functions take the following form:
u f = u f ( a f , ah ) and ug = ug (ag, ah ),
∂ u f (· ) ∂ ug ( · )
with > 0 and < 0.
∂ ah ∂ ah
As the partial derivatives indicate, we assume that an increase in ah has asymmet-
ric effects abroad. Country f benefits, while country g loses. When ah stands for an
export subsidy, we know that the sum of these two effects of opposite sign has to be
Rodrik 9
positive. That is because the export subsidy deteriorated the home country’s terms of
trade, and therefore improves the terms of trade of the rest of the world in aggregate
(f and g taken together). The asymmetric effects in turn would be due to the pattern
of comparative advantage across countries. Country g may have a comparative ad-
vantage structure similar to the home country, so that the terms of trade of g and of
the home country move together. So agricultural export subsidies, for example, will
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make net exporters of agricultural products in the rest of the world worse off, while
making net importers better off.
There are three arguments for why export subsidies should nevertheless be glob-
ally disciplined, none of which is very compelling. First, it is the case that some for-
eign countries lose. Members of the Cairns group of large agricultural exporters have
made their case loudly and successfully within the GATT/WTO regime in the case of
agricultural subsidies. But this is a curious argument insofar as there are multitudes
of policies that are left under national prerogative, but likewise produce asymmet-
ric effects abroad. These include policies that are roundly applauded by economists
and technocrats as appropriate policies. Consider unilateral import liberalization as
a blatant example. When a large country unilaterally reduces its import barriers, it
normally incurs a terms-of-trade loss. More to the point, foreign countries that share
this country’s comparative advantage pattern also experience a terms-of-trade loss.
(When I increase my imports of textiles and autos, driving their relative prices up on
world markets, all other net importers of textiles and autos suffer too.) And in their
case, there is no compensating increase in gains from trade. So some foreign coun-
tries are definitely left worse off. To my knowledge, this has never been used as an
argument for placing global limits on countries’ ability to unilaterally liberalize their
trade regimes.
The second argument is that subsidies, unlike unilateral import liberalization, are
globally inefficient. This justification for global governance has to do with the eco-
nomic desirability of subsidies in general, and not with the incidence of their external
effects. The trouble here is that it is difficult to take such a categorical stance against
the use of subsidies. There may be genuine learning externalities associated with ex-
porting, which the subsidizing country aims to reap. Or there may be social or po-
litical objectives that are equally justifiable on broader grounds, even if not strictly
economically. Just as the moral stance reflected in the import ban on slave-produced
goods cannot be second-guessed by other countries, it may not be appropriate for for-
eign countries to question whether a particular social objective is valid or best ad-
dressed through subsidies. I will scrutinize these issues at greater length in the next
subsection. What can be said unambiguously is that when the subsidies do not serve
a real economic purpose, unlike BTNs, their most immediate costs are shouldered by
domestic taxpayers and consumers.
The third argument is that subsidies (and similar policies) are “unfair” because
they undermine level playing fields in global trade. This argument is based on the
10 The World Bank Research Observer, vol. 35, no. 1 (2020)
view that all nations should compete on an even basis.6 But what constitutes a level
playing field, like fairness, is very much in the eye of the beholder. For example, devel-
oping nations have long made the argument, not entirely unreasonably, that subsi-
dies (like lax patent rules) serve to compensate for the disadvantages of backwardness,
and in any case are practices that advanced nations themselves pursued when they
were poorer. In other words, they make trade fairer rather than less so. Of course, if
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global agreement can be reached on what is “fair,” it makes sense to pursue common
standards. But often such common ground will be lacking. In those cases, it would be
inappropriate to seek global disciplines.
This is not to say that “unfair trade” is an empty and useless concept. When nations
face trade transactions that they think undermine domestic moral codes or norms of
fairness, they should be free to regulate them accordingly.7 The difference is between
living by one’s own moral standards and imposing them on others.8
Non-BTN spillovers: Policies with Ambiguous Domestic Efficiency Implications
We finally consider policies that produce adverse spillovers to other countries, but
are used for domestic reasons rather than for BTN purposes. These domestic reasons
might be economic or non-economic, well-grounded or not. There is a very wide va-
riety of such policies that are either already regulated internationally or frequently
come under international scrutiny. Here is a partial listing:
• “weak” intellectual property rights protections;
• industrial policies that do not involve export subsidies, such as domestic subsidies,
local content requirements, “trade-related investment measures,” etc.;
• bans on GMOs, hormone-fed beef, and other similar “health” measures;
• “excessive” fiscal austerity;
• “lax” financial regulation;
• import protection to prop up employment in certain industries or regions;
• “very low” levels of corporate taxation (i.e., as in Ireland, where there may be
effects on domestic capital formation, not pure tax havens such as the Cayman
Islands);
• data localization, local-cloud policies, and other Internet-nationalizing policies.
The domestic economic effects of all these policies ex ante are either negative or
ambiguous. And they typically generate negative spillovers for other countries. All
of this may suggest a rationale for global governance in these areas. The difficulty
is that, as in the export subsidy case, there are strong countervailing arguments that
cannot be dismissed. First, while policy failures are obvious ex post, they may not be so
clear ex ante. To take a prominent example, there is now widespread agreement that
financial regulators in the United States did a poor job of reining in risk-taking in
Rodrik 11
mortgage lending and in the shadow banking sector prior to 2007. But views on the
appropriateness of prevailing regulatory practices diverged significantly at the time.
It is not at all clear that greater international coordination on financial regulation
would have produced better outcomes. In fact, given the influence the U.S. financial
sector exerted on the determination of Basel rules, the opposite was just as likely.
Second, there may indeed be market failures of distortions at home that justify the
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use of such policies, as second-best remedies even if not first-best ones. It is not obvi-
ous that trade negotiators or international bureaucrats are better placed than domes-
tic legislatures and policy makers to make the right call in complex cases. Third, there
may be overwhelming non-economic considerations—social, environmental, health,
national security or moral—that trump economic costs and benefits. Once again,
the relevant trade-offs are better evaluated at the national level, within pre-existing
democratic decision-making bodies, than via delegation to international agencies.
The primary argument for global governance in these cases, one that economists
are especially fond of making, is that global rules can prevent countries from us-
ing “beggar thyself ” policies by correcting domestic political failures. A more so-
phisticated political-science version is provided in Keohane, Macedo, and Moravcsik
(2009); it is a version of the standard delegation argument. Essentially, it views exter-
nal constraints acting as a counterweight to special interests or rent-seeking lobbies.
Trade agreements, for example, allow governments to say “no” to their protectionist
lobbies at home by adhering to the following logic: “we would love to raise tariffs on
this product, but WTO rules do not allow us to do so.”
There are three counter-arguments. First, non-standard, heterodox policies can
have economic justification in second-best contexts (Rodrik 2008). Global rules
or bureaucracies cannot reliably distinguish between “beggar thyself ” and eco-
nomically desirable policies. This is especially true in policy domains that require
significant local knowledge, as with industrial policies or financial regulations. Sec-
ond, even when there is a strong presumption that countries are engaged in “beggar
thyself ” policies, democracies should be allowed to make their own “mistakes.” For
example, the European Union may be deluded in banning GMOs or hormone-fed beef,
but allowing supranational bodies to pass judgment in such matters undermines
both democracy and the legitimacy of global governance arrangements. Third, and
perhaps most importantly, there is no presumption that global governance institu-
tions are more immune to capture by special interests than domestic policymaking.
Indeed, large corporations, international banks, and Big Pharma have exercised
disproportionate influence on global economic governance. It would be naïve to
presume that they have prioritized the public interest over their particular interest in
shaping global agreements in line with their needs.
I have developed the last point in Rodrik (2018) in the context of trade agreements.
The conventional view of trade agreements is that they offer welcome relief against
protectionist interests at home, that is, inefficient import-competing firms and labor
12 The World Bank Research Observer, vol. 35, no. 1 (2020)
unions. When trade agreements were largely about import tariffs and quotas—that
is before the 1980s—this made a lot of sense. Multilateral trade negotiations were
about lowering these barriers, which meant going against what protectionist inter-
ests at home wanted. But after the establishment of the WTO in 1995, and especially
with the mushrooming of regional trade agreements after the 1990s, the political
economy of trade agreements began to look very different. The new-style agreements
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increasingly focused on domestic rules and regulations, such as intellectual property
rights, investor rights, health and sanitary regulations, subsidies, and so on.
Unlike in the case of tariffs and quotas, there is no natural benchmark that readily
allows us to judge whether a regulatory standard is excessive or protectionist. Differ-
ent national assessments of risk—safety, environmental, health—and varying con-
ceptions of how business should relate to its stakeholders—employees, suppliers, con-
sumers, local communities—produce different standards, none obviously superior to
others. In other words, regulatory standards are public goods over which different na-
tions have different preferences. An optimal global governance scheme would trade
off the benefits of expanding market integration (by reducing regulatory diversity)
against the costs of excessive harmonization. But it is difficult to know where that op-
timal point may lie. Asking trade negotiators to perform this task adequately across a
wide variety of policy domains seems unrealistic.
And this is before we allow for the political influence of internationally-oriented
special interest lobbies, which have played a critical role in these new domains, by
shaping the formulation of global intellectual property regulations, investor arbitra-
tion clauses, banking standards and many others. Public information in the United
States on lobbying for trade issues shows that pharmaceutical manufacturing firms
and PhRMA (the industry association) top the list by a wide margin. Other significant
contributors are auto manufacturers, milk and dairy producers, textiles and fabrics
firms, information technology firms, and the entertainment industry. Labor unions
such as United Steelworkers and the AFL-CIO, which are traditionally associated with
protectionist motives, tend to lag considerably behind these industry-based groups.
These considerations suggest a different political economy model than the one
economists have long been partial to. The domestic game that is played is not one
between a free-trading government and protectionist interests, with international
commitments serving to tie the government’s hand against protectionism. Rather, it
is one where large international firms capture the international policy-making pro-
cess to design global governance regimes in IPRs, banking, investment rules, etc., that
are highly partial to their own interests. Unlike in the conventional model, the rent-
seekers here are not the traditional protectionists. Instead, they are pharmaceutical
companies seeking tighter patent rules, financial institutions that want to limit the
ability of countries to manage capital flows, or multinational companies that seek
special tribunals to enforce claims against host governments. In this setting, trade
agreements serve to empower special interests, rather than rein them in.
Rodrik 13
Democracy-Enhancing Global Economic Governance
Whether international agreements can systematically alter domestic political equi-
libria in a desirable direction is a question with no clear-cut answer in theory. The re-
cent evidence from trade agreements, reviewed briefly in the previous section, is not
encouraging. Moreover, using external restraints to shape domestic policy has a cer-
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tain cost in terms of democratic legitimacy: it reinforces nativist populists’ message
of sovereignty being ceded to cosmopolitan technocrats. It should not be up to the
“global community” to tell individual nations how they ought to weight competing
domestic goals and priorities.
This does not preclude a global conversation over the nature of diverse benefits and
harms to the parties. Such conversations can be helpful in reducing international
misunderstandings about policy objectives, and sometimes in establishing new be-
havioral norms. When adverse economic spillovers are large, other countries may be
able to convince governments that are the source of these spillovers to engage in bet-
ter policies. International dialogue can enable some Coasian bargains to be struck
when the losses incurred by other nations exceed domestic benefits.
The question I have tried to answer in this paper is: what are the circumstances
under which countries should enter into binding international agreements? A some-
what different question relates to the form that these agreements should take—not
just which policies should be covered, but also what types of domestic policy processes
should be encouraged or discouraged. The article I mentioned above by Keohane,
Macedo, and Moravcsik (2009) argues that multilateral agreements help democra-
cies function better.9 While I disagree with this conclusion as a general rule (see, e.g.,
Rodrik 2018), it is possible to turn their argument on its head, and use it as a nor-
mative proposition (about how things should be) instead of a positive one (about how
things are). Accordingly, we can envisage an alternative conception of global eco-
nomic governance that directly targets potential domestic governance failures with-
out presuming either that the appropriate national policies are known ex ante, or that
global governance can have a significant impact. I call this democracy-enhancing
global governance (DEGG), after Keohane, Macedo, and Moravcsik (2009).
We can usefully distinguish DEGG from “globalization-enhancing global gover-
nance” (GEGG), which comes closer to the spirit of prevailing practice in the world
economy today. Under GEGG, we can justify any and all external rules that restrict
domestic policy autonomy if the result is to minimize transactions costs associated
with national borders. Under DEGG, we would impose only those (mostly procedural)
obligations that enhance domestic deliberation or are consistent with democratic del-
egation.
I have in mind procedural requirements designed to enhance the quality of do-
mestic policy making. Examples of such requirements would be global disciplines per-
taining to transparency, the broad representation of stakeholders, accountability, and
14 The World Bank Research Observer, vol. 35, no. 1 (2020)
the use of scientific/economic evidence in domestic proceedings. These procedural
requirements would not prejudge what the end result might be—whether a country
might impose a tariff, subsidy or any other “beggar thyself ” policy.
Disciplines of this type are already in use in the WTO to some extent. The Agree-
ments on Safeguards and Anti-Dumping specify domestic procedures that need to be
followed when a government contemplates restricting imports from trade partners.
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Similarly, the SPS Agreement explicitly requires the use of scientific evidence when
health concerns are at issue. Procedural rules of this kind can be used much more
extensively and to greater effect to enhance the quality of domestic decision-making.
For example, anti-dumping rules can be improved by requiring that consumer and
producer interests that would be adversely affected by the imposition of import du-
ties take part in domestic proceedings. Subsidy rules can be improved by requiring
economic cost-benefit analyses.
We should not exaggerate the positive contribution such requirements can
make to domestic decision-making. Consider, for example, Trump’s national se-
curity argument for hiking tariffs on steel and other imports. This is a classic
beggar-thyself policy. WTO principles in this area are vague and remain largely
untested in practice. On the one hand, the relevant text seems to open the door
very wide by saying “Nothing in this Agreement shall be construed . . . to pre-
vent any contracting party from taking any action which it considers necessary
for the protection of its essential security interests.” Article XXI of the WTO
https://www.wto.org/english/res_e/booksp_e/gatt_ai_e/art21_e.pdf . On the other
hand, in a recent ruling in a case not involving the United States, the WTO adopted
the position that it can review national decisions in this area and judge their appro-
priateness. Predictably, the United States has criticized this decision.10
One can imagine more explicit rules about the process the United States (or any
other country) must go through before the national-security case is established. For
example, has the government prepared a public report, with input from economists
and national security experts, which lays out the case in favor? Have the domestic
opponents of the policy been given the chance to make the case against? Nevertheless,
it is doubtful that any WTO approach would make a difference to Trump’s trade follies.
But at least it might deny Trump (and other nativist politicians) the grounds for the
habitual complaint that the WTO and other international bodies are trampling on
national sovereignty.
At best, the light governance rules of DEGG I propose here can help somewhat. At
worst, they do no harm. These rules entail soft disciplines for countries that already
uphold democratic norms at home and that would benefit from the additional rein-
forcement that comes from international fora. But it is also possible to envisage harder
disciplines, where countries get the full benefits of trade agreements only to the ex-
tent that they live up to democratic commitments. Such requirements already exist
in some trade agreements (e.g., the U.S. system of trade preferences for low-income
countries).
Rodrik 15
Concluding Remarks
International agreements are contracts into which nations freely enter. And since
they are voluntary contracts, there would seem little reason to question them on
the basis of loss of national autonomy or democratic legitimacy. But this approach
begs the question of why states enter into such contracts in the first place. To have
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democratic legitimacy, international agreements have to pass political and economic
tests: they must produce broad benefits and be consistent with democratic delegation
(impose restraints that enhance democratic functioning). By developing principled
arguments for global economic governance, we can clarify the set of circumstances
under which such contracts are broadly desirable—as well as distinguish these cir-
cumstances from instances where the contractual nature of international agreement
is used as a cloak to hide the privileging of particular special interests.
When, for example, U.S. trade negotiators obtain TRIPS concessions from another
country in return for opening the U.S. market to that country’s exports of garments,
they effectively trade-off gains to Big Pharma against concentrated losses on some
segments of the domestic labor market. How do we think about the appropriateness
of such a contract? Fundamental economic arguments of the type I have examined
here are critical for supplying appropriate justifications. In the presence of BTN/GPG
considerations, the contract could be win-win. In their absence, what superficially
appears to be win-win—a mutual exchange of market access—is essentially a
policy that induces a first-order redistribution at home. International agreements
would have more democratic legitimacy at home in the first instance than in the
second.
Of course, even in BTN/GPG cases, there is no guarantee that democracies will
solve their domestic political problems and reach appropriate international bargains.
The U.S. withdrawal from the Paris climate agreement is a notable example. Such
problems are yet another reflection of one of the key arguments in this paper: most
policy mishaps in the world economy today occur due to failures of national gover-
nance, not due to lack of international cooperation.11 To take yet another American
example, Trump’s national security tariffs are bad policy not because they harm cer-
tain other nations; they are bad policy because they impose substantial costs directly
on the U.S. economy.
Conventional wisdom on global governance relies on international coordination
failures arising from global public goods or beggar-thy-neighbor policies. When the
troubles originate with beggar-thyself policies instead, or legitimate grounds for di-
versity in economic policies, this perspective is no longer helpful. For such circum-
stances, we need to update our thinking. We need to adopt a different approach to
global cooperation, one that respects the policy space of nations and targets demo-
cratic decision-making norms instead of one that emphasizes the harmonization of
policies or the removal of (real or perceived) trade barriers.
16 The World Bank Research Observer, vol. 35, no. 1 (2020)
Notes
Dani Rodrik is with the Harvard Kennedy School. This is a revised version of a paper prepared at the
World Bank ABCDE conference on June 17–18, 2019 in Washington, DC. I am grateful to three refer-
ees, Robert Cook, Robert Keohane, Robert Staiger, and especially Harlan Grant Cohen for very useful
feedback.
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1. See U.S.-China Working Group on Trade Policy (2019) for a statement along these lines, and an
approach that follows the ideas in the paper.
2. There is a rich body of analytical literature on the economics of trade agreements, which is
complementary to my discussion here. See Bagwell and Staiger (2001, 2004); Frieden et al. (2012);
Grossman (2016) and the references therein. See also Gallagher and Kozul-Wright (2019) for an artic-
ulation of a new set of principles for the future of multilateralism, and Cohen (2019) for an argument
for “re-embedding” international trade law in domestic policy priorities.
3. A commitment problem arises because each country would still like to deviate from the coopera-
tive equilibrium and resort to BTN policies. The issue of commitment also raises the question of why a
cooperative outcome could not be obtained through repeated-interaction incentives in dynamic games,
instead of relying on an international agreement or organization such as the WTO. Formal governance
structures may have an advantage in that they allow for coordination when there are multiple equilibria
to select from and provide information on compliance in settings with many players (see discussion in
Grossman 2016).
4. There is also a wide range of circumstances with imperfect competition where governments may
want to shift rents from foreign to domestic firms. Policies used in such cases sometimes look like BTN
policies, but the presence of imperfect competition means that their global efficiency consequences can
be quite different from standard BTN policies. For example, when a country subsidizes its domestic
oligopolist (say Airbus) to shift rents from a foreign oligopolist (Boeing), the rest of the world benefits
through lower prices.
5. A possible exception arises in the case of truly predatory pricing: subsidies may enable the home
firm to drive foreign competitors out of business and subsequently exert monopoly power on world mar-
kets. But such cases are rare (and would fall under BTN policies discussed previously). Current trade
rules do not single out predation (as they should).
6. I am grateful to Robert Cook for reminding me of this argument.
7. I provide a concrete example in my proposal for an anti-social dumping clause in Rodrik (2019).
This proposal seeks to marry national autonomy in upholding domestic social bargains with the global
procedural restraints discussed below.
8. In some areas, there may well be well-established global norms. (I will treat democracy as one
such global norm later in the paper when I discuss democracy-enhancing globalization.) But in other
areas, including especially the treatment of labor markets, practices obviously differ.
9. At least one of the authors (Keohane) seems to have changed his mind subsequently (see Colgan
and Keohane 2017).
10. This is a case involving Russia’s transit restrictions affecting Ukraine. See
https://www.wto.org/english/news_e/news19_e/dsb_26apr19_e.htm.
11. The word “today” is important in this sentence. It is possible to envisage situations where fail-
ure in international cooperation plays a much more significant role. Trade and macroeconomic policies
during the 1930s provide an example. Similarly, a future world where statist/nationalist governments
pursue a wide range of BTN policies is not unimaginable.
References
Bagwell, K., and R. W. Staiger. 2001. “Domestic Policies, National Sovereignty and International
Economic Institutions.” Quarterly Journal of Economics 116 (2): 519–62.
Rodrik 17
———. 2004. The Economics of the World Trading System. Cambridge, MA: MIT Press.
Cohen, H. G. 2019. “What is International Trade Law For?” American Journal of International Law 113
(2): 326–46.
Colgan, J. D., and R. O. Keohane. 2017. “The Liberal Order is Rigged: Fix it Now or Watch it Wither.”
Foreign Affairs (May/June): 36–44.
Eichengreen, B., and R. Baldwin. 2008. “What the G20 Should Do on November 15th to Fix the Finan-
cial System.” Vox, November 10, 2008. http://voxeu.org/index.php?q=node/2544.
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Frieden, J., M. Pettis, D. Rodrik, and E. Zedillo. 2012. After the Fall: The Future of Global Cooperation.
Geneva, Switzerland: Geneva Reports on the Global Economy International Center for Monetary
and Banking Studies. https://www.sss.ias.edu/files/pdfs/Rodrik/Research/After-the%20Fall-Future-
Global-Cooperation.pdf .
Friedman, T. L. 2019. “Has Our Luck Run Out?” New York Times, April 30, 2019.
https://www.nytimes.com/2019/04/30/opinion/trump-climate-change.html.
Gallagher, K. P., and R. Kozul-Wright. 2019. A New Multilateralism for Shared Prosperity: Geneva Principles
for a Global Green New Deal. Boston, MA: Boston University Global Development Policy Center and
UNCTAD.
Grossman, G. 2016. The Purpose of Trade Agreements. Princeton: Princeton University.
Johnson, H. G. 1953. “Optimum Tariffs and Retaliation.” Review of Economic Studies 21 (2): 142–53.
Keohane, R. O., S. Macedo, and A. Moravcsik. 2009. “Democracy-Enhancing Multilateralism.” Interna-
tional Organization 63 (Winter): 1–31.
Rodrik, D. 2008. “Second-Best Institutions.” American Economic Review 98 (2): 100–4.
———. 2018. “What Do Trade Agreements Really Do?” Journal of Economic Perspectives 32 (2): 73–90.
———. 2019. “Policy Brief No. 9: Towards A More Inclusive Globalization: An Anti-Social Dump-
ing Scheme.” Economics for Inclusive Prosperity. https://econfip.org/policy-brief/towards-a-more-
inclusive-globalization-an-anti-social-dumping-scheme/#.
Shafik, N. 2013. “Smart Governance: Solutions for Today’s Global Economy.” International Monetary
Fund, December 3, 2019. https://www.imf.org/en/News/Articles/2015/09/28/04/53/sp120513.
Tørsløv, T., L. Wier, and G. Zucman. 2018. “The Missing Profits of Nations.” NBER Working Paper No.
24701 (August).
U.S.-China Trade Policy Working Group. 2019. U.S.-China Trade Relations: The Way For-
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18 The World Bank Research Observer, vol. 35, no. 1 (2020)
Supporting Policy Reform from the
Outside
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Lodewijk Smets
Sound economic and social policies are important if countries wish to prosper and achieve
sustainable development. It is far from guaranteed, however, that policymakers select and im-
plement good policies, which provides a rationale for external policy support. Indeed, many
organizations are engaged in supporting policy reform processes in recipient countries. This
study investigates the limits and opportunities of supporting policy reform by focusing on
four dimensions of support: conditional financing, policy dialogue, technical evidence and
political institutions. Four findings follow from a review of the literature. First, without
commitment on the recipient side, conditional financing is unlikely to induce policy reform.
Second, when external actors acquire a seat at the policy dialogue table, it is important to de-
tect (and influence) the beliefs policymakers hold. Third, outside parties should bring sound
evidence to the table about the costs, benefits, and effectiveness of their policy proposals.
Finally, supporting changes in political institutions without considering general equilibrium
effects can be counterproductive. The study concludes with a discussion and some avenues for
future research in this field.
JEL Codes: E60, F35, F53, O19, O20
Keywords: Policy-based lending, aid effectiveness, policy reform, political institutions,
persuasion, evidence, policy dialogue, belief change.
Introduction
Public policies are needed to provide public goods and address externalities, should
aim for equitable redistribution, and support a good functioning of the economy.
Sound economic and social policies are therefore important if countries wish to pros-
per and achieve sustainable development. Several studies have demonstrated the pos-
itive effects of public policies on growth and development. For example, Knack and
Keefer (1995) show that strong contract enforceability and low risk of expropriation
The World Bank Research Observer
© The Author(s) 2019. Published by Oxford University Press on behalf of the International Bank for Reconstruction and
Development / THE WORLD BANK. All rights reserved. For permissions, please e-mail: journals.permissions@oup.com
doi: 10.1093/wbro/lkz006 35:19–43
Figure 1. Quality of the Policy and Institutional Framework, 2015
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Source: Gwartney, Lawson, and Hall (2015).
are associated with investment and economic growth. With regard to inflation
control, Fischer (1993) demonstrates that keeping inflation sufficiently low is con-
ducive to sustained economic growth. Burnside and Dollar (2000) report evidence of
a strong association between economic growth and a policy index that includes bud-
get surplus, inflation, and openness to trade. Henry and Miller (2009) compare the
growth experience of Barbados and Jamaica and conclude that—next to the broader
institutional framework—macroeconomic policies also matter for economic success.
It is far from guaranteed, however, that good policies arise in equilibrium.
Figure 1 illustrates for the year 2015 the quality of the policy framework for a large
set of countries. The figure is based on the Fraser Institute’s Economic Freedom of
the World Index, which measures the degree to which the policies and institutions
of countries are supportive of economic development.1 Scores range from 1 to 10.
Figure 1 shows that considerable variation exists in the quality of policies that coun-
tries end up with. In 2015, Venezuela was ranked at the bottom with a score of 2.96,
while Hong Kong topped the list with a score of 8.95. Though most countries with
below-mean policy ratings are found in Africa, other regions also include countries
with low quality policies. For example, Myanmar, Ukraine, and Argentina all scored
more than one standard deviation below the mean.
Given that countries could end up with bad policies, external policy support may be
of some benefit. Indeed, many organizations are engaged in supporting policy reform
processes in recipient countries. International financial institutions (IFIs) such as the
World Bank and the IMF play a leading role in this.2 For example, since 1980 the
World Bank has provided conditional financing to recipient governments to support
20 The World Bank Research Observer, vol. 35, no. 1 (2020)
specific policy and institutional reforms. The World Bank’s development policy loans
(DPLs) seek to improve policy in many different sectors, from economic management
to public-sector governance.
Supporting policy reform has become an important component in the financing
of development operations. For example, from 2009 to 2012, World Bank develop-
ment policy lending reached around $45 billion. Furthermore, Clemens and Kremer
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(2016) and Ravallion (2016) see the provision of well-informed policy advice as one
of the key roles of development institutions such as the World Bank. Clemens and
Kremer (2016) note that:
“In many of the countries where the [World] Bank operates, political competition
is focused on patronage or ethnic and cultural issues rather than economic policy.
Think tanks are scarce, and the senior civil service is stretched thin. In this envi-
ronment, Bank staff can have tremendous influence […] Bank staff have access to
policymakers and often build relationships of trust with key civil servants. Politi-
cians will make the overall decision about whether, say, a conditional cash transfer
policy should be implemented. But the World Bank can then have huge influence
on decisions regarding the details and implementation of the program.”
The available evidence thus far suggests that success in supporting policy change
has been uneven.3 For instance, analyzing the change from 1982 to 1995, Knack
(2001) finds that higher levels of official development assistance (ODA) negatively af-
fect corruption in government, bureaucratic quality, and adherence to the rule of law.
Brautigam and Knack (2004) repeat this exercise for Sub-Saharan Africa and come to
similar conclusions. Smets and Knack (2018) focus specifically on the World Bank’s
DPLs that target public sector governance. The authors present empirical evidence—
using data from a panel of aid-receiving countries from 1996 to 2008—that devel-
opment policy loans are not effective in supporting anticorruption or civil service
reform. The authors do show that the DPLs are able to improve the quality of bud-
getary and financial management, which accords to similar findings from other stud-
ies (World Bank 2008; de Renzio 2009).
A related pattern appears when looking at policies for social inclusion (i.e., gender
equality, social protection, environmental sustainability). Bogetic and Smets (2017)
investigate the association of World Bank policy lending with social development poli-
cies over the period 2006–2014. These authors find econometric evidence that DPLs
targeting social protection and environmental sustainability are effective at influenc-
ing policy, but that policy loans related to gender equality and health and education
reform have no significant impact on policies in those areas.
Finally, the empirical literature indicates that foreign assistance has been instru-
mental in improving the quality of economic management (i.e., macroeconomic
stabilization, debt management, trade and business regulation). Covering the years
1970–1997, Boockmann and Dreher (2003) show that World Bank lending is able
to improve the quality of economic policies, a finding recently corroborated by
Smets 21
Smets and Knack (2016). Analyzing the period 1995–2008, Smets and Knack
(2016) present econometric evidence that the quality of economic management in-
creases with the cumulative number of World Bank economic policy DPLs. Moll and
Smets (2018) repeat this exercise for the period 1998–2015 and come to similar con-
clusions. Kilby (2005) shows that multilateral aid was effective in supporting fac-
tor and output market deregulation during the period 1970–2000. Banerjee and
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Rondinelli (2003) present empirical evidence spanning the period 1988–1999 that
shows foreign aid does not affect the timing of privatization, but that technical assis-
tance has a positive effect on the implementation of privatizations. Finally, Giordano
and Pagano (2017) econometrically show that World Bank DPLs were able to fa-
cilitate the ease of doing business during the period 2004–2014, especially for less
developed countries.
What then can we learn from these results to better support policy reform pro-
cesses? Building on the existing literature, I will argue that policy dialogue and high-
quality evidence are important, more so than the financial arrangements or condi-
tions that often come with it. More specifically, I will make four points. First, without
commitment on the recipient side, conditional aid contracts are unlikely to induce
policy reform. Second, when external actors acquire a seat at the policy dialogue table,
it is important to detect the beliefs that policymakers hold and be able to persuade gov-
ernment officials to change inaccurate attitudes. Third, outside parties should bring
sound evidence to the table—not best-practice—about the costs, benefits, and effec-
tiveness of their policy proposals. High-quality, technical evidence may increase the
demand for public policies and serves a crucial input for the design of policy reform
operations. Finally, an alternative (and indirect) route for external actors to encour-
age policy reform is to support changes in political institutions. I will argue, however,
that doing so without considering general equilibrium effects can be counterproduc-
tive.
The next section elaborates on the four abovementioned ways to influence policy
reform, that is, conditional financing, policy dialogue and belief change, technical
evidence, and supporting changes in political institutions.4 The final section offers
some concluding remarks and avenues for future research.
Supporting Policy Reform from the Outside
Building on a large review of the literature, this section discusses the limits and oppor-
tunities to influence policy reform along four dimensions. The first sub-section exam-
ines conditional financing and indicates that without commitment, aid contracting
is unlikely to induce sustainable change. The second sub-section argues that policy
dialogue may build commitment for reform through belief change, while the third
sub-section provides several arguments for why sound evidence is conducive to policy
22 The World Bank Research Observer, vol. 35, no. 1 (2020)
reform. Finally, sub-section four points to the risks of supporting changes in political
institutions.
Contracting for Policy Change
To support policy change, donor agencies typically transfer financial resources to the
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recipient country’s budget, conditional on meeting certain reform actions. Building
on principal-agent theory, I illustrate in this section the limits and opportunities of
using aid contracts to support policy reform.
Azam and Laffont (2003) provide a benchmark study in this respect. The authors
investigate how an aid contract between donor and recipient can affect a developing
country’s redistribution policy. Assuming that the donor can credibly commit, the
authors find that financial transfers induce a more equitable redistribution, even in
the case of asymmetric information. In a variation, Cordella and Dell’Ariccia (2002)
assume that some of the relevant policy actions under recipient control are not ob-
servable. The authors show that the use of conditionality, targeted at observable (and
thus contractible) components, increases social spending, albeit inefficiently. These
stylized models thus indicate that conditional financing, to a greater or lesser extent,
is able to induce policy reform.
There are, however, some inherent difficulties in using aid contracts for policy
change. Historically, contract theory originated when studying labor relations be-
tween employer and employee. Applying these methods to sovereign nations funda-
mentally limits the use of contractible variables. In other words, when contracting for
policy reform, an independent arbitrator—that is, an international court of law—is
lacking ability to punish any player who breaks contract stipulations. So, in case a
recipient government cannot commit to contract conditions, the financial incentives
provided in the contract will no longer guarantee effective policy reform.
As Azam and Laffont (2003) note, a possible way to get around post-contractual
opportunism is for the donor to commit aid ex ante and design a credible contract such
that aid is disbursed only after observing reform. However, Svensson (2003) and Kilby
(2005) provide empirical evidence that donors often fail to enforce contract condi-
tions due to spending pressure, defensive lending or political pressure from powerful
donors. Consequently, without commitment the moral hazard problem persists, and
the relationship is characterized by a Samaritan’s Dilemma where donors transfer re-
sources and recipients refrain from reforming (Buchanan 1975; Svensson 2000).
These theoretical results are corroborated by many qualitative and quantitative
studies which show that, without engagement on the side of the recipient, the imple-
mentation of conditional financing is bound to fail (see, e.g., Killick 1997; World Bank
1998; Devarajan, Dollar, and Holmgren 2001; World Bank 2001; Dijkstra 2002;
Svensson 2003; World Bank 2005; Dreher 2009). For instance, using principal-
agent theory to analyze a sample of 21 developing countries, Killick (1997) finds that
Smets 23
political consensus in the recipient country concerning the proposed reforms has
a decisive influence on effectiveness of IFI conditionality. Devarajan, Dollar, and
Holmgren (2001) present 10 insightful country cases regarding the World Bank’s
early experience with policy reform in Africa. The 1987 structural adjustment credit
in the Democratic Republic of Congo (DRC) provides a telling illustration. In June
1987, the World Bank approved a Structural Adjustment Credit, including measures
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to reform the public investment program. However, even before the loan was de-
clared effective, large inefficient investments were initiated outside the agreed-upon
investment plan. As a result, the World Bank reform program had to be abandoned.
Devarajan, Dollar, and Holmgren (2001) relate the failure to the DRC leadership and
note that President Mobutu had no intention of making any change in the way he
was handling the country.
Though Azam and Laffont (2003) provide a useful and tractable benchmark, in
reality the principal-agent relations of policymaking are more complex. Dixit (2003)
notes that
“There are multiple horizontal links; each principal has several agents, and most
importantly in many political contexts, each agent is simultaneously answerable
to several principals whose interests are not perfectly aligned and who act non-
cooperatively in trying to influence the agent’s actions […] In such a relationship,
we have the usual problems of moral hazard and asymmetric information. They
are made more complex by the multi-task and multi-principal features, and by the
possibility of collusion among a subset of agents.”
The 1987 DRC reform program again offers a neat example. Devarajan, Dollar,
and Holmgren (2001) state that the dialogue between the World Bank and high-level
government officials was open and productive, with a broad consensus on the reform
agenda at that level. President Mobutu, on the other hand, completely disregarded
the loan conditions and continued with discretionary spending, leading to the break-
down of the reform program.
To incorporate the issue of multiple principals and multiple agents, several com-
mon agency models have been developed. For instance, Martens et al. (2002) extend
the basic principal-agent analysis and study agency models with multi-tasking, mul-
tiple players, and incomplete contracting. In that volume, Murrell (2002) shows that
multiple equilibria are possible when an external agent hires a local contractor to
design a legal reform that might affect recipient country interest groups. Similarly,
Mourmouras and Mayer (2009) find that a powerful interest group might block an
economic reform program proposed by an IFI.
An added problem of using conditional financing relates to incentive compatibility
and participation, that is, recipients must be motivated to fulfill contract conditions.
While there are some reported cases where the availability of funds played a positive
role (Devarajan, Dollar, and Holmgren 2001; Dijkstra 2002), most of the available
empirical evidence fails to find any significant effect of loan size on reform success
24 The World Bank Research Observer, vol. 35, no. 1 (2020)
(Dollar and Svensson 2000; Malesa and Silarszky 2005; Moll, Geli, and Saavedra
2015). Given the limited impact of financial transfers, it is worthwhile considering
other incentives that might incite a government to engage in policy reform.
Incentive compatibility may also explain the limited success in supporting public
sector governance reform. Implementing reforms is (politically) costly in the short
term, especially in the public sector, which is often used as an instrument for patron-
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age and clientelism (Devarajan, Khemani, and Walton 2011). On the other hand,
the benefits from building a well-functioning state apparatus may take several years,
if not decades (Pritchett and de Weijer 2010). For many governments, this time in-
consistency problem makes it unattractive to engage in public sector reform.
Next to providing the right incentives, the timing of external support also mat-
ters. An important issue often stressed in the literature is that the occurrence of an
economic crisis provides a window of opportunity for change (see, e.g., Ranis and
Mahmood 1992; Krueger 1993; Haggard and Webb 1994; Alesina, Ardagna, and
Trebbi 2006). That is, a deep economic crisis dramatically reduces the reservation
utility for engaging in reform. Indeed, Smets, Knack, and Molenaers (2013) find
empirical evidence that deteriorating economic conditions motivates governments
to reform.
Dialogue for Belief Change
The previous section shows that commitment—or so-called ownership—is needed
on the side of the recipient for policy reform support to be successful. In this section
I argue that policy dialogue may build ownership for reform through belief change.5
I first show that beliefs matter for policy choice. Then I assert that new information
may lead policymakers to update their beliefs—but not necessarily so—and that also
non-informative dimensions of communication matter for believe formation. I con-
clude the section by highlighting cases where external agents were instrumental in
influencing policymakers’ mindset, resulting in increased commitment for reform.
A burgeoning literature convincingly shows that the views policymakers hold con-
cerning the functioning of the economy and the way they learn from past experiences
determines policy choice. For instance, in a recent paper Rodrik (2014) neatly illus-
trates the importance of beliefs for policymaking:
“Policymakers operate under certain working assumptions about how the world
works. Their worldviews shape their perception of the consequences of their and
others’ actions in both economic and political domains. These ideas may fall on ei-
ther side of some of the biggest controversies in the history of economic thought:
Does the economy work better under laissez-faire or planning? Are economic
growth and development more rapid under free trade or under protection? […]
Each of these positions presumes a particular model of how the economy works
and therefore has different implications for political behavior.”
Smets 25
Mukand and Rodrik (2018) formalize these ideas and show how worldviews—
that is, the electorate’s understanding of how the world works—can be incorpo-
rated in standard political economy models of policymaking. In another study, Buera,
Monge-Naranjo, and Primiceri (2011) develop a Bayesian learning model in which
policymakers decide whether or not to pursue market policies based on updated beliefs
concerning the growth performance of market and interventionist economies. These
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authors find empirical evidence that such a learning mechanism is able to explain
almost all of the policy choices and a substantial fraction of the policy switches ob-
served in the data. Interestingly, the authors also econometrically show that the evo-
lution of beliefs—and not redistributive concerns—crucially explains the observed
dynamics of policy adoption. Bénabou and Tirole (2006) provide another illustra-
tion. These authors show that individual beliefs shape (the demand for) redistributive
policies. It is well-established that Europeans and Americans hold different views on
the role of self-reliance vs. societal factors in determining income and success. Based
on a model of imperfect will-power, Bénabou and Tirole (2006) show that two types
of equilibria emerge: an “American” equilibrium with self-reliant beliefs and low re-
distribution, and a “European” one with more pessimistic beliefs and high redistribu-
tion. Finally, Besley, Montalvo, and Reynal-Querol (2011) provide empirical evidence
that more educated leaders are associated with higher growth rates, hence linking
cognitive characteristics of political leaders with economic and policy outcomes.
The above shows that beliefs matter for policy choice. While it is beyond the scope
of this article to provide a comprehensive overview on the evolution of beliefs, I
first present some research to show that beliefs can be influenced by information ex-
change. Murphy and Shleifer (2004) present a model where beliefs are transformed
due to communication in a network, where interactions may take the form of infor-
mation exchange. Glazer and Rubinstein (2004) show the conditions under which a
speaker is able to persuade an imperfectly informed decision maker to take a certain
(policy) action, only using verbal information. Similarly, Kamenica and Gentzkow
(2011) investigate the issue of persuading, that is, changing the beliefs of a rational
agent by sharing information, and conclude there is substantial scope to do so. The
authors apply their theoretical insights to a setting where an economic agent com-
missions a study to influence a politician. Kamenica and Gentzkow (2011) show that
the study will help in persuading the politician if the preferences of the agent and the
politician are sufficiently aligned. Finally, Della Vigna and Gentzkow (2009) review
the empirical literature on persuasion and conclude that persuasive communication
is at least somewhat effective in influencing behavior, especially if it involves personal
contact. In some settings, receivers of information respond more when they are more
uncertain and when the information conveyed is credible.
Accurately updating beliefs based on new information is the traditional way that
economists analyze belief formation. However, it is important to note that infor-
mation exchange does not always help in changing beliefs. For example, cognitive
26 The World Bank Research Observer, vol. 35, no. 1 (2020)
limitations and behavioral biases may prevent Bayesian updating from taking place.
Furthermore, Bénabou and Tirole (2016) forcefully argue that beliefs also fulfill im-
portant functional and psychological needs of the individual, such as moral esteem or
self-confidence, which may make them resilient to many forms of information. The
mechanisms that prevent beliefs from being updated (in a Bayesian sense) include
strategic ignorance, reality denial, and self-signaling.6
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For instance, many at-risk subjects refuse to be tested for terminal diseases as the re-
sults may drastically alter their beliefs and expectations (Oster, Shoulson, and Dorsey
2013). Examining the beliefs of developing country government officials, Vivalt and
Coville (2019) experimentally show that government officials are biased towards
good news and overweigh the positive results from impact evaluations. Interestingly,
the authors also find evidence that providing more detailed information leads govern-
ment staff to more precisely update their beliefs. Banuri, Dercon, and Gauri (2017) in-
vestigate how World Bank staff interpret information about the impact of a (fictitious)
development intervention that raised minimum wages. These authors find experi-
mental evidence that World Bank staff ’s assessments are biased towards their prior
beliefs regarding redistribution, which is suggestive of confirmation bias.7 Finally, ex-
perimental evidence from psychology shows that subjects are more likely to believe
assertions when they are repeated, irrespective of whether the statements were true
or false (Hasher, Goldstein, and Toppino 1977).
Besides information, other, non-informative dimensions of communication also
influence the evolution of beliefs. For instance, Mullainathan, Schwartzstein, and
Shleifer (2008) model a persuasion game where individuals are coarse thinkers, that
is, they think in categories and apply the same causal model to all situations in a cate-
gory. This allows persuaders to exploit the fact that situations can be framed in several
ways, and that individuals transfer certain properties to other situations.8 Bassi and
Razul (2017) present empirical evidence on how non-informative but highly salient
communication by a leader affects beliefs. These authors do so in the context of the
1991 Papal visit to Brazil, and show how persuasive but non-informative messages by
John Paul II increased fertility-related beliefs. This finding corresponds to research in
social psychology about the persuasive power of authority figures (see, e.g., Cialdini
2007). Finally, Custer et al. (2015) report that government officials appreciate pol-
icy advice more when they had a work history with the development institution that
provided the information.9 This result is consistent with the idea that shared identity
matters for belief formation (Gennaioli and Tabellini 2018).
Given that beliefs determine policy choice, and given that they are potentially flex-
ible, it is important for external agents to detect the beliefs that policymakers hold
and be able to influence beliefs during policy discussions. Haggard and Webb (1994)
note that in the long run, the transmission of ideas may be more important for policy
reform than conditional financing. The authors present several cases demonstrating
the powerful effect of policy dialogue on the reform process.
Smets 27
The Polish recovery program in the early 1990s provides a case in point. At the
beginning of 1990, the Polish government implemented a radical reform program
that brought inflation down, reduced external imbalances, and made the currency
convertible. Before coming to power in 1989, the ruling party did not have any
clear ideas about which economic policies to implement. Johnson and Kowalska
(1994) argue that Jeffrey Sachs and David Lipton played an influential role in shaping
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the reform program. After months of intense discussions with senior political lead-
ers, many of their ideas were actively taken on board by the key political actors in
Poland.
Smets, Knack, and Molenaers (2013) provide another example. In the early 2000s,
Mozambique successfully privatized their telecommunications sector, supported by a
World Bank policy loan. Faced with the Marxism-Leninism inspired Frelimo, it took
the World Bank considerable effort to convince the Ministry of Planning to allow a
second player into the telecommunications market. A number of political advisors to
the Minister of Planning openly questioned the benefits of privatization and claimed
that only a state monopoly would serve the people. An extensive World Bank staff
team, however, succeeded in convincing the Mozambican government officials. The
task team leader at the time recalled that a presentation showing the positive impact
of telecom privatization—with examples from all over the globe—was instrumen-
tal in shifting the mindset. After the negotiations, the government of Mozambique
expressed a clear and firm commitment to implement the program. Smets, Knack,
and Molenaers (2013) argue that the extensive negotiation process facilitated belief
change concerning the benefits of market reform, which increased ownership over
the reform program.
Evidence for Change
The previous section has shown that evidence and new information may—but not
necessarily will—help in changing a policymaker’s attitude. Sound evidence about
the costs and benefits of policy reform can also be used to reduce (pervasive) un-
certainty regarding the winners and losers of reform. That is, at the core of many
political economy models are politicians who are interested in redistributing power
and income to a certain subset of the population. Not knowing how the benefits and
costs of reform will be distributed may prevent reform from taking place (Fernandez
and Rodrik 1991; Majumdar and Mukand 2004). Fernandez and Rodrik (1991) re-
fer to the early 1960s where the South Korean business community fiercely opposed
trade liberalization since it was difficult to determine ex ante which sectors would win.
Therefore, providing evidence about the distributional impacts of policy change may
unlock the status-quo.
This requires a thorough political economy analysis (PEA) about how different
interest groups are related to the political elite and how they would be affected by
28 The World Bank Research Observer, vol. 35, no. 1 (2020)
reform. Over the past two decades many PEA tools have been developed to assist ex-
ternal agents in understanding the power relations in recipient countries. For in-
stance, the Swedish International Development Cooperation Agency (SIDA) devel-
oped a method called Power Analysis to identify such issues. A recent evaluation on
the use of PEA in development policy lending indicates that DPLs that include a PEA
are more effective in reaching their reform objectives (Independent Evaluation Group
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2016).
Relatedly, evidence can also be used to increase the demand for public policies.
That is, due to various barriers and limitations, countries may lack the capacity to
generate and process the information necessary to identify high-value public poli-
cies. For instance, Ndulu (1997) and Howlett (2009) note that countries—even ad-
vanced ones—often lack sufficient analytical capacity to design and execute public
programs, a problem further exacerbated by human capital flight (Haque and Kim
1995). Spolaore and Wacziarg (2009) take a different approach and show that bio-
logically and culturally transmitted traits and characteristics may prevent countries
from adopting knowledge and new technologies. When countries are disadvantaged
in such ways, public programs are not expected to generate high returns. Conse-
quently, policymakers will not be inclined to allocate resources to public spending
(Besley and Persson 2011a).
When countries lack such technical expertise, external agents may provide assis-
tance to find out what works and thus increase the valuation and selection of sound
public policies (Besley and Persson 2011a). For instance, over the past decades, rig-
orous methods have been employed to assess program effectiveness.10 The Abdul
Latif Jameel Poverty Action Lab (J-PAL) is a global network of researchers who use
randomized controlled trials (RCTs) to provide scientific evidence for enhanced pol-
icy effectiveness (Duflo, Glennerster, and Kremer 2008). Since its inception in 2003,
J-PAL has performed more than 900 randomized evaluations in 80 countries, cover-
ing themes that range from microfinance and health to political economy and gover-
nance. Where RCTs are not feasible or possible (how to randomize monetary policy?)
more and more econometric studies employ advanced quasi-experimental designs
such as instrumental variables, regression discontinuity, or differences-in-differences
(Angrist and Pischke 2010).
That being said, it is important to note that it is not always straightforward to gen-
erate high-quality evidence about policy effectiveness. Our knowledge is limited with
respect to the equilibrium outcome we can expect from policy reform. Even if we as-
sume a competitive economy with complete information, one cannot exclude the ex-
istence of multiple equilibria given the implementation of a set of policy instruments
(Arrow and Hahn 1971). In more realistic settings, many policy decisions are made
in the face of ambiguity, or what Knight (1921) called fundamental uncertainty. In
such a case, we do not know the distribution of how policy actions map into policy
outcomes, hence precluding the choice of optimal policy (Manski 2000).
Smets 29
More and more, it is argued that policy design should embrace economic complex-
ity and make policy prescriptions robust to economic and political uncertainty (see,
e.g., Caballero 2010). Acemoglu and Robinson (2013) provide a recent illustration.
These authors argue it is necessary to take into account future political equilibria
when addressing current market failures. That is, economic reforms may be sensible
from an economics point of view but could actually reduce economic efficiency when
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including dynamic political economy considerations in the analysis. As an example,
the authors describe how the Russian privatizations of the early 1990s dramatically
shifted income distribution towards an economic elite and gave rise to significant po-
litical changes and a backtracking of the reform process.
Furthermore, Deaton (2010) notes that for empirical research to be useful for pol-
icy analysis, it needs to be embedded in theory that explains the underlying mecha-
nisms. In some reform areas theory is well established with broad expert consensus
on what works. Khemani (2017) highlights macroeconomic stabilization and fiscal
adjustment as examples. The large evidence base in these areas may explain why sup-
port for economic reform has generally been found to be successful.
In other reform areas—such as public-sector governance—credible evidence to de-
sign sound policies is often lacking (World Bank 2012). Public sector reform requires
a deep understanding of local context and behavior, without which reforms may fail.
For instance, human decision making relies on mental models through which infor-
mation is processed. Often it is assumed that these underlying mappings of the world
are correct and universal. Yet, the mental models individuals use to process informa-
tion are the result of cultural heritage and encountered problems, and hence tend
to differ (North and Knight 1997). Not considering the possibility of faulty mental
models can hamper policy effectiveness. For instance, Harun (2007) notes that senior
civil service officials in Indonesia are reluctant to embrace new accounting standards
since they share the opinion that “what worked before will continue to work in the
future”.
Andrews (2009) distinguishes between public sector reforms involving relatively
“concentrated” and “deconcentrated” sets of actors. Successful implementation of
reforms is more difficult when it requires changing the behavior and norms of larger
and more disparate groups of (public) agents (cf. Dixit 2003). For example, Khemani
(2017) notes that stable norms of non-cooperation in society explain why reform ef-
forts by powerful leaders to reduce corruption often fail. Khemani (2017) argues that
legitimacy is needed to accept new norms of behavior. A quote from the Italian polit-
ical scientist Gaetano Mosca reinforces this point:
“It has happened in the limited number of societies that arrived at a certain level
of development, that the political class does not exclusively justify its power solely
on the grounds of possessing it, but seeks to give it a moral or legal basis, making it
originate as a necessary consequence of beliefs generally recognized and accepted
in the society (Mosca 1939).”
30 The World Bank Research Observer, vol. 35, no. 1 (2020)
Since norms of behavior and cultural context differ from society to society (see, e.g.,
Platteau 2000; Mullainathan 2006; Cardenas and Carpenter 2008), it is important
to customize external policy support and the evidence backing it, especially in reform
areas where local context and behavioral norms play an important role. This implies
that transplanting best practices to other cases may not always be a good idea (Rodrik
2008; Pritchett, Woolcock and Andrews 2013).
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Finally, high-quality evidence is not only useful to show the distributional impacts
of reform and to increase the demand for public policies, they also serve as an im-
portant input for the design and success of policy-based lending programs (Ravallion
2016). Deininger, Squire, and Basu (1998) empirically demonstrate that knowledge
products improve World Bank project outcomes. Wane (2004) finds that analytical
work and economic analysis have a large positive impact on the quality at entry of
World Bank loans.11 Smets, Knack, and Molenaers (2013) go on to show that the
quality at entry of World Bank economic reform programs significantly increases
the success of those operations. The authors also provide empirical evidence that re-
sources are more productive—in terms of reform success—in the design of policy op-
erations than in their supervision. Moll, Geli, and Saavedra (2015) investigate the
impact of several design elements and find that development policy operations with
evidence-based results frameworks perform better.
Changing Political Institutions
Policies are not only determined by beliefs and preferences, but also by the constraints
provided by political institutions (North and Knight 1997). A large body of theoreti-
cal and empirical literature convincingly shows that institutions such as checks and
balances on the executive or broad political representation promote investments in
the common good, regardless of who holds power. This in turn incentivizes political
leaders to build fiscal capacity and implement growth-enhancing policies (see Besley
and Persson 2011a). Without such institutions inefficient policies may persist, as
incumbents cannot credibly commit to not using their political power in the future
(Acemoglu 2003).
Given the importance of inclusive political institutions, many external agents
make resources available to change the structure of the political system in recipient
countries. For instance, Africa’s third wave of democratization in the early 1990s was
heavily supported by Western countries (van de Walle 2001). Several strategies are
employed to constrain policymakers and build commitment devices for enhanced pol-
icymaking. I argue in this section that supporting political change without taking into
account general equilibrium effects can be counterproductive. It is important to re-
alize that political institutions are not subject to linear change but are determined in
a dynamic way (see Aghion, Alesina, and Trebbi 2004; Robinson and Torvik 2016).
Smets 31
I use the introduction of competitive elections and support for political parties as ex-
amples to illustrate this point.
Under ideal circumstances, elections can be regarded as a mechanism to make gov-
ernments accountable, retaining good performers in office and removing those who
do not (see, e.g., Przeworski, Stokes, and Manin 1999). However, in contexts without
complementary institutions that constrain the behavior of politicians, supporting the
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introduction of democratic elections may not be of much avail, or even be counter-
productive (Policy and Operations Evaluation Department 2012). Indeed, Chauvet
and Collier (2009) find empirical evidence that frequent elections improve economic
policymaking; however, this is not so in developing countries with low-quality elec-
toral systems. The authors conclude that
“For international policy to promote development the results have an important,
if uncomfortable, implication. It is widely accepted that good economic policy is
critical to successful development. […] Our results suggest that the route to policy
improvement is through accountability of governments to their citizens through
proper elections. To the extent that this process has failed it is because governments
have subverted the electoral process […] Clearly, where governments steal elections
by resort to illicit means citizens are powerless other than by themselves resorting
to illicit methods of opposition. The task for the international community is thus to
promote the effective accountability of government to citizen (Chauvet and Collier
2009).”
Furthermore, Collier and Vicente (2008, 2012) show that in “bad environments”
voter intimidation, ballot fraud, and violence are used as strategies to affect voter
turnout and influence electoral results. Another example comes from the Ivory Coast.
After the 2010 elections, Laurent Gbagbo refused to step down despite the fact that
the Electoral Commission declared Alassane Ouattara as the winner. Part of this dead-
lock was caused by the Constitutional Council’s ruling that the elections were marred
with massive fraud. Gbagbo repeatedly referred to the (questionable) ruling as a jus-
tification to stay in power.
Political parties have the potential to play an important role for a country’s develop-
ment (see, e.g., Huntington 1968; Keefer 2011). However, Randall (2007) notes that
in developing countries the impact of political parties in fostering democracy and de-
velopmental policy making is disappointing. According to the author, this is due to
the fact that parties are weakly institutionalized, that is, do not function according
to formal rules, are faced with low party loyalty, and low autonomy. Weak institu-
tionalization is explained by individualistic party origins, severe clientelism and con-
textual factors such as the international pressure for democratization. Especially in
Africa, Western support for multi-party elections meant that political parties had to
develop with very short notice (Bratton and van de Walle 1997). Building a more ef-
fective party system with external support is difficult. For instance, Carothers (2006)
fails to find consistent evidence that external support for building developmental
32 The World Bank Research Observer, vol. 35, no. 1 (2020)
political parties has been effective, and stresses the need to study the local context
before engaging in any type of assistance.
Discussion and Conclusion
Policies are not designed and implemented by a farsighted social planner but are de-
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termined through a political process, based on policymakers’ preferences, beliefs, and
the constraints provided by political institutions. Building on principal-agent theory,
this study shows that without commitment on the recipient side, conditional financ-
ing is unlikely to induce policy reform. This begs the question of whether there is a
need to review the way development agencies finance policy change.
As financial transfers in and by themselves are unlikely to be effective, are there
other ways external agents can incentivize policymakers to engage in reform? Mattli
and Plumper (2002) analyze the expansion of the European Union and suggest that
accession to a club—partly driven by a sense of identification with core values—is
an important stimulus for reform. Svensson (2003) and Zinnes (2009) propose aid
tournaments where aid budgets are pooled and committed to a group of countries,
with disbursements taking place based on the countries’ relative performance.
While such proposals may seem hard to implement, some elements are already
present in the World Bank’s financing model for low-income countries. That is, the
World Bank allocates its concessional funds based on each country’s performance in
implementing policies that promote economic growth and poverty reduction. Prop-
erly piloting and evaluating new incentive mechanisms within that framework may
eventually lead to high development returns.
Relatedly, one may wonder whether it is advisable to combine two objectives—
providing predictable budget financing on the one hand, and supporting policy re-
form on the other—in one instrument, as with development policy loans. The danger
exists that recipient countries may run out of (politically) feasible reforms (Eifert and
Gelb 2006). When that happens, development agencies may still want to close the
financing gap by providing budget support but include policy conditions that have
a negligible reform impact (World Bank 2018). Such potential trade-offs need to be
taken into account. On the other hand, it is important to note that the provision of
financing acts as a signal of credibility for financial markets and international in-
vestors (Clemens and Kremer 2016). Furthermore, financial support allows external
agents to buy a seat at the policy dialogue table. So, while budget support funds do
have a role to play in the policy reform process, it is necessary for external agents to
be aware of and manage potential risks.
When acquiring a seat at the policy dialogue table, this study argues that external
agents need to find ways to detect the beliefs that policymakers hold and be able to
persuade government officials to change inaccurate attitudes. While theoretical and
methodological advances have been made to elicit beliefs in laboratory settings (see,
Smets 33
e.g., Schlag, Tremewan, and Weele 2015), finding out the views of policymakers dur-
ing policy discussions may not be straightforward. Furthermore, as beliefs may be re-
sistant to many forms of information, external agents need more than evidence alone
to convince policymakers. Exploiting non-informative dimensions of influencing—
for example, a common work history or the persuasive power of trusted experts—
may help. Furthermore, development agencies often organize study tours to expose
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recipient country policymakers to new environments. Recent research by Stegmann
(2018) indicates that such approaches may indeed help in transforming values and
beliefs.
A proper focus on beliefs and influencing—which is currently lacking in many de-
velopment organizations—also has implications for who takes a seat at the policy di-
alogue table. Indeed, policy discussions are often led by technical experts. Such com-
petencies are essential, but they need to be complemented with a different set of skills
that allow one to gauge beliefs and tap into the non-informative dimensions of influ-
encing. Therefore, reform teams need not only include topical experts, but also per-
sons with the proper “soft skills”.
In addition to the appropriate skills, external agents also need to bring sound ev-
idence to the table about the costs and benefits of policy reform. Even though new
information may not always be effective in shifting policymakers’ mindsets, it could
reduce uncertainty about the distributional impacts of reform and help in identifying
high-value public policies. Knowledge products also serve as an important input for
the design and success of policy-based lending programs.
Credible evidence needs to be based on high-quality research designs, while the re-
sulting policy prescriptions need to be robust to economic uncertainty and adapted
to local context. However, all too often evaluations of development projects—which
serve as an input in the design of new operations—are based on unrealistic assump-
tions, which indicates a need for methodological improvement (see Raifman et al.
2018). More broadly, Ravallion (2016) notes that World Bank spending dedicated
to research has declined over recent years and is increasingly based on trust fund
money. This author also points to a disconnect between the supply and demand of
knowledge products within the World Bank. To ensure that policy advice and lending
programs are built on the best available evidence, there is arguably a need to reverse
those trends.
Given the importance of inclusive political institutions, it may be worthwhile in-
vesting resources in changing the structure of the political system. However, even if
distributional considerations are binding, supporting political reform without taking
into account general equilibrium effects can be counterproductive.
So how then to support effective accountability of government to citizens without
the danger of large, negative, unintended consequences? While Besley and Persson
(2011b) note that more research is needed in this area, Khemani et al. (2016) of-
fer some interesting insights. These authors’ well-documented policy research report
34 The World Bank Research Observer, vol. 35, no. 1 (2020)
argues for the need to support political engagement and transparency initiatives that
may cultivate and improve the quality of political engagement. The authors state
that, combined, transparency and political engagement can not only hold political
leaders more accountable, but can also improve the incentives, beliefs, and behav-
ioral norms of elected officials and the electorate.
What the above clearly illustrates is the need for further research. First, it is neces-
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sary to investigate the different dimensions to influence policy reform—that is, con-
tracting, beliefs, evidence, and political institutions—more deeply. For instance, while
financial transfers are unlikely to incentivize policy makers, tournament approaches
are suggested as an alternative. However, these ideas have not been put to the test. Fu-
ture research may investigate the effectiveness of these and other modalities in sup-
porting policy reform.12 With respect to beliefs, a burgeoning body of literature shows
that beliefs matter for policymaking and that they are potentially open to change.
While that may be so, Della Vigna and Gentzkow (2009) note a lack of empirical ev-
idence on how to influence policymakers and the role of persuasion in autocracies.
Providing hard evidence on the impact of (informative and non-informative) persua-
sive efforts in relevant field settings may prove very valuable.
With respect to evidence, how can we leverage current research methods and de-
velop new ones to design policies that are robust to economic uncertainty as well as
adapted to the local context? Regarding political institutions, how can external agents
support political reform while limiting negative unintended consequences? Khemani
et al. (2016) highlight transparent information provision and citizen engagement,
but they also note the need for further research. For instance, the electorate may be
resistant to new information. Moreover, Mukand and Rodrik (2018) argue that politi-
cal leaders may strategically influence the public’s beliefs, which could limit the scope
for external actors to strengthen transparency.
Next, there is a need to think more coherently about the four dimensions. For
one, how to find out which constraints are binding? External agents may unsuccess-
fully invest resources in persuading a political leader to change policy, while all along
vested interests—and not biased beliefs—prevent the political leader from taking any
action.13 To determine the margins for change—if any—useful information is needed
on the policymakers’ preferences, beliefs, and the strength of political institutions.
Another question is how evidence and new information affect the political equilib-
rium. Manski (2013) notes that learning will be beneficial in a society when pol-
icy disagreements arise due to belief differences. If, however, heterogeneity of policy
preferences arises from conflicting objectives, learning may increase polarization and
induce conflict.
Besides the dimensions discussed in this paper, other factors also influence pol-
icy choice. For instance, Banerjee and Duflo (2014) present several examples where
policies emerge due to slack in the political game or accidental factors. Alesina and
Guiliano (2015) discuss how other cultural traits—generalized morality, trust,
Smets 35
family ties, and individualism—are related to policies and institutions. Passarelli and
Tabellini (2017) show that political unrest—fueled by an emotional reaction to un-
fair treatment—influences policy. Khemani (2017) highlights the importance of le-
gitimacy and citizen communication for reform success. Relatedly, Stromberg (2004)
shows how the interplay between media markets and political competition shapes
public policy. Mukand and Rodrik (2018) demonstrate how identity politics deter-
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mines voter behavior and policy choice. Future research should investigate the ex-
tent to which external actors can build on these factors to successfully support policy
reform.
To conclude, this study has argued that external agents must pay proper attention
to the nature of policy dialogue and quality of engagement with government.14 Given
the importance of political institutions, there is also continued need to find effective
ways to make politics work for good policies. Finally, as research continues to enrich
our understanding of the determinants of policy choice, external agents need to be
prepared to act on those findings and expand the instrument set available to support
policy reform in recipient countries.
Notes
Lodewijk Smets is an affiliated researcher at the LICOS Centre for Institutions and Economic Perfor-
mance, Economics Department, KU Leuven, Belgium. This paper is the result of a long journey that
started when I began my doctoral studies in 2008. I would like to thank everyone who was involved
in that process, including—but not limited to—PhD supervisors, co-authors, seminar participants at
various conferences and the three referees of this journal. All views and errors remain my own. Corre-
spondence to be sent to: lode.smets@kuleuven.be.
1. The Economic Freedom of the World (EFW) Index ranks countries based on five policy dimensions:
government consumption and taxation, policies and institutions related to rule of law, monetary policy
and inflation, trade policy and factor market, and business policies (see Gwartney, Lawson, and Hall
2015 for more details). While the EFW Index represents a specific view on what constitutes good policy, it
is highly correlated with other measures of institutional quality such as the World Bank’s Country Policy
and Institutional Assessments (r = 0.63) or the Heritage Foundation’s Index of Economic Freedom (r =
0.85). It is important to note, however, that this study does not attempt to identify which specific policies
bring countries to the economic frontier, but rather how external actors can support reform processes.
2. This study analyzes policy reform support through the lens of development assistance, with a
specific—though not exclusive—focus on the World Bank. However, much of the discussion also applies
to other producers of policy advice, such as research institutes, consultancy firms, universities, etc.
3. Many factors may explain differences in results between studies, among others the choice of esti-
mation method, the country sample, the period of analysis, and the variables of interest. The empirical
papers reported here generally cover a representative sample of low- and middle-income countries and
estimate the impact of aid on policy quality using similar econometric techniques. Thus, the mixed con-
clusions are arguably not driven by these factors. It is important to note, however, that the papers do
typically differ in terms of the period of analysis and the type of aid analyzed—that is, ODA, multilateral
aid, World Bank DPLs, or technical assistance. While it is beyond the scope of this study to elaborate on
how these factors may matter (see Clemens et al. 2012 or Smets 2016 for more details), we do report
these dimensions in the text for clarity and ease of interpretation.
36 The World Bank Research Observer, vol. 35, no. 1 (2020)
4. See Smets (2018) for a formal model on how these factors matter for policy reform support.
5. Alternatively, policy dialogue may affect behavior independent of beliefs, where non-informative
factors of communication result in preference change. See Della Vigna and Gentzkow (2009) or Petty
and Cacioppo (1986) for an overview of preference-based models of persuasion.
6. Strategic ignorance involves the avoidance of new information sources to protect valued beliefs;
reality denial is the selective and distorted interpretation of new information to fit one’s prior beliefs;
and self-signaling corresponds to agents producing desired information themselves to reinforce certain
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beliefs (Bénabou and Tirole 2016).
7. Confirmation bias is a tendency to interpret information in a way that confirms one’s prior beliefs.
8. As an example, Mullainathan, Schwartzstein, and Shleifer (2008) refer to Arnold Schwarzeneg-
ger’s speech at the Republican Convention defending free trade policy. Schwarzenegger framed trade as
a war where countries either win or lose. Using this frame, he transferred America’s propensity to be
victorious onto trade, claiming that America will win the trade war.
9. This is especially relevant for multilateral development banks such as the World Bank or the Inter-
American Development Bank where many former staff members occupy senior policymaking positions
in their home countries (e.g., Sri Mulyani or Ivan Duque).
10. Note that in practice even the most refined methods are not necessarily free from problems. In-
variably, statistical techniques are based on assumptions to draw inferential conclusions. For instance,
for IV techniques to be valid, the instruments employed need to be exogenous, that is, orthogonal to
the error term. This assumption requires more than instruments not being determined by the variables
in the model, it requires (statistical) independence. Regression discontinuity assumes that around the
threshold treated individuals have similar distributions of treatment response. Differences-in-differences
methods allow outcomes to differ across treated individuals but assume that the observations in a study
are subject to a similar time trend and respond identically to treatment. Theoretical modeling techniques
also need assumptions and decisions rules to generate predictions. Even though in theory RCTs require
minimal assumptions, in practice they also deserve scrutiny. First, generally it is assumed that treat-
ment response is individualistic. However, when members of a population potentially interact with each
other—like in a vaccination program—the predictive power of RCTs is compromised. And second, in
order for RCTs to have external validity, it is required that the experimental distribution of outcomes be
the same as the population distribution of outcomes, which is far from guaranteed. For instance, the
study population might be different from the population of interest due to non-random partial compli-
ance. Also, the experimental treatments might differ from the ones offered in actual policies. According
to Manski (2011), policy analysis is often based on strong but incredible assumptions. As an alternative,
the author suggests using layered policy analysis that starts with weak but credible assumptions and
then moves to findings based on stronger, less credible ones.
11. Quality at entry refers to the extent to which the World Bank identified, facilitated preparation
of, and appraised the operation such that it was most likely to achieve planned development outcomes.
12. While not explicitly addressed in this paper, other features on the side of the external agent
may also prevent policy reform support from being effective. It is well-documented that powerful donors
strategically influence the decision-making processes at international financial institutions (see, e.g.,
Kilby 2009). Bilateral aid development assistance is also partly driven by strategic and political con-
siderations (Alesina and Dollar 2000). Next, external agencies are often faced with spending pressure,
which might endanger the longer time frame needed to provide context-specific policy advice (Svensson
2006). As promotion in IFIs tends to be based on loan approval rather than loan quality, the design of
policy-based operations may suffer. In addition to extrinsic incentives, intrinsic, psychological factors
such as biased beliefs may also prevent accurate policy advice from being generated (see Banuri, Dercon,
and Gauri 2017). Thus, research is needed to investigate what organizational structure on the side of
the external agent is most conducive for supporting policy reform.
13. I thank one of the reviewers for highlighting this example.
14. Recent empirical evidence indeed seems to suggest that the process of policy engagement is more
important than the number of conditions or financial arrangements that come with it. For instance,
Moll and Smets (2018) econometrically examine the impact of World Bank conditionality on the
Smets 37
quality of economic policy and find that the exact number of policy actions makes no difference to the
quality of economic policy, while the fact that there was at least one policy action does make a significant
difference. The authors interpret this finding to mean that the process of generating economic reform
results in improved quality of government policy. Giordano and Pagano (2017) regress the “doing busi-
ness” indicator on the cumulative number of DPLs and their cumulative value, and find that only the
number of loans come out significantly. The authors derive from these results that overall engagement
with the World Bank is more relevant than the amount of resources invested.
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Smets 43
Illicit Financial Flows: Concepts,
Measurement, and Evidence
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Matthew Collin
There is a growing consensus that the presence of illegal and harmful cross-border financial
flows is one of the factors impeding economic and human development. In recent years, a
new conceptual framework for describing these “illicit” financial flows (IFFs) has emerged
that combines issues ranging from cross-border money laundering to tax evasion. This ar-
ticle summarizes and clarifies recent empirical work in this area. Three types of studies are
considered and critiqued: (i) methods of measuring IFFs, (ii) constructed risk indicators,
and (iii) forensic studies that aim to uncover instances where illicit flows have occurred. The
article discusses the limitations of all three approaches and proposes ways in which the re-
search agenda on IFFs could be reasonably advanced, given the hidden nature of the subject.
JEL Codes: K42, H26
Keywords: illicit financial flows, tax evasion, money laundering.
1 Introduction
Several trillion dollars cross international borders every day (Mallaby 2016). Much
of this movement is perfectly legitimate, part of the ordinary workings of the global
financial system. Yet some of the money is considered to be either illegal or harmful
because of the way it was generated, transferred, or used. These international trans-
fers have come to be known as “illicit financial flows” (IFFs), a concept which com-
bines several—occasionally disparate—activities ranging from illegal capital flight to
international money laundering to tax evasion.
By their very nature, IFFs are usually hidden from sight and therefore difficult
to measure. Global estimates—fraught with error—are of the order of magnitude
of $1–1.5 trillion a year.1 While these estimates appear to have been largely sta-
ble or even decreasing over time relative to overall economic activity, international
The World Bank Research Observer
© The Author(s) 2019. Published by Oxford University Press on behalf of the International Bank for Reconstruction and
Development / THE WORLD BANK. All rights reserved. For permissions, please e-mail: journals.permissions@oup.com
doi: 10.1093/wbro/lkz007 35:44–86
attention and concern around IFFs has been increasing. Multilateral initiatives, such
as the Addis Ababa Action Agenda around Financing for Development and the Sus-
tainable Development Goals, have resulted in renewed fervor for raising government
revenue in developing countries, a process that is seen as being threatened by the
prevalence of IFFs. Connected to this is a slowly mounting effort to curb interna-
tional tax evasion and excessive tax avoidance, made particularly salient by recent
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events such as the Mossack Fonseca leaks. Independently, the past decade and a half
has seen growing concern with international money laundering and terrorist financ-
ing, leading to global initiatives to curb these practices led by institutions such as the
Financial Action Task Force (FATF).
With the exception of work on tax evasion and crime, mainstream development
economic research has largely failed to coherently engage with attempts to estimate
IFFs, despite the growing attention from policymakers. This is in part due to the amor-
phous nature of IFFs, both in their definition and in their measurement. Despite this,
there are several reasons to believe that IFFs are particularly relevant for developing
and emerging economies.
The first of these is the fact that, because of poor-quality institutions and low ca-
pacity, many of these countries lack the apparatus to either detect IFFs or curb the
practices that give rise to them. For example, governments of poorer countries are less
likely to be compliant with international anti-money-laundering standards set by the
FATF; see fig. 1(a). They are also less likely to have successfully negotiated bilateral
tax-information exchange agreements or signed up to multilateral agreements that
can be used by authorities to exchange information useful for tracking down interna-
tional tax evasion cases. Developing and emerging economies are also more likely to
suffer from corruption and informality, which are potential drivers of illicit flows. As
this article will highlight, the empirical evidence base underlying the effectiveness of
some of the institutions is still nascent, but the absence of such institutions suggests
that developing countries are no better equipped to deal with the problem.
The second reason is that the damage that IFFs can do to developing and emerg-
ing economies is potentially greater. For one, as can be seen in fig. 1(b), developing
countries struggle to raise the same proportion of their national income in tax rev-
enue as richer countries. There is not enough evidence to indicate that the share of
revenue lost to IFFs is higher in developing countries, but as many of these coun-
tries already struggle to maintain basic social services, functioning institutions, and
a viable social contract, revenue losses will be more damaging to them (OECD 2014;
Gaspar, Jaramillo, and Wingender 2016). In addition to these harms, IFFs also po-
tentially give rise to negative impacts through the underlying activities that generate
them, such as violent crime associated with drug trafficking, government decisions
distorted by corrupt practices, or outright kleptocracy/state capture of resources.2
Finally, developing countries are disproportionately likely to be punished by inter-
national institutions for failing to deter illicit flows. For example, emerging economies
45
Figure 1. Developing Countries have Weaker Anti-IFF Institutions and Potentially Face Worse
Harm from IFFs
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Source: FATF compliance data were taken from scores on Mutual Evaluation Reports (https://www.fatf-
gafi.org/publications/mutualevaluations/) and from FATF’s high-risk and non-cooperative jurisdictions list
(https://www.fatf-gafi.org/publications/high-riskandnon-cooperativejurisdictions/). The exchange-of-information
data were obtained from the OECD’s exchange-of-information portal (http://www.eoi-tax.org). The tax-to-GDP
ratios are from UNU-WIDER’s Government Revenue Dataset (UNU-WIDER 2018), and the data on GDP per capita
and the World Governance Indicator Control of Corruption are from the World Bank’s Open Data Portal.
Note: IFF = illicit financial flow. The graphs show the cross-sectional relationships of (a) anti-IFF institutions
(compliance with international standards, exchange-of-information agreements, and levels of corruption) and
(b) IFF-related outcomes (tax revenue and greylisting by the FATF) with the log of GDP per capita.
46 The World Bank Research Observer, vol. 35, no. 1 (2020)
are at higher risk of being added to the FATF’s “greylist” of countries that are not
making enough effort to improve anti-money-laundering institutions; see fig. 1(b).
This greylisting, which calls on regulators and banks to enact stricter procedures
when dealing with listed countries, has the potential to do significant damage: Collin,
Cook, and Soramäki (2016) found that the volume of international payment flows to
greylisted countries decreased by approximately 10 percent.
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The goal of this article is to give an overview of the issue of IFFs, discuss popular
academic and policy-oriented methods of quantifying these flows, elucidate how the
methods are related to each other, and suggest potential ways to advance the research
agenda. Section 2 discusses issues around the definition of, composition of, and policy
efforts to fight IFFs. Section 3 covers various methods for measuring specific types
of IFFs and IFFs in aggregate. Section 4 describes constructed indices of the risk of
IFFs and reviews studies in the field of “forensic” economics that have been used to
discover the contexts in which IFFs are likely to happen. Section 5 details ongoing
policy efforts to curb illicit flows and a few of the ways in which those efforts are being
measured. Section 6 discusses ways in which research on IFFs might progress, and
Section 7 concludes.
2 Defining and Classifying Illicit Financial Flows
In his book Capitalism’s Achilles heel: Dirty money and How to Renew the Free-Market
System, Baker (2005) defined “dirty money” as money that is illegally earned, moved,
or used. The most widely cited definition3 of IFFs involves just a minor tweak of
Baker’s definition: an illicit financial flow is dirty money that crosses an international
border.
This definition implies that a flow can be classified as illicit if either its origin
(source), the method used for moving it across a border (channel), or its eventual
use is illegal. Taking into account whether the source or channel is legal, fig. 2 dis-
plays how a set of different types of international financial flows would be classified
as IFFs.4 For simplicity, this figure leaves out the third dimension: the use of these
funds when they reach their destination.5 Common sources of IFFs described by Baker
(2005) include (i) corrupt proceeds, which include money stolen from the state or
funds acquired through abuse of state power, (ii) criminal proceeds, which include
drug money and individual tax evasion or tax fraud, and (iii) commercial proceeds,
which include multinational tax or tariff evasion.
These sources of illicit flows should be distinguished from the channels used to
transfer them. In some cases, the channels themselves are illegal due to a failure to
report the existence of assets or their transfer, or because they actively circumvent
government policy on the transfer of resources, such as capital controls. Channels
commonly thought of as being illicit include all forms of cross-border money launder-
ing. This includes cash smuggling and trade-based money laundering, accomplished
47
Figure 2. Classification of Channels and Sources of Illicit Financial Flows
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Source: Author’s classification of illicit financial flows according to their sources and channels.
Note: The figure illustrates the author’s classification of various combinations of sources and channels of financial
flows as either licit flows or the narrow and broad definitions of illicit flows.
by obscuring the true price or quantity of goods being exported or imported. Some-
times the source and channel of an IFF are hard to disentangle. For example, a person
may transfer their assets to a “tax haven,” a jurisdiction that does not share benefi-
cial ownership or taxpayer information with the person’s tax authority back home,
in an effort to evade taxation. In this case, the flow could be considered illicit because
the activity that gave rise to it involves the intention to evade tax or because moving
money to tax havens regardless of the purpose might be considered by some to be use
of an illicit channel.
Other definitions of IFFs go beyond flows that explicitly break the law. These include
more normative or consequentialist definitions which take into account whether the
flows are within the spirit of the law or the impact they can have on an economy.
For example, Cobham (2014) argues that IFFs should also include socially damaging
48 The World Bank Research Observer, vol. 35, no. 1 (2020)
flows that are not necessarily illegal, such as aggressive profit-shifting by multina-
tional corporations and other forms of tax avoidance. Some take the definition even
further: Blankenburg and Khan (2012) consider illicit (capital) flows to include any
cross-border flows that have a negative effect on an economy, either directly (e.g., via
lost tax revenue) or indirectly (e.g., by eroding institutions). These definitions often
rely on the idea that the word “illicit” should also capture the socially undesirable as
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well as the explicitly illegal. Bohoslavsky (2016) refers to this as the “broad” defini-
tion of IFFs, as opposed to the “narrow” definition described at the beginning of this
section.
While the narrow definition is more or less objective in nature, the broad definition
suffers from being largely subjective: whether or not a flow is socially undesirable can
be debated and judged differently by different parties. By contrast, the narrow view
can occasionally lead to uncomfortable classifications, such as when legal money is
moved out of a country to avoid expropriation by an autocratic regime or flows that
lead to economic instability.
As such, this article will largely be concerned with the narrow definition of IFFs
based around illegality, which has the advantage of being concrete. However, given
the attention that corporate tax avoidance has received in the IFF-related literature,
it will also include estimates or discussions of estimates of these phenomena, as they
are closely related. To reflect this, fig. 2 includes transfer price abuse,6 the manipu-
lation of intra-subsidiary transactions by multinationals in order to shift profits be-
tween countries, as a potential channel of IFFs. In addition to this, “aggressive tax
avoidance” has been included as an illicit source under the broad definition to ac-
count for any aggressive or undesirable behavior of firms or individuals that could
lead to a reduction in their tax obligations.
Certain flows may not be considered IFFs at the time they were moved abroad. For
example, a transfer of money to an overseas tax haven may not break any domestic
laws until the owner fails to declare the wealth or subsequent interest to their do-
mestic tax authority. Also, the inclusion of “use” in the categorization of IFFs can be
problematic for their measurement, as money that has crossed a border may not be
used for an illegal purpose until some time after its transfer.7
Also, funds that are considered IFFs may not have actually been transferred in the
traditional sense. Value may be created in one jurisdiction as the result of illegal be-
havior in another. For example, if a company bribes a government official by deposit-
ing funds in an account in the official’s name in a tax haven, this could be considered
an illicit outflow. A generalization of Raymond Baker’s definition to account for these
indirect transfers might include any money that is generated in one jurisdiction as a
result of illegal activity in another jurisdiction by an entity who has a controlling in-
terest in that money after it has been generated. Thus, illicit flows might also include
value that is controlled across borders by those who generated that value illegally (or
use it for an illegal purpose). They might also include financial instruments which at
49
first glance do not appear to involve a transfer of money (e.g., equity or securities) and
the transfer of non-monetary assets (e.g., precious stones or paintings).
Many studies refer to illicit flows as being hidden by definition (OECD 2014;
Financial Transparency Coalition 2015) or implicitly assume this by attempting to
measure only unreported international flows, but this need not be the case. Money
that has been generated through illegal activity may be moved out of a country
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through an entirely legitimate channel and held in a transparent manner, especially
if it has been laundered prior to crossing a border.
3 Measuring Illicit Flows
By their very nature, IFFs are difficult to measure and even harder to aggregate. There
are three main challenges in estimating IFFs. The first is a measurement issue. As the
true value of illicit flows to and from an economy is never truly observed, most meth-
ods produce a constructed estimate, which will deviate from the true estimate by an
error term of unknown size and direction. These estimates are often indexed over time
and by the direction or type of flow. They are likely to be unbiased if the measurement
error is truly random, although if there is a high degree of noise in the data, it can be
difficult to determine whether observed changes over time are meaningful.
However, in practice, the error term of an IFF estimate is likely to contain more than
just noise. For example, if the error term is not centered at zero then estimates of IFFs
will be biased up or down, even if changes over time would still contain meaningful
information. Worse, if the error associated with an IFF estimate is spuriously corre-
lated with other characteristics that change over time, then trends in IFF estimates
will be difficult to interpret. Thus, the problem of estimating IFFs—measuring an un-
observed, latent variable—is very similar to that of measuring the informal economy
(Frey and Weck-Hanneman 1984). Unsurprisingly, many of the methods described
here closely mirror both direct and indirect methods used in the economics literature
to measure informality (Medina and Schneider 2018).
The second challenge in estimating IFFs comes from the fact that most methods
of estimating specific types of IFFs are overlapping in nature: they are measuring in
part the same source or channel. This makes constructing an aggregate figure sum-
ming all types of IFFs particularly challenging—perhaps even fruitless. Section 6 will
discuss how different measures can be more meaningfully aggregated.
The final challenge is that measures of IFFs are going to favor types of illicit flows
that can be more easily measured or for which measures are more likely to be con-
structed. Therefore it is difficult to make definitive statements as to whether certain
sources or channels of IFFs are more prevalent, as the relative importance of a source
or channel in global estimates may be driven merely by the relative demand for or sup-
ply of those estimates. For example, the proceeds of grand corruption may actually
make up a large proportion of global IFFs but appear smaller relative to tax evasion
50 The World Bank Research Observer, vol. 35, no. 1 (2020)
because the latter is easier to model. This can also make changes in IFFs over time
or across certain dimensions—such as GDP—hard to interpret, as they may reflect a
shift in illicit activity from things that are more easily measured to those that are not.
How this should affect considerations about lumping measures of IFFs together will
be discussed in section 6.
The rest of this section will review popular, data-driven methods that researchers
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have used to estimate IFFs, examine what estimates have actually been produced, and
discuss their relative strengths and weaknesses.8
Balance-of-Payments Methods
One of the most common ways of estimating illicit flows relies on methods devel-
oped in the capital flight literature. Researchers often use macroeconomic identities,
specifically balance-of-payment statistics, to determine when capital is shifting over-
seas. The “sources-and-uses method” is based on the fact that a country’s balance-
of-payment identity must hold: sources of capital inflows (net increases in foreign
debt and foreign direct investment, FDI) should only exceed the uses of capital inflows
(the current account deficit and changes in reserves) when capital is moving overseas
(Johannesen and Pirttilä 2016). The sum of the net change in debt, FDI, current ac-
count surplus, and change in reserves is then used as an empirical estimate of capital
flight.
To better distinguish between ordinary capital flight and that which is hidden
from official statistics (and hence presumably illicit), researchers have begun to rely
on more narrowly defined measures of deviation. The “hot-money-narrow method”
focuses only on the net errors and omissions (NEOs) entry in balance-of-payment
statistics, and occasionally also on flows of short-term capital. The underlying ar-
gument is that because NEOs are unexplained, they are more likely to capture hidden
flows. Various attempts to estimate aggregate IFFs use variations of either the sources-
and-uses method or the hot-money-narrow method, but all are conceptually similar
(Ndikumana and Boyce 2008; Kar and Cartwright-Smith 2010; Kar and Spanjers
2015; UNECA 2015).
Estimates using the hot-money-narrow method have typically involved substan-
tial sums: the nonprofit organization Global Financial Integrity (GFI) estimates that
in 2015, roughly $342 billion left developing countries, an increase on previous years
(Salomon 2019), although this is only a fraction of their total estimate of IFFs (most
of which consist of trade-based estimates, to be discussed next). Henry (2012) esti-
mates annual IFFs of roughly the same magnitude and also uses the sources-and-uses
method to produce estimates of the total stock of hidden capital held overseas. Fol-
lowing this approach, he estimates that up to $9.3 trillion in unrecorded wealth has
been generated from a group of 139 lower and middle-income countries since the
1970s.
51
Criticisms of the hot-money-narrow approach fall into two categories: reasons why
the flows it captures might not be illicit and reasons why it might not be capturing
anything at all. Researchers have pointed out that short-term capital, which is in-
cluded in some hot-money-narrow calculations (albeit not GFI’s), largely consists of
commercial credit, which is not usually thought of as either being capital flight or at
risk for being an illicit flow. Thus the hot-money-narrow method may lead to over-
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counting or false positives. Others have pointed out that NEOs, which make up the
bulk of hot-money estimates, are largely going to be driven by compilation errors
in capital accounts, incomplete measurement, or inadequate currency conversions
(Schneider 2003). Therefore, large-scale estimates may be significantly made up of
noise in the data, making it impossible to know precisely how much capital has left.
Finally, methods based on balance-of-payment statistics will provide a net estimate
of capital flight or illicit flows (Johannesen and Pirttilä 2016). Inflows and outflows
are likely to have different effects on a local economy, and there is currently no con-
sensus on whether these flows should be netted out or added up (Nitsch 2016).
As can be seen in fig. 3 (in section 4), illicit outflows as a percentage of trade vol-
umes measured using GFI’s variant of the hot-money-narrow method are weakly in-
creasing with a country’s income, suggesting that to the extent that the hot-money-
narrow method is picking up meaningful variation in IFFs, they are likely to be an
emerging country phenomenon.
Trade Gap Analyses
Although its intellectual origins are half a century old (Bhagwati 1964), the method
of using trade data to estimate or detect illicit behavior has risen to particular promi-
nence in the past 15 years, largely due to the work of GFI in deriving global estimates
of IFFs. The concept is fairly simple: after accounting for shipping and insurance costs,
the declared price and quantity of an export from one country should match the de-
clared price and quantity when that shipment reaches its destination and is recorded
as an import. The only legitimate deviation between the two records should come
from shipping and insurance costs (which typically go unrecorded in aggregate trade
statistics) or an error in recording the import/export value or quantity.
As described by Bhagwati (1964), there may be incentives to either under- or over-
report the value (or quantity) of an export or import. For example, if an agent wished
to quietly move money out of Malawi, they could over-invoice an imported shipment
of mobile phones from the United States by $100,000, paying the difference to an
intermediary that they own outside of Malawi. There are various incentives ascribed
to over-/under-reporting exports/imports, which include:
(1) over-invoicing imports—retaining money abroad, avoiding capital controls (by
obtaining excess foreign exchange), reducing taxable profit;
52 The World Bank Research Observer, vol. 35, no. 1 (2020)
Figure 3. Correlation between Various IFF Measures and Indices
Source: Author’s analysis based on data from Salomon and Spanjers (2017) for HMN, Salomon and Spanjers (2017) for GER, Alstadsæter, Johannesen, and Zucman (2018)
for OFFSHORE, ICAR (2017) for BASEL, Tax Justice Network (2016) for FSI, and the World Bank for LNGDP.
Note: Each graph shows the scatterplot of an estimation measure (or a risk measure) for illicit financial flows (IFFs) against another measure or against log(GDP per capita).
HMN = illicit outflows in 2014 measured using the hot-money-narrow method as a percentage of total trade; GER = illicit outflows in 2014 measured using the gross
excluding reversals method as a percentage of total trade; OFFSHORE = total offshore wealth as a percentage of GDP; BASEL = Basel AML Index score (lower is “better”); FSI
= Financial Secrecy Index secrecy score; LNGDP = log(GDP per capita in constant 2011 dollars). The figure shows every possible combination of measures, with measures
53
listed along the left side being assigned to the vertical axis and those listed along the top assigned to the horizontal axis. Pairwise correlations are listed within each graph.
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(2) under-invoicing imports—evading customs duties;
(3) over-reporting exports—taking advantage of export credits;
(4) under-invoicing exports—avoiding export tariffs, retaining money abroad, avoid-
ing capital controls (by obtaining excess foreign exchange).
Note that for a source country, only (1) over-invoicing imports and (4) under-
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invoicing exports have the potential to be driven by the desire to secretly (or illicitly)
move or retain money abroad. The other two are likely to be driven by the desire to
avoid paying tariffs, which, while it deprives one country of potential tax revenue,
does not necessarily involve the transfer of resources abroad. However, GFI’s esti-
mates consider both (2) and (3) as potential signs of illicit inflows.
To quantify total trade-based IFFs, GFI’s “gross excluding reversals” (GER) method
examines mirrored statistics (i.e., what country A declares it has exported to country
B and what country B declares it has imported from country A) between developed
countries and developing countries, under the assumption that values reported to
customs officials in the former are likely to be true. GER does take into account that
there will be a natural discrepancy between the two reported values due to shipping
and insurance costs, which it assumes to be 6 percent of the value of the export when
actual data on these costs are not available.9 In light of the incentives listed above,
after correcting for shipping costs, the GER method assumes that any deviation in
mirrored trade statistics that indicates an over-invoiced import or an under-invoiced
export is an illicit financial outflow. Note that the 6 percent assumption is invariant
with respect to the distance the export is traveling, so it is likely to lead to a declaration
of under-invoicing (a false positive) when the distance leads to a higher shipping cost,
and vice versa.
To come up with country and global estimates, GFI first uses the GER method to
sum up the total amount of IFFs due to trade-based money laundering between each
developing country and the set of richer country counterparts.10 It does this using
both aggregate data from the IMF’s Direction of Trade Statistics database and, in its
most recent release, commodity-specific data from the UN’s COMTRADE database. It
then uses this sum to calculate the share of the country’s trade that involves illicit
transactions and multiplies that share by aggregate estimates of the country’s trade
to arrive at an aggregate value for illicit outflows. Summing country-level estimates
results in a global estimate of trade-based money laundering. GFI’s latest estimates
of trade-based money laundering exceed those obtained via the hot-money-narrow
approach by a significant margin: GFI’s estimates put the total amount of money
that left developing countries due to mis-invoicing at roughly 85 percent of the total
($598–807 billion a year) in 2015 alone (Salomon 2019). Besides GFI, several re-
search outfits and non-governmental organizations have produced similar figures for
individual countries, groups of countries, and specific product categories (Nicolaou-
Manias 2016).
54 The World Bank Research Observer, vol. 35, no. 1 (2020)
These methods have come under heavy criticism from those who point to more
innocent reasons why there might be a deviation in mirrored trade statistics: errors
in recording prices or amounts, differences between countries in categorizing prod-
ucts, differences in reporting rules or transparency, and deviations between actual
shipping and insurance costs and the fixed 6 percent assumption used in the GER
method (Johannesen and Pirttilä 2016; Nitsch 2016). Many of the same critics have
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also questioned the GER assumption that trade statistics from rich countries are mea-
sured without (or at least with less) error. Because of these legitimate criticisms, ag-
gregates based on trade gaps are likely to be both imprecise and over-inflated. Others
have pointed out that the GER method will not appropriately account for re-exporting
via, for example, bonded warehouses. GFI does correct its figures for re-exports be-
tween China and Hong Kong,11 but this issue is still likely to plague other bilateral
estimates (Forstater 2016).
These concerns are not purely theoretical, as there have been some high-profile ex-
amples of the GER method leading to substantial overestimates of IFFs. Most notable
was a report released by the United Nations Conference on Trade and Development
(UNCTAD) in 2016 which claimed that 67 percent of gold exports from South Africa
were mis-invoiced, resulting in IFFs of nearly $80 billion between 2000 and 2014.
It was later revealed that much of the discrepancy was due to a deviation in the re-
porting standards which prevented gold exports from being correctly recorded in the
COMTRADE database (Forstater 2017a; Eunomix 2017).
The correlation between GER estimates of illicit outflows (as a share of total trade)
and the log of per capita GDP is 0.07 (see fig. 3 in section 4), indicating that if this
method is picking up trade-based money laundering, it is equally an issue in poor and
emerging economies.
Trade Price Deviation Analyses
There is a separate line of research that estimates illegal capital flight based on de-
viations of exports/imports from some reasonable range of prices, rather than us-
ing mirror trade statistics. Zdanowicz (2009) examines US exports and imports and
concludes that transfers for which the price exceeds some distributional margin (e.g.,
50 percent of the average price or the upper/lower quartile) are plausibly the result of
illicit behavior. Using this form of analysis combined with data on corporate tax rates,
Christian Aid (2009) calculated that developing countries are losing up to $160 bil-
lion a year due to trade mis-pricing.
The difficulty with this approach is that it conceptually conflates two types of trans-
fers: trade mis-invoicing (over-/under-invoicing at one end of the transfer and report-
ing truthfully at the other end) and transfer mis-pricing (where the price is reported
correctly at both ends of the transaction but is distorted to affect the location where
55
profits are reported).12 An unusually low export price could be due to an artificially
low transfer price, or it might be due to under-invoicing.
Given that estimates of IFFs obtained with this method will be increasing in the
price variance within a given product category, it is difficult to know what propor-
tion of these estimates are driven by natural deviations in price and which estimates
are actually driven by some form of illicit flow. As with trade gap analyses, errors in
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the data will often manifest as phantom illicit flows. Forstater (2015) notes that price
outliers in trade data (such as a bucket priced at $973 which has been used by many
nonprofits as an example of mis-pricing) are likely to be partially explained by mis-
takes in recording either the value or the quantity of the shipment. Similarly, goods
that are of higher/lower quality than or otherwise differentiated from the intended
classification may be mistakenly flagged as being priced higher/lower than the norm.
Despite these limitations, analyzing extreme deviations in trade prices is likely to
be a useful tool in forensic approaches to detecting illicit behavior used by interested
parties such as customs agents. Using trade price deviations as a risk indicator to drive
auditing decisions may make more sense than using them to estimate aggregate IFFs.
Transfer Price Analyses
Tax authorities typically enforce transfer price regimes by comparing firm-level data
on transfer prices with some reasonable comparator (usually the price set for the same
product for transfers between unrelated parties) or by calculating the profit margin
of transactions for an entire enterprise. The former approach is known as the arms-
length principle: that related firms should transfer goods at the same price as they
would have if they had been unrelated, and that significant deviations in the transfer
price are a sign of attempted profit-shifting.
These analyses require micro-level data on the transfer price decisions of firms,
decisions that are typically available only to the firms themselves or to tax authori-
ties. Researchers often look for evidence of transfer pricing and profit-shifting using
publicly available or purchasable data, which typically contain information about
a multinational’s cross-border operations, revenues, and profits, but often does not
include transfer pricing decisions. However, exceptions exist, such as the US Census
Bureau Longitudinal Firm Trade Transactions Database, which was used by Bernard,
Jensen, and Schott (2006) to determine that US exporters systematically set lower
prices when exporting to related parties than when exporting to unrelated firms.
Recently, researchers have begun to use similar data sources to produce estimates
of the revenue loss from tax-motivated transfer mis-pricing (Vicard 2015; Cristea
and Nguyen 2016; Liu, Schmidt-Eisenlohr, and Guo 2017; Davies et al. 2018; Wier
2018). These estimates are largely obtained by first calculating the deviation in the
arms-length price observed when a firm transacts with related parties and then
observing how that deviation changes when the transacting firms face different
56 The World Bank Research Observer, vol. 35, no. 1 (2020)
corporate tax rates. The resulting estimates of the response of the declared prices to
differential tax rates are then used to calculate how much extra revenue would have
resulted if there were no tax incentives to misreport. These estimates, which cur-
rently cover only developed countries, range from less than 0.5 percent for the United
States to roughly 2.5 percent for France (Wier 2018). This work also fits into a wider
forensic literature investigating the determinants of corporate profit-shifting, which
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will be discussed later.
International Portfolio and Deposit Data
Instead of estimating cross-border flows, Zucman (2013) attempted to estimate the
overall stock value of wealth that is held offshore. While money held overseas is not
necessarily of illicit origin, its unreported nature might indicate a substantial risk that
a law has been broken. Zucman’s estimation strategy relies on the fact that unre-
ported wealth drives a wedge in international portfolio statistics: because owners of
hidden financial assets do not declare them, the asset position of source countries will
be systematically under-reported. Because tax havens record liabilities on their books
correctly (although the ultimate source of a liability will usually not be recorded), this
will leave a gap between aggregate worldwide reported assets and liabilities.
Zucman (2013) uses aggregate international investment position data.13 Assum-
ing that gaps in the global aggregates of portfolio liabilities and assets represent hid-
den securities, the aggregate value is combined with reported data on cross-border
deposits provided by the Bank of International Settlements (BIS) to yield an estimate
that approximately 8 percent of household financial wealth is held overseas, with no
more than a fifth of that being reported in the source countries.
One potential criticism of Zucman’s method is that, similar to the balance-of-
payment estimates discussed above, it relies on deviations in aggregate data that could
also be explained by measurement error. To support the main result with more de-
tailed evidence, Zucman used bilateral portfolio data taken from the IMF’s Coordi-
nated Portfolio Investment Survey to show, for a limited group of countries, that bi-
lateral estimates of unreported wealth are largest for countries recognized to be tax
havens and are minimal otherwise. In a more recent study, Alstadsæter, Johannesen,
and Zucman (2018) used updated BIS bilateral banking statistics to allocate the es-
timates of offshore wealth to each country in the world. As can be seen in fig. 3
(section 4), these estimates suggest that offshore wealth is roughly proportional
to country income, with lower-, middle-, and upper-income countries maintaining
roughly the same shares of their national income in offshore tax havens.
Deviations from Traditional Gravity Models of Financial Flows
Another method for estimating illicit flows is based on an empirical model that
predicts cross-border flows and attempts to estimate an “illicit premium,” the
57
additional amount that is sent to a certain jurisdiction solely because of its attrac-
tiveness in terms of hiding illicit funds. An example of this can be found in Pérez,
Brada, and Drabek (2012), which estimates a variation of a gravity model that
predicts FDI from transition economies to the rest of the world. After controlling
for source and destination characteristics that would normally be expected to pre-
dict FDI, the authors found that the designation of a destination jurisdiction as
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a “jurisdiction of primary concern” by the US State Department’s International
Narcotics Control Strategy Report (INCSR) predicts a higher share of FDI; this ex-
tra share is assumed to be a direct estimate of FDI directed toward the purpose of
facilitating IFFs.
These models are attractive because they are easy to estimate given any measure
of bilateral flow. However, they potentially suffer from an omitted variable problem. If
the chosen measure of attractiveness is systematically correlated with unobservable
characteristics that predict FDI but have nothing to do the “illicit premium,” then
these models will lead to an overstatement of the level of illicit finance. Because of
these limitations, most gravity model estimates of the attractiveness of destination
countries as tax havens or money laundering centers do not attempt to calculate ac-
tual amounts (e.g., Rose and Spiegel 2007).
Bottom-up Methods of Estimating Money Laundering
In addition to estimation based on macro-data on bilateral flows, changes in the
current account, or trade data, there are a few methods of estimating IFFs that
rely on aggregating data on crime to produce a national-level measure of money
laundering. These methods vary in the sophistication of the aggregation approach
used.
The Walker Model
Walker’s model of money laundering is part of a class of “constructed” money laun-
dering estimates. To generate these estimates, researchers first estimate or assume
a relationship between observed indicators of crime (e.g., estimates of drug pro-
ceeds, national crime surveys, corruption indicators, and suspicious transaction re-
ports) and the amount of money laundering in a country. The estimates are often
educated guesses or based on expert surveys and are rarely derived from true esti-
mates of money laundering. Once an estimated relationship between observed crime
statistics and money laundering is established, a total amount for a country can be
calculated.
Walker’s (1999) variation on this approach was to also estimate the share of
laundered money that is sent abroad, which is presumed to be related to a coun-
try’s rating on the Transparency International Corruption Perceptions Index, with
58 The World Bank Research Observer, vol. 35, no. 1 (2020)
the most corrupt countries sending 70–80 percent of laundered money abroad
and the least corrupt sending nothing abroad. To determine where in the world
laundered money would be sent, Walker defined the attractiveness of a destination
country as a function of several observable characteristics (such as GNP per capita
and measures of bank secrecy and anti-money-laundering effort), parameters that
are impossible to verify. Discounting this measure of attractiveness by the distance
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between the source and destination countries, Walker then used it to estimate money
laundering flows between all countries in the world, which could be summed to pro-
duce a global estimate of IFFs. The main critique of such models was that many of
the choices of parameters seemed arbitrary, despite attempts by some (e.g., Walker
1999; Walker and Unger 2009) to triangulate the results using other estimates
of IFFs.
In an attempt to generate empirical estimates of the parameters in the Walker
model, Ferwerda et al. (2013) estimated an empirical gravity model with the same
structure as the Walker model but using estimates from the trade price deviation
method of estimating money laundering flows used in Zdanowicz (2009). The pa-
rameter estimates in that exercise deviated wildly from the original Walker estimates,
and it is unknown whether this is because the estimates in Ferwerda et al. (2013) are
closer to the truth or because both methods are flawed.
Structural Models of Money Laundering
Avoiding the ad hoc nature of the Walker model, other researchers have attempted
to model the relationship between existing data on the sources of illicit finance and
the flows themselves in a more rigorous fashion. In a recent article, Villa, Misa, and
Loayza (2016) created a model to describe the Colombian economy made up of a
licit sector and an illicit sector, the latter comprising both the cocaine market (which
has market value) and common crime (which does not). In the model a propor-
tion of savings from the illicit economy is laundered back into capital investment.
From this structural model the authors derived a series of equations that can be esti-
mated using existing data on the illicit economy, allowing them to estimate both the
amount of undetected illicit income and the stock of laundered assets as a share of
Colombian GDP. The analysis is confined to money laundering in a broad sense, mak-
ing it difficult to determine what proportion of illicit income eventually leaves the
country.
Studies such as these that rely on economic theory and structural modeling do
have an advantage over ad hoc methods such as the Walker model in that they care-
fully consider the equilibrium effects of changes in the illicit economy. However, these
models are also based on assumptions that are difficult to test empirically, making es-
timates based on the models equally hard to verify.
59
4 Predicting Illicit Flows
Faced with the difficulty (or impossibility) of precisely calculating illicit flows, many
researchers have instead tried either to construct indicators that proxy for the expo-
sure of a country to illicit flows or to empirically identify the correlates of IFFs.
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Indices Indicating the “Risk” of Illicit Flows
Instead of attempting to measure illicit flows directly, some researchers have turned
to constructing indices that reflect the exposure a jurisdiction might have to IFFs. To
do this, they assume that there is an empirical relationship between unobserved illicit
flows and a set of observable characteristics of a given country. As actual data on illicit
flows are unavailable, this relationship is usually an assumed one. Frequently, such a
constructed index is a linear combination of the observable characteristics and typi-
cally takes the form of a composite index. In this context, the index is not expressed in
meaningful units and is not considered to be an actual estimate of illicit flows. Rather,
it is treated as a quantity that is thought to be meaningfully correlated with actual
IFFs or with the probability that those flows exceed some arbitrary threshold. Thus
the term “risk” in this context is not used in the economic sense (i.e., variation or
deviation from expectations) but rather in the probabilistic sense.
One difficulty with this approach is in choosing a functional form that accurately
reflects the direction of the true relationship between observed characteristics and
IFFs. Most importantly, exposure to IFFs (or the risk of IFFs) should be monotonically
increasing with the value of an index. If this relationship holds, then a ranking of
countries based on the index will be equivalent to a ranking based on the true value
of IFFs. But because the functional form of the indices is often ad hoc, it is difficult to
know how often the monotonic relationship holds in practice.
Financial Secrecy Index
The Financial Secrecy Index (FSI) is a product of the Tax Justice Network. It is in-
tended to measure both the level of financial secrecy available in a given jurisdiction
and the scale of financial activity based there. It reflects a careful review of the regu-
latory, legal, and tax situations in approximately 100 countries, covering four main
attributes: beneficial ownership transparency, regulation of corporate transparency,
efficient tax and financial regulation, and compliance with international standards
around tax and anti-money-laundering (AML). These qualitative assessments are
used to compile a “secrecy score,” which is normalized to range from zero to 100. To
calculate the overall index, the proportion of global financial services exported from
the jurisdiction in question, referred to as a “global scale weight,” is transformed and
then multiplied by a transformed secrecy score.14 Thus the FSI is both a measure of
60 The World Bank Research Observer, vol. 35, no. 1 (2020)
the financial secrecy afforded by moving money to a jurisdiction and a measure of
how much money sits in that jurisdiction.
While infamous small island tax havens typically have the highest secrecy scores
(as can be seen in fig. 3, middle-income countries tend to have higher secrecy scores),
once the global scale weight is applied, large economies such as the USA, Germany,
Japan, and the UK end up near the top of the ranking. While the secrecy score can
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be thought of as a measure of the risk that a marginal dollar sent to that jurisdiction
is hidden, the full FSI can be thought of as a measure of the risk that a dollar float-
ing around in the global economy is hidden in that jurisdiction. This might make the
secrecy score component of the FSI more useful in gauging IFF risk, as it is easier to
infer that a dollar sent from a developing country to a country that has a high secrecy
score is in fact at risk of being hidden.
The FSI does not measure illicit cash directly, only the characteristics that would
make holding cash in a jurisdiction attractive from a secrecy standpoint. Thus it can
be thought of as a country risk indicator largely for illicit financial inflows. How-
ever, unusual levels of cross-border transfers to countries that have a high secrecy
score might themselves be suspicious. Although the FSI does not distinguish between
sources and channels of IFFs, the fact that most countries scoring high on the FSI are
considered to be “tax havens” suggests that tax evasion is a strong motive for mov-
ing money to these locations. Empirically, the FSI is correlated with other tax haven
measures: an analysis of data leaked from the Panamanian law firm Mossack Fonseca
revealed that an increase of one standard deviation in a country’s FSI was associated
with a 90 percent increase in the number of entities from the country named in the
Panama Papers (Collin 2016).
The Basel Anti-Money-Laundering Index
The Basel AML Index is a product of the International Centre for Asset Recovery
(ICAR), based at the Basel Institute for Governance. Running since 2012, it is an
annual assessment and ranking of countries based on their “risk regarding money
laundering/terrorism financing” that covers 149 countries. The index is a composite
of about 14 publicly available indicators, which are divided into five broad categories:
(i) money laundering or terrorist finance risk; (ii) corruption risk; (iii) financial trans-
parency and standards; (iv) public transparency and accountability; and (v) politi-
cal and legal risk. ICAR aggregates these indicators into a single index using weights
based on expert assessment.15 The result is both an index and a ranking, which ICAR
updates and releases every year.
The Basel AML Index’s composite nature makes it difficult to discern what exactly
is being measured. There is a substantial amount of conceptual overlap between com-
ponents, as many of them are designed to measure similar factors. Because neither
the index nor the underlying subindices have even been calibrated against actual
61
measures of financial crime or money laundering, changes in illicit flows cannot read-
ily be inferred from changes in the index.
One attractive feature of the Basel AML Index is its partial reliance on subindices
that measure government policy, such as the FSI and, to lesser extent, the results of
Mutual Evaluation Reports produced by members of the FATF. However, a number
of the subindices are based on subjective expert assessments of a country, such as
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Transparency International’s Corruption Perceptions Index. Many of these indica-
tors (such as the Corruption Perceptions Index) are not direct measurements of AML-
related policies, but instead are measures of environments or activities that are likely
to result in stolen or illicit money (even if that money never leaves the jurisdiction in
question). As with many of these other indicators, the Basel AML Index is likely to
be a composite measure of the risk of illicit outflows, illicit inflows, and illicit finance
that does not leave the country.
Unsurprisingly, the Basel AML Index is strongly correlated with a country’s per
capita income (fig. 3), as its components are largely measures of institutions that typ-
ically vary with income.
Correlations between Indices and IFF Outcomes
Figure 3 displays bilateral correlations between the FSI’s secrecy score, the Basel
AML Index, and three of the main IFF outcomes described in the previous section—
GFI’s hot-money-narrow measure, its GER measure,16 and recent country-level es-
timates of offshore wealth by Alstadsæter, Johannesen, and Zucman (2018). The
FSI’s secrecy score and the Basel AML Index are strongly correlated by construc-
tion (as the former is an input into the latter); neither display a particularly strong
correlation with measured IFFs. In the case of the secrecy score, there is a moder-
ate correlation of 0.31 with the hot-money-narrow measure of illicit outflows. This
is somewhat less intuitive as financial secrecy should be a determinant of illicit in-
flows (the correlation between the secrecy score and the hot-money-narrow mea-
sure of inflows, not shown, is 0.27). The fact that these indices of illicit flows are
only weakly correlated with popular measures of IFFs suggests that either the in-
dices are not particularly useful at predicting IFFs, or the measures themselves should
be treated with caution. None of the illicit outcomes themselves are highly corre-
lated, indicating that they either are measuring different concepts or are all very
noisy.
Forensic Studies of Illicit Flows
Both aggregate estimates of IFFs and indices are difficult to verify as they are rarely
tested against actual data on illicit flows. In the absence of certainty regarding
these methods, a growing “forensic” literature aims to identify specific instances
62 The World Bank Research Observer, vol. 35, no. 1 (2020)
where there is likely to have been an increase in IFFs. These methods have the
advantage of not relying solely on estimates that might be prone to error, in-
stead focusing on how these estimates change across different economic actors or
contexts.
Most studies in this forensic literature estimate a relationship by taking an estimate
or a proxy for IFFs and regressing it on a series of observable characteristics (or ex-
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ogenous shocks) that are thought to be correlated or causally linked to illicit flows.
If a particular characteristic is found to have a significant impact on the measure
of IFFs, and that effect is suggested by theory, then there are two ways—depending
on one’s priors—to interpret the result. The first is that if the theoretical relation-
ship between the characteristic in question and the latent value of IFFs is believed
to be true, then the result can be interpreted as indicating that the estimate of IFFs
contains meaningful information. For example, theory suggests that the capacity of
a country’s customs administration will affect the level of trade mis-invoicing. If a
study then finds a negative correlation between a cross-country trade-gap measure
and a proxy for a country’s quality of customs administration, then one way to inter-
pret the finding is that the trade-gap measure is meaningfully picking up variation in
trade mis-invoicing.
The second interpretation is that if one’s prior was that the measure of IFFs
(e.g., the trade-gap measure) picks up meaningful variation in IFFs (e.g., trade mis-
invoicing), then correlation with a given characteristic (e.g., customs administration
quality) provides empirical validation as to which characteristics predict IFFs. For ex-
ample, if one’s measure of IFFs is found to increase after an unexpected windfall in
natural resource rents, but only in countries with weak institutions, then this might
contain information on where IFFs are likely to be occurring.
Disconcertingly, these two interpretations are somewhat competing: they require
priors either about the theoretical relationship between the measure of IFFs and the
characteristics being regressed on or about the validity of the IFF measure in the
first place. Furthermore, both interpretations rely on an important identification as-
sumption: that the various characteristics being investigated are uncorrelated with
measurement error in the estimate of IFFs. For example, countries lacking institu-
tional capacity might struggle both to detect illicit behavior and to produce error-
proof statistics that can be used in IFF estimates. Despite these concerns, the forensic
approach can still be used to identify candidate characteristics for future investiga-
tion.
The rest of this subsection will describe recent studies that fit into this class of re-
search. These have been categorized roughly according to the origins of illicit flows
and the channels that they can take. However, many of the studies cover more than
one source or channel of illicit flows. Table 2 summarizes the main results of these
studies, including roughly which sources and channels of IFFs they cover.
63
Table 1. Different Methods of Quantifying Illicit Financial Flows and Their Rough Classification
Closest
definition
Estimation method Flow Channels Sources of IFFs
Balance of payments All unrecorded, unaccounted Any formal Any source Narrow
methods (sources and capital flows channel
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uses, hot-money-narrow,
etc.)
International portfolio and Transfers of assets overseas Wire transfer Any source Narrow
deposit data that remain undeclared to
(source) tax authorities
Trade gap analyses Money moved (or retained) Trade-based Any source Narrow
abroad due to mis-invoicing money
laundering
Transfer price analyses Profits shifted due to Transfer Corporate Broad
aggressive transfer pricing mis-pricing profits
Trade price deviation Combination of trade gap and Combination of Any source Broad
analyses transfer price analyses trade gap and
transfer price
Gravity model deviations Money sent to a jurisdiction Wire transfer Any source Narrow
solely for its secrecy
Walker model Money generated illegally (or Any channel Any illegal Narrow
illegally withheld from state) source
that crosses a border
Structural models Estimates of illicit finance that Any channel Any illegal Narrow
is laundered source
Source: Author’s summary and elaboration of estimation methods, along with assessment of their appropriate clas-
sification.
Note: This table lists various methods of estimating illicit financial flows (IFFs), the types of flows, sources, and chan-
nels they likely measure, and the most appropriate definition of IFFs they measure, as determined by the author.
Trade Gaps and Trade Misinvoicing
There is a large economic literature on the determinants of trade mis-invoicing. One
component focuses on how measures of the trade gap change as the incentives to
evade increase. Fisman and Wei (2004) found that the evasion gap between Hong
Kong exports and Chinese imports is positively correlated with Chinese tax rates.
Similar studies have been conducted in India (Mishra, Subramanian, and Topalova
2008), in Kenya, Mauritius, and Nigeria (Bouet and Roy 2012), and cross-nationally
(Kellenberg and Levinson 2019), all yielding similar results. Vézina (2015) found
that trade discrepancies in exports of natural resources are more likely to occur
when export controls are in place. Yang (2008) found that efforts to curb tariff eva-
sion in the Philippines reduced evasion gaps but were displaced by other forms of
tariff evasion, such as importing into an special export-processing zone with tariff
64 The World Bank Research Observer, vol. 35, no. 1 (2020)
Table 2. Links between Forensic Studies and IFF Channels, Sources and Risk Factors
Study Risk factor identified Outcome Channels Sources Notes
Trade gaps and trade mis-invoicing
Fisman and Wei (2004) Import taxes 1% increase in tax rate = Trade-based money Tax/tariff evasion Import taxes on Hong Kong
3% increase in trade gap laundering (TBML) shipments to China
Mishra, Subramanian, Higher trade gaps TBML Tax/tariff evasion India
and Topalova (2008)
Yang (2008) Export processing zones Higher trade gaps TBML Tax/tariff evasion Philippines
Javorcik and Narciso Differentiated products 1.3% increase in trade gap TBML All potential sources Germany to Eastern Europe
(2008) (1992–2003)
Rotunno and Vézina • Tariff rates Higher trade gap TBML Tax/tariff evasion; potentially all China and trade partners
(2012) • Trading partner with other sources of IFFs
significant percentage of
co-ethnics
Bouet and Roy (2012) TBML Kenya, Mauritius, and
Nigeria
Vézina (2015) Export controls Higher trade gaps (36–50%) TBML Global; effects higher for
more corrupt countries
and those that had higher
levels of customs official
bribes (WEF Expert
Opinion Survey, 2010)
Rijkers, Baghdadi, and Politically connected firms Higher trade gaps TBML Tax/tariff evasion; corrupt Tunisia
Raballand (2015) proceeds; potentially all other
sources of IFFs
Kellenberg and Levinson • Export/import tariffs or taxes Higher trade gaps TBML Tax/tariff evasion; corrupt Global
(2019) • Poor auditing standards proceeds; potentially all other
• Corruption sources of IFFs
• Lack of a trade agreement
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66
Table 2. continued
Study Risk factor identified Outcome Channels Sources Notes
Sequeira (2016) • Tariff rates Higher trade gaps TBML Tax/tariff evasion; potentially all Mozambique and South
• Bribe payments to customs other sources of IFFs Africa
officials
Worku, Mendoza, and • Tariff rates Higher trade gaps TBML Tax/tariff evasion; corrupt SSA
Wielhouwer (2016) • Levels of corruption (in both proceeds; potentially all other
sending and receiving) sources of IFFs
Javorcik and Narciso Lack of WTO accession Higher trade gaps TBML Tax/tariff evasion; potentially all Global
(2017) (customs valuation other sources of IFFs
agreements)
Illegal capital flight and money laundering
Shortland (2012) Unexpected economic Satellite-based measures of All, including Criminal proceeds (ransom Somalia
development economic growth in legitimate transfers money)
pirate-held areas
Chernykh and Mityakov Banks make high percentage of Higher rates of money Legitimate transfer Criminal proceeds; potentially all Russian banks
(2017) payments to tax laundering charges, of money/assets to sources of IFFs
haven/secrecy jurisdictions estimated tax evasion a tax haven
Badarinza and Political risk Higher amounts of capital All, including All, including licit sources London/NY property
Ramadorai (2018) flight to overseas property legitimate transfers market, all potential source
markets countries
Oliver, Jablonski, and Unexpected increases in Commodity prices in areas All, including Criminal proceeds (ransom Somalia
Hastings (2017) commodity prices associated with Somali legitimate transfers money)
piarcy
Profit shifting, transfer pricing (and transfer pricing abuse)
Huizinga and Laeven Import taxes; higher corporate Lower reported profits Transfer price abuse Aggressive tax avoidance or tax European multinationals
(2008) tax rates (relative to other evasion
countries with multinational
presence)
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Table 2. Continued
Study Risk factor identified Outcome Channels Sources Notes
Fuest and Riedel (2012) Firm has related subsidiary or Lower reported profits Transfer price abuse Aggressive tax avoidance or tax
parent in a tax haven evasion
Jansky and Prats (2015) Firm has related subsidiary or Lower reported profits Transfer price abuse Aggressive tax avoidance or tax
parent in a tax haven evasion
Liu, Schmidt-Eisenlohr, Territorial system of taxing Lower reported profits Transfer price abuse Aggressive tax avoidance or tax United Kingdom
and Guo (2017) foreign profits evasion
Johannesen, Tørsløv, and Higher corporate tax rates Lower reported profits Transfer price abuse Aggressive tax avoidance or tax Developing countries
Wier (2017) (relative to other countries evasion
with multinational presence)
Wier (2018) Higher corporate tax rates Lower reported profits Transfer price abuse Aggressive tax avoidance or tax South African-based
(relative to other countries evasion subsidiaries
with multinational presence)
Private tax evasion and hidden wealth
Johannesen and Zucman Lack of a bilateral exchange of Higher levels of offshore Legitimate transfer of Tax evasion, potentially other Evidence suggests that
(2014) information (EOI) treaty wealth held in a tax haven money/assets to a tax sources bilateral EOIs largely
haven, potentially displace offshore wealth
other channels rather than leading to a
repatriation
Gorea (2015) Lack of EOI Higher levels of offshore Legitimate transfer of Tax evasion, potentially other Evidence suggests that
wealth held in a tax haven money/assets to a tax sources bilateral EOIs largely
haven, potentially displace offshore wealth
other channels rather than leading to a
repatriation
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68
Table 2. Continued
Study Risk factor identified Outcome Channels Sources Notes
Caruana-Galizia and Lack of withholding tax on Higher levels of offshore Legitimate transfer of Tax evasion, potentially other Evidence suggests that
Caruana-Galizia (2016) undeclared wealth wealth held in a tax haven money/assets to a tax sources withholding taxes largely
haven, potentially displace offshore wealth
other channels rather than leading to a
repatriation
Omartian (2016) Lack of automatic exchange of Higher levels of offshore Legitimate transfer of Tax evasion, potentially other Overall reduction in overseas
information wealth held in a tax havenmoney/assets to a tax sources undeclared wealth
haven, potentially
other channels
Alstadsæter, Johannesen, High levels of wealth Higher propensity to appear Legitimate transfer of Tax evasion, potentially other Denmark, Norway, and
and Zucman (2019) in the Panama Papers money/assets to a tax sources Sweden
database haven, potentially
other channels
Andersen et al. (2017) • High natural resource An increase in cross-border Legitimate transfer of Tax evasion, theft of state Relies on BIS Locational
(petroleum) rents banking deposits in tax money/assets to a tax resources Banking Statistics;
• Source country is an havens haven, potentially outcome is driven by
autocracy other channels autocracies
Johannesen et al. (2018) Lack of EOI, amnesty programs Higher levels of offshore Legitimate transfer of Tax evasion, potentially other
wealth held in a tax haven money/assets to a tax sources
haven, potentially
other channels
Londoño-Vélez and Increase in wealth taxes/lack of Higher propensity to appear Legitimate transfer of Tax evasion, potentially other Colombia
Ávila-Machecha (2018) amnesty in the Panama Papers money/assets to a tax sources
database haven, potentially
other channels
Source: Author’s summary of the cited studies, together with author’s assessment of each study’s classification.
Note: The table lists each study discussed in the article, the risk factors associated with illicit financial flows (IFFs) that the study identifies, the outcome measure used to
proxy for IFFs, the likely channels and sources that are covered, and any context-specific information.
The World Bank Research Observer, vol. 35, no. 1 (2020)
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exemptions. Javorcik and Narciso (2008) determined that evasion is more responsive
when the taxed products are differentiated and hence harder for customs officials to
gauge whether the price has been understated or overstated.
Corruption is also found to be a predictor of evasion gaps (Worku, Mendoza, and
Wielhouwer 2016; Kellenberg and Levinson 2019). Sequeira (2016) found a simi-
lar connection between tariff rates, bribe payments to customs officials, and evasion
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gaps in the Mozambique to South Africa trade corridor. Javorcik and Narciso (2017)
showed that evasion gaps are reduced by the customs valuation agreements imposed
by WTO accession.
There is a connected line of research showing that trade gaps are more likely for
certain types of economic actors. Rotunno and Vézina (2012) found that the semi-
elasticity between tariff rates and missing exports is higher between China and coun-
tries where a higher percentage of the population is ethnically Chinese, suggesting
that trade along these routes is more likely to be subject to abusive practices. Mis-
pricing could also be more frequent among firms that are less likely to be subject to
scrutiny by the state: Rijkers, Baghdadi, and Raballand (2015) found that politically
connected firms in Tunisia were more likely to engage in under-invoicing.
Illegal Capital Flight and Money Laundering
In an ingenious study of Russian banks, Chernykh and Mityakov (2017) used central
bank data to construct an “exposure index” based on the proportions of payments
that banks make to tax havens in a year. They found that bank exposure to less
scrupulous tax havens is correlated with an increase in an index of tax evasion,
constructed using the deviation between an employee’s official salary and the value
of their car. Moreover, they found that firms which are more closely connected to
banks using tax havens also score higher on the tax evasion index. Banks that engage
more readily with tax havens are also more likely to subsequently face money laun-
dering charges or have a criminal investigation brought against their top managers,
suggesting that some of the transactions that these banks had made are likely to
have been illicit.
Researchers have also attempted to detect capital flight by looking for changes in
the prices of assets that are likely to be in high demand by people who are moving
their money out of a country. For example, Badarinza and Ramadorai (2018) found
that when a country’s political risk goes up, there is a concurrent rise in the price
of real estate in neighborhoods in New York and London that have a relatively large
share of residents from that same country. The interpretation is that political insta-
bility leads people to stash their money in safe assets (e.g., property) in areas where
they have pre-existing connections and that the increased demand for such assets
leads to the observed increase in prices. As with many studies of this type, it is im-
possible to tell whether this capital flight is actually illicit. A significant amount of
(presumably foreign-owned) property in cities such as London is purchased via
69
anonymous offshore shell corporations, arrangements that are significantly more
likely to come under criminal investigation (Transparency International 2016).
Several studies have attempted to find evidence of laundered or illicit assets
within the context of Somali piracy, although these do not strictly qualify as cross-
border IFFs. Shortland (2012) investigated how satellite-based measures of economic
growth show that geographic areas connected to Somali pirate groups see improve-
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ments in local economic conditions. Similarly, Oliver, Jablonski, and Hastings (2017)
investigated how ransom disbursements coincide with changes in commodity prices
in areas of Somalia associated with piracy.
Private Tax Evasion and Hidden Wealth
A growing strand of literature focuses on identifying what happens to hidden wealth
when destination countries are forced to reveal information about its source or own-
ership. Using data from the Bank of International Settlements (BIS) locational bank-
ing statistics (bilateral data on the amount of deposits in country A held by residents
of country B), Johannesen and Zucman (2014) investigated the impact of the signing
of bilateral exchange of information (EOI) treaties on cross-border wealth held in tax
havens. They found that bilateral treaties tend to reduce offshore deposits in signa-
tory countries but that this effect is largely counterbalanced by a shift of deposits to
tax havens which have not signed up to an EOI treaty. While it is impossible to know
what share of such shifting wealth is illicit (e.g., part of a tax avoidance scheme),
the behavioral response to the introduction of a treaty suggests that it is nonnegligi-
ble. Likewise, bilateral efforts to crack down on unreported wealth, such as the USA-
initiated drive that began in the late 2000s, have been shown to have an impact on
reported wealth (Johannesen et al. 2018).
Similarly, the results of studies using other measures of indirect wealth—such as
official statistics (Gorea 2015) or leaked data from tax havens (Caruana-Galizia and
Caruana-Galizia 2016)—suggest that standard bilateral EOI treaties or larger initia-
tives such as the EU Tax and Savings Directive displace, rather than reduce, hidden
wealth. However, unpublished work by Omartian (2016) using data leaked as part
of the Mossack Fonseca/Panama Papers scandal suggests that adoption of the OECD
Common Reporting Standard, which requires automatic exchange of information,
does lead to a reduction in assets held offshore.
The recent high-profile leaks of sensitive data from banks and law firms have
also been used to examine whether or not the risk of cross-border tax evasion in-
creases with wealth. In a recent study, Alstadsæter, Johannesen, and Zucman (2019)
matched detailed data leaked from HSBC Switzerland and from Mossack Fonseca
to estimate the incidence of undeclared wealth and use of offshore shell compa-
nies across the wealth distribution in Denmark, Norway, and Sweden. They found a
sharp increase in (presumed) tax evasion (95 percent of the Swiss accounts were not
70 The World Bank Research Observer, vol. 35, no. 1 (2020)
declared) and use of shell companies by the ultra-rich, behavior that had not been de-
tected in randomized audits by the Scandinavian authorities. Using a similar method,
Londoño-Vélez and Ávila-Machecha (2018) found that offshore entities connected to
Colombian taxpayers increased as wealth taxes in Colombia grew, and that after an
individual opens up a new offshore entity the total value of assets they declare to the
tax authority fell by nearly 11 percent on average.
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The release or acquisition of information itself can lead to changes in behavior,
as tax evaders anticipate future enforcement when tax authorities gain access to
confidential information. Bethmann and Kvasnicka (2016) found that voluntary dis-
closures of wealth by residents of the German state of North Rhine-Westphalia in-
creased after local tax authorities purchased confidential data on Swiss bank account
holders.
Hidden wealth has also been shown to be correlated with natural resource rents.
Using BIS data, Andersen et al. (2017) showed that an increase in petroleum rents
(driven by increases in the global oil price) leads to an increase in wealth held in tax
havens by citizens of autocratic, oil-producing countries.
Profit-Shifting and Transfer Pricing Abuse
While it is difficult to use aggregate data to estimate financial flows driven by trans-
fer pricing abuse, economists have been successful in using econometric methods to
detect behavior consistent with transfer pricing abuse and aggressive profit-shifting.
Using detailed micro-data on European multinationals, Huizinga and Laeven (2008)
found that companies report fewer profits in jurisdictions where the tax rate is higher
than the rates other affiliates face. Johannesen, Tørsløv, and Wier (2017) extended
this analysis to a global set of multinationals, finding that evidence of profit-shifting
is higher among developing countries.
As there is evidence that tax havens allow firms to efficiently avoid taxes
(Bennedsen and Zeume 2015), multinationals with connections to tax havens may be
more likely to engage in profit-shifting. Fuest and Riedel (2012) and Jansky and Prats
(2015) have both found evidence in a number of developing countries that multina-
tionals with such connections report fewer profits and pay less tax.
The type of tax regime that a country has in place influences the propensity of com-
panies to engage in profit-shifting. Liu, Schmidt-Eisenlohr, and Guo (2017) found evi-
dence of transfer pricing among UK-based multinational firms using methods similar
to those of the aforementioned studies, but they also found that the relationship be-
tween relative tax rates and profit-shifting became stronger when the UK authorities
moved from a worldwide to a territorial system of taxing foreign profits.
Evidence of profit-shifting is not in itself sufficient evidence that abusive trans-
fer pricing practices are at play, but it does suggest that corporations are rationally
arranging their operations in a way that minimizes their tax burden in high-tax
jurisdictions. To investigate this hypothesis, researchers typically combine the
71
methods used by Huizinga and Laeven (2008) and Johannesen, Tørsløv, and Wier
(2017) with data on actual or imputed transfer prices, as described above in the sub-
section on transfer price analyses (Bernard, Jensen, and Schott 2006; Vicard 2015;
Cristea and Nguyen 2016; Liu, Schmidt-Eisenlohr, and Guo 2017; Davies et al. 2018;
Wier 2018).
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5 Current Policy Efforts to Curb IFFs
The expansive definition of IFFs has given rise to quite a large and diverse set of
policy efforts to fight these flows. This section briefly covers some of the domestic
and international efforts on this front, including some methods used to measure the
efforts.
Fighting the Sources of Illicit Flows
The first set of policy efforts can broadly be thought of as attempts to stop the illegal
activities that give rise to IFFs. This includes work on fighting “standard” crimes such
as drug and people trafficking, violent crime, theft, and terrorism. These crimes are
typically dealt with by local law enforcement agencies, although international orga-
nizations such as the United Nations Office on Drugs and Crime and the myriad mul-
tilateral counter-terrorism groups play a major role in coordinating efforts around
curbing criminal activities with a cross-border element.
Domestic tax evasion can be another precursor to illicit flows. Efforts to increase do-
mestic tax compliance include adopting or adjusting specific tax regimes in order to
encourage compliance, such as introducing or adjusting value-added tax (Pomeranz
2015), encouraging voluntary compliance (Luttmer and Singhal 2014), and broader
endeavors to increase tax administrations’ ability to detect tax evasion (Keen and
Slemrod 2017) through risk assessments and audits. However, when tax evasion or
avoidance is inherently cross-border (as it would be when undeclared wealth is earn-
ing interest overseas or when a corporation uses abusive transfer pricing techniques),
the tax authority will be limited by its ability to obtain taxpayer information from
overseas.
Corruption can also be a source of IFFs, and international conventions such as
the UN Convention Against Corruption, the OECD Anti-bribery Convention, and the
USA’s Foreign Corrupt Practices Act have been used to establish norms and best
practices around preventing corrupt practices. Many countries around the world
have established anti-corruption offices, which are government agencies specifically
tasked with examining and investigating government corruption, although their
efficacy is likely to be context-specific. Specific interventions have typically focused
on increasing transparency concerning politicians’ finances and conflicts of interest
72 The World Bank Research Observer, vol. 35, no. 1 (2020)
as well as the financial decisions made by governments (Djankov et al. 2010). In
areas where there is a perception of increased risk of corruption, such as the natural
resources and mining sectors, initiatives such as the Extractive Industries Trans-
parency Initiative have attempted to shed more light on the contracts signed between
governments and the private sector as well as the flow of subsequent revenues.
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Making the Formal Financial Sector More Hostile to IFFs
When illicit activity cannot be staunched, the formal financial sector is a common
conduit for the resulting flows. The large banking scandals involving money laun-
dering and sanctions violations in recent years suggest that this remains a sizable
problem (Collin, Cook, and Soramäki 2016). As a result, policymakers have focused
on making the financial sector as inhospitable for IFFs as possible. These efforts come
mainly in the form of AML regulations, for which common standards are now set by
the FATF. The FATF has produced 40 recommendations of actions for governments to
take, such as to implement international AML conventions, to make money launder-
ing itself a crime, to promote due-diligence efforts in the public and private sectors,
to establish special institutions (known as financial intelligence units) to fight money
laundering, and to increase cooperation between law enforcement agencies in dif-
ferent jurisdictions (Financial Action Task Force 2012).17 These actions also include
putting pressure on the financial sector or related industries to report suspicious
transactions to authorities and to collect and share beneficial ownership information
when it is requested. There has been near-universal adoption of FATF standards
across the globe, although many jurisdictions are not fully compliant with the 40
recommendations.18
In the following, three ways in which AML institutions or underlying risks are
commonly measured—by the FATF, by the US State Department, and by countries
themselves—will be detailed.
FATF Mutual Evaluation Reports
To judge how countries are performing against its recommendations, the FATF
facilitates a review of each country’s effort in fighting money laundering. Members
of what are called “FATF-style regional bodies” are subject to mutual evaluations
every five to ten years. Over an 18-month process, expert groups assess the extent to
which countries are compliant with FATF’s recommendations. Countries are rated as
non-compliant, partially compliant, largely compliant, or compliant. Much like the
FSI, FATF’s Mutual Evaluation Reports (MERs) are likely to be reasonable estimates
of how conducive a country is for money launderers. However, to date there has
been no attempt to link FATF ratings to any indicators of money laundering (actual
or constructed). Furthermore, the infrequency of MERs and follow-up reporting and
the lack of any consolidated database of MER results make it difficult to construct a
73
useful time-varying measure of risk from this exercise. Finally MERs can be thought
of as assessments of overall money laundering risk, including the risk of internal
money laundering, which does not qualify as an IFF under standard definitions.
However, flows either entering or leaving countries that score poorly on MERs might
be considered at risk for being illicit flows.
With regard to the channels of IFFs, the FATF recommendations are largely focused
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on ensuring that both the facilitators of cross-border financial transactions (mainly
banks) and the methods used for those transactions (e.g., wire transfers and money
orders) are secure and not at risk of abuse. However, many FATF recommendations
deal with a country’s overall ability to detect and address suspicious cross-border ac-
tivity, which is likely to affect all potential IFF channels to some degree. In terms of
sources of IFFs, the FATF recommendations have a keen focus on criminal money
laundering, terrorist financing, and money handled by those in political power, but
they have the potential to affect all potential sources of IFFs.
It is unclear whether lack of compliance with FATF standards, as measured by
MERs, is likely to be a strong predictor of actual illicit behavior. While FATF-compliant
countries tend to be more prosperous (see fig. 1) and less corrupt, this tells us very
little about their actual propensity for IFFs. What little evidence there is suggests
that national FATF compliance may not strongly affect the decisions of the private
sector when it comes to dodgy behavior: a study by Findley, Nielson, and Sharman
(2014) found that when approached, corporate service providers in countries that
scored well on MERs were just as likely to offer offshore services without the required
due-diligence checks as those in countries with low scores. Furthermore, countries
that score well on MERs appear more likely to make use of offshore shell corporations
based in tax havens, even accounting for differences in income (Collin 2016).
International Narcotics Control Strategy Reports
Every year the US Department of State produces an International Narcotics Control
Strategy Report (INCSR), which contains an expert (though largely desk-based) as-
sessment of countries’ susceptibility to money laundering abuse. This includes an
assessment of 23 actions (mainly laws and regulations) and designation of a sub-
set of countries as “jurisdictions of primary concern.” As with previous exercises, it
is hard to discern how closely the INCSR assessments are correlated with underlying
illicit flows. While INCSRs are largely focused on the proceeds of drug trafficking as
a source of IFFs, the 23 actions they assess, similar to the FATF’s recommendations,
are likely to affect all potential sources and channels of IFFs.
National Risk Assessments
The FATF requires countries to identify and assess the money laundering and terror-
ist financing risk that they face. National Money Laundering and Terrorist Financing
74 The World Bank Research Observer, vol. 35, no. 1 (2020)
Risk Assessments (NRAs) are comprehensive expert assessments of the degree to
which an economy risks abuse by either money launderers or terrorist financiers.
Although countries have been performing these kinds of assessments for a number
of years, recent FATF guidance concerning the structure and format of NRAs has led
to an increase in their use. As per the FATF guidelines, NRAs consider country-level
risks to be a function of three factors: the underlying threat of money laundering,
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the vulnerability of the economy to money laundering abuse, and the consequences
that money laundering (or terrorist financing) might have on the country. Countries
undergoing an NRA exercise typically form an “expert team” or “working group,”
comprising experts from relevant agencies who assess these three factors using
all available information and data. Many developing countries use a standardized
toolkit designed and supported by the World Bank to conduct these risk assessments.
At present, NRAs are conducted too infrequently and idiosyncratically to produce
comparable cross-country data on IFF risk.
Helping Governments Detect and Track Down IFFs
International borders create a substantial information asymmetry problem for tax
authorities and financial intelligence units. It can be difficult, for instance, for a tax
authority to determine whether a specific taxpayer holds untaxed assets overseas or
if the subsidiary of a multinational corporation is reporting the majority of its profits
in an offshore financial center. Similarly, if an anti-corruption agency wants to know
whether a local politician is the true owner of a shell corporation that just bought
property in London, it will be unable to find answers without assistance from the
British authorities.
To overcome the asymmetry problem, there have been recent efforts to increase
information sharing between relevant government agencies (sometimes referred to
as “competent authorities”). Tax authorities can form bilateral and multilateral ar-
rangements with other competent authorities for the purpose of sharing informa-
tion, either by requesting information on specific taxpayers (known as exchange of
information on request, or EOIR) or through the automatic receipt of information
on all relevant taxpayers on a regular basis (known as automatic exchange of infor-
mation, or AEOI). A recent addition has been the move to require parent multina-
tional companies to file country-by-country reports (CBCR) in their home jurisdic-
tion, detailing aggregate information on the profits, tax payments, and operations
of their subsidiaries in every jurisdiction of operation. The creation and prolifera-
tion of standards and legal frameworks for AEOI, EOIR, and sharing CBCR are pro-
moted by initiatives such as the Global Forum on Transparency and Exchange of
Information for Tax Purposes and the OECD Base Erosion and Profit Shifting action
plan.
75
Finally, when illicit flows that involve stolen assets are detected ex post, repatriating
lost revenue or government resources can be legally difficult. Programs such as the
Stolen Asset Recovery Initiative (StAR), a collaboration between the United Nations
Office on Drugs and Crime and the World Bank, assist countries in requesting legal
assistance from other jurisdictions to freeze and repatriate stolen assets.
Many of the policies described here have not yet been subject to careful empirical
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investigation, although some of them have been examined in the forensic literature
discussed earlier.
6 Reconciling and Advancing Research on IFFs
Despite the considerable number of studies dealing with IFFs, rigorous research on
the topic is still in its infancy. This section discusses a few directions in which the re-
search might progress if it is to become more coherent and useful for detecting and
fighting IFFs.
Efforts to Verify the Scale and Scope of Actual IFFs
The three broad approaches surveyed here share a similar limitation: a lack of data
on the underlying phenomenon. Without reliable, representative data on actual il-
licit activity, the estimates will inevitably contain an unverifiable amount of error,
which will limit their usefulness for determining the scale of illicit flows and in iden-
tifying areas of urgency. Refinements to existing methods might help to reduce the
error. For example, recent revisions to GFI’s methodology have led to a reduction
in their global estimates of IFFs. However, these refinements can carry with them a
false sense of precision; without the ability to calibrate or compare the estimates with
actual numbers, the effects of methodological improvements will always be in the
abstract.
It would then seem that uncovering better data on actual IFFs should be a priority.
On a micro scale, randomized audits could play a role. For any population that could
be contaminated by IFFs (e.g., taxpayers, exports, or financial transactions), a ran-
domized audit can uncover the true amount that was illicit, as well as the underlying
characteristics that predict it. For example, Alstadsæter, Johannesen, and Zucman
(2019) combined randomized audits and leaked tax haven data to determine that
high levels of wealth predict greater levels (and proportions) of tax evasion.
There are limits to this approach; audits are expensive and can cover only specific
populations in specific contexts. Those wishing to quickly verify global estimates
of IFFs will not find this approach satisfactory. The process would be slowed down
even further by the fact that randomization omits any risk criteria that investigators
might have used to select their audit sample, and so may be an inefficient way to
detect illicit behavior.19 Finally, while audits are considered to reveal the “truth”
76 The World Bank Research Observer, vol. 35, no. 1 (2020)
in many contexts, they are less likely to pick up cross-border activity (Alstadsæter,
Johannesen, and Zucman 2019). Despite these limitations, combining estimates
of IFFs with actual audit data could be a useful way to gain understanding of how
robust the estimation methods really are.
In addition to carefully targeted attempts to verify IFF estimates, more work could
be done to compare existing estimates (or construct new ones) using proprietary
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or government-generated data sources. Governments and multilateral institutions
gather and control many sources of data that are pertinent to the study of illicit
flows, ranging from crime data to suspicious transactions reports to more detailed
trade and firm data. Such data could be used to improve upon the forensic methods
and evidence presented earlier in the article. The refinement process is likely to con-
tinue in the piecemeal way it has so far, but more gains may be achieved with a more
concerted effort by governments and multilateral organizations to share and link
data.
The Dashboard Approach to Illicit Financial Flows
Aggregating IFFs into a single number may not make much sense. As discussed ear-
lier, certain types of flows may be easier to measure, or there may be more demand for
measuring them. Estimates can sometimes conflate sources and channels or double
count. This could make certain problems seem worse than others solely because they
are more readily measured. While having a single global number may seem desirable
from the perspective of tracking progress, such numbers can convey a false sense of
precision and make it more difficult to understand whether policy efforts are actually
having an impact on illicit flows. Instead, research and measurement work would be
more fruitful if a “dashboard” approach to IFFs is taken (Ravallion 2011), such that
efforts to measure different sources and channels are both considered and improved
upon separately.
Taking Lessons from the Impact Evaluation
Although research on IFFs is growing in scope and sophistication, the focus has been
largely descriptive so far. Even the forensic results are somewhat limited in their ability
to causally connect changes in policies to reductions in estimates of IFFs. This is often
a consequence of the scale of these studies—causal identification for cross-country
studies is a difficult problem. Ignoring the issue of noise in IFF estimates, many of the
studies involving risk factors fall victim to the Lucas (1976) critique that even if a
change in a risk factor is associated with a change in the outcome of interest, policies
which affect that risk factor may not lead to actual changes in the outcome.
Carefully designed impact evaluations, particularly those that rely on experi-
mental or quasi-experimental methods, could help shed more light on the policies
77
that are most effective at fighting IFFs. This approach is already becoming more
popular in areas closely associated with IFFs, including tax compliance (Hallsworth
2014; Pomeranz 2015; Carrillo, Pomeranz, and Singhal 2017), corruption (Olken
2007), and regulatory compliance (Duflo et al. 2013). The concern that changes
in certain characteristics seen in many forensic studies may also lead to changes
in the measurement error of IFFs was discussed above. A further benefit of re-
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lying on rigorous, well-identified studies is that they more often focus on very
specific policy changes, which are likely to have a more direct effect on the outcome
of interest.
Turning to Structural Methods
Where causal or direct estimates are difficult or impossible to obtain, the IFF re-
search agenda may benefit from techniques developed in other areas concerned with
estimating unobserved, latent phenomena. As discussed previously, there are al-
ready similarities between IFF research and the literature on measuring the informal
economy. Indirect structural methods such as the “multiple indicators, multiple
causal” (MIMIC) approach, which are popular in the latter literature, might both al-
low for the construction of meaningful estimates and solve the interpretation prob-
lem posed in the section on forensic studies. However, without calibration with actual
underlying data, structural methods for estimating latent variables will not escape
criticism (Feige 2016; Kirchgässner 2017).
Opening up Methods and Data to Verification and Replication
To date, although most estimates of the volume of IFFs are available to the public,
the underlying data and code used to calculate them are not. Given that economic
research is facing a replication crisis similar to, albeit less severe than, that of other
social sciences (Chang and Li 2017), opening the data and code up to the public
could have a number of benefits. Many estimates, especially those involving the
manipulation of detailed bilateral trade data, entail substantial fixed costs for any
researchers wishing to calculate new figures or replicate older ones. Recent work by
Nitsch (2016) has suggested that small changes to underlying assumptions can have
large implications for the resulting estimates. Sometimes, as in the case of UNCTAD’s
study on gold exports from South Africa, the resulting revision to estimates can be
substantial (Forstater 2017a). As assumptions are difficult to investigate without
the source data and code, estimates often enter the public debate before they have
been externally verified. Increasing the transparency around these calculations
might also make it easier for researchers to discuss ways to improve them for future
iterations.
78 The World Bank Research Observer, vol. 35, no. 1 (2020)
Looking at the Impact of IFFs on Source and Destination Countries
The majority of the studies discussed in this article attempt to either measure IFFs or
examine their determinants. As laid out in the introduction of this article, the reasons
that economists and policymakers should be concerned with IFFs stem from their po-
tential negative impacts on both sending and receiving economies. As measurement
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of IFFs improves, a natural next step will be to examine these negative impacts, which
at this stage are largely theoretical. Current estimates have mostly focused on lost tax
revenue due to base erosion and profit-shifting (Crivelli, De Mooij, and Keen 2016;
Cobham and Jansky 2018) or interest on undeclared wealth (Zucman 2013). There
is considerable room for further research on other negative impacts, such as market
distortions driven by incoming illicit flows, distortions in policymaking due to incom-
plete information on financial flows, and whether or not underlying criminal activi-
ties are elastic with respect to the ability to channel ill-gotten gains overseas.
7 Conclusion
Many will find the term “illicit financial flows” to be arbitrary and overly broad. How-
ever, this concept can still be useful for broadly classifying cross-border flows that de-
serve further attention from researchers and policymakers. As IFFs represent a di-
verse, disparate group of activities and flows, it would make sense to break the defini-
tion down into specific, manageable problems and lines of inquiry.
This article has attempted to survey the current state of thinking about the defini-
tion of IFFs and to present and critique methods of measuring and investigating such
flows. While this review is not fully comprehensive, it should nevertheless be indica-
tive of the empirical state of knowledge around the issue of IFFs. Finally, the article
has suggested some potential ways forward for the IFF research agenda, largely rely-
ing on a bottom-up approach to validating estimates and considering specific types
of flows. While top-down estimates might be more useful for garnering attention to
and support for the issue, bottom-up approaches can potentially yield more effective
policies for dealing with illicit flows.
Notes
Matthew Collin is David M. Rubenstein Fellow at the Brookings Institution, Washington, DC; email:
mcollin@brookings.edu. This article was written while the author was a Young Professional in the
World Bank’s Global Tax Team. He would like to thank Joel Turkewitz, Peter Reuter, and Marijn Verho-
even for their support, discussions, and suggestions, as well as Maya Forstater, Bob Rijkers, Pierre-Louis
Vézina, participants at the 2nd Zurich Conference on Public Finance in Developing Countries, and two
anonymous reviewers for their helpful feedback. All errors and all views expressed in this article are the
author’s own.
79
1. Salomon and Spanjers (2017) estimates illicit flows from developing countries to have been nearly
$1 trillion in 2014. In a recent report for the United Nations Office on Drugs and Crime, Pietschmann
and Walker (2011) estimated total money laundering to be approximately $1.5 trillion a year as of 2009,
although it is not clear what proportion of this would qualify as illicit flows under prevailing definitions.
2. Other negative consequences might include increases in inequality driven by untaxed offshore
wealth, market distortions driven primarily by the demand for illicit flows to remain hidden, such as real
estate bubbles or tax haven services, and finally distortions in official statistics and lack of government
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influence over financial flows, both of which can impede macroeconomic forecasting and planning.
3. This is the definition followed by the non-governmental organization Global Financial Integrity,
the International Monetary Fund, and the World Bank.
4. The use of “sources” and “channels” as ways of characterizing IFFs was developed by Peter Reuter.
5. A flow will also qualify as an IFF if its ultimate use is illegal. The most commonly cited illicit use
of cross-border funds is terrorist financing.
6. “Abuse” in this context is often ill-defined, but a common metric is whether or not a transaction
between subsidiaries deviates from the arms-length principle—that related firms should transfer goods
at the same price as they would have if they had been unrelated.
7. One way of restricting the range of funds that might be classified as IFFs due to illegal use would
be to consider only funds transferred for the sole purpose of that use.
8. The working paper of Johannesen and Pirttilä (2016) provides a useful summary of methods for
estimating various forms of capital flight or IFFs.
9. GFI updated this markup from 10 percent to 6 percent following updates to the OECD Interna-
tional Transport and Insurance Cost (ITIC) database.
10. Until its most recent publication, for a subset of countries with lack of data coverage or idiosyn-
cratic errors in their bilateral statistics, GFI used global comparisons rather than bilateral ones (Forstater
2017b).
11. This change was made after criticism by Kessler and Borst (2013).
12. The GER method discussed earlier might also pick up transfer mis-pricing when exports or im-
ports are routed through marketing hubs.
13. Zucman (2013) uses a constructed dataset, namely the “External Wealth of Nations” produced
by Lane and Milesi-Ferretti (2007). √
14. The formula is FSI = (Secrecy Score)3 × 3 of Global Scale Weight.
15. In reality, the weighting is highly subjective and somewhat arbitrary. The author notes that he
has twice been part of an expert panel that reviews the AML Index on an annual basis.
16. The results here use GER and hot-money-narrow results published by the GFI in 2017 (Salomon
and Spanjers 2017), as this is the latest year in which GFI released both its GER and hot-money-narrow
calculations at the country level.
17. Since 2014, the FATF has included indicators intended to capture the effectiveness of AML in-
stitutions, rather than focusing solely on technical compliance.
18. For the 46 countries that have been assessed against the 2012 FATF standards, the average coun-
try had a rating of “mostly compliant” or “compliant” for only 24 out of the 40 technical recommenda-
tions (author’s calculation).
19. A second approach might involve using existing estimates of IFFs and their risk indicators as
the criteria for audit decisions. For example, recent research on trade gaps in Madagascar has suggested
that with detailed data, specific products or firms could be targeted for further investigation by customs
officials (Chalendard, Raballand, and Rakotoarisoa 2019).
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Preventing More “Missing Girls”:
A Review of Policies to Tackle Son
Preference
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Sneha Kumar and Nistha Sinha
In parts of Asia, the South Caucasus, and the Balkans, son preference is strong enough to
trigger significant levels of sex selection, resulting in the excess mortality of girls and skew-
ing child sex ratios in favor of boys. Every year, an estimated 1.8 million girls go “missing”
because of the widespread use of sex selective practices in these regions. The pervasive use
of such practices is reflective of the striking inequities girls face immediately, and it also has
possible negative implications for efforts to improve women’s status in the long term. Rec-
ognizing this as a public policy concern, governments have employed direct measures such
as banning the use of prenatal sex selection technology, and providing financial incentives
to families that have girls. This study reviews cross-country experiences to take stock of the
direct interventions used and finds no conclusive evidence that they are effective in reducing
the higher mortality risk for girls. In fact, bans on the use of sex selection technology may
inadvertently worsen the status of the very individuals they intend to protect, and financial
incentives to families with girls offer only short-term benefits at most. Instead, what seems
to work are policies that indirectly raise the value of daughters. The study also underscores
the paucity of causal studies in this literature.
JEL codes: J13, J16, J18, O10, N35
Keywords: missing girls, sex ratios, sex selection, gender discrimination, Asia, South
Caucasus.
In parts of Asia, the South Caucasus, and the Balkans, son preference is strong
enough to trigger substantial levels of prenatal and postnatal sex selection, result-
ing in the excess mortality of girls and skewing child sex ratios in favor of boys (see
figure 1). Every year, an estimated 1.8 million girls under the age of five go “missing”1
The World Bank Research Observer
© The Author(s) 2019. Published by Oxford University Press on behalf of the International Bank for Reconstruction and
Development / THE WORLD BANK. All rights reserved. For permissions, please e-mail: journals.permissions@oup.com
doi: 10.1093/wbro/lkz002 35:87–121
Figure 1. Child Sex Ratios for Select Regions and Countries, 2010–2015
SUB-SAHARAN AFRICA
NORTHERN AMERICA
EUROPE
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Pakistan
Georgia
India
Vietnam
Armenia
Azerbaijan
China
1.00 1.02 1.04 1.06 1.08 1.10 1.12 1.14 1.16
Source: United Nations (2017).
Note: Child sex ratio: boys/girls, <5 years of age fig. 1 displays child sex ratios for countries where the ratio is greater
than 1.06; 1.06 is used as a cutoff to restrict this figure to countries where the ratio of boys to girls is strikingly skewed.
Normal child sex ratios, i.e., when there is no prenatal and postnatal sex selection, would be 1.00 or close to 1.00.
Normal sex ratios at birth (SRB), i.e., when there is no prenatal sex selection, would be 1.06. The Republic of Korea
is not included here because it has seen a turnaround in its sex ratio since the mid-1990s.
because of sex selective practices widely adopted in these regions (World Bank 2012).
To provide a sense of magnitude, this is almost as if the entire female population of
Los Angeles, California, vanished every year.
While excess girl mortality has been documented in countries like mainland China,
Taiwan, India, and Pakistan since the early twentieth century2 (Visaria 1971; Das
Gupta and Li 1999), it is a more recent phenomenon in countries like Albania, Ar-
menia, Azerbaijan, Georgia, Vietnam, and Nepal. In Albania, it has been noted since
the 1970s. In the South Caucasus, it has been noted since the 1990s, following the
collapse of the Soviet Union. In Vietnam and Nepal, it has been noted since the late
1990s and early 2000s (United Nations 2017). the Republic of Korea, like some of
its Asian counterparts, witnessed an excess of boys over girls for several years as well;
however, since the mid-1990s, it has managed a turnaround on this front (Chung
and Das Gupta 2007; Guilmoto 2012a).
In the last four decades, the availability of prenatal sex diagnostics has allowed
couples with strong son preference to select the sex of their baby before birth, and
more effectively achieve their desired sex composition of children (World Bank 2012;
Bongaarts and Guilmoto 2015). Between 1980 and 2015, the sex ratio at birth (SRB),
that is, the number of male births per female birth, in some countries increased from
88 The World Bank Research Observer, vol. 35, no. 1 (2020)
1.07 to over 1.15 (United Nations 2017) representing a stark departure from the bio-
logical norm of 1.06 that would be observed without prenatal sex selection. Prenatal
sex selection also accounted for an increasingly greater portion of the total missing
girls during this period (Bongaarts and Guilmoto 2015).
Not surprisingly, bans on the use of prenatal sex selection technology have been
one of the most widely used measures by countries trying to curb the excess mor-
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tality of girls. Bans are a common legal tool used by governments to restrict socially
“undesirable” behavior and promote social equality (Sunstein 1994). Bans against
child labor, discriminatory hiring, and underage drug use are all examples of pro-
hibitive legal measures that seek to protect vulnerable and/or discriminated groups,
much like bans against the use of prenatal sex selection technology.
It is important to note, however, that prenatal sex selection is only one of the per-
nicious ways in which son preference manifests itself. Son preference can also trigger
a range of postnatal sex discrimination strategies from infanticide, to abandonment,
to differential care during early infancy and childhood. These strategies were the pri-
mary cause for the excess mortality of girls before the 1980s, and they continue to
be used by parents who prefer sons, but do not have the financial means to access
prenatal sex selection methods. Estimates by the United Nations (2011) suggest that
in China and India in the 1990s and 2000s, infant mortality (probability of dying
between birth and age 1) and child mortality (probability of dying between age 1 and
4) was higher for girls than for boys, contrary to the biological norm.3
From a policy perspective, sex selection – before or after birth – is cause for concern.
While restrictions on prenatal sex selection particularly raise ethical concerns sur-
rounding reproductive choice and abortion, what is strikingly clear is that prenatal
(and postnatal) sex selection are stark indicators of the dismal status and systematic
devaluation of girls and women today. In the long run, as the excess of boys translates
into the excess of men, these gender inequities are likely to persist. Natural experi-
mental evidence from Grosjean and Khattar (2015) suggests that today, in commu-
nities that were historically male-biased, people are less likely to favor women’s eco-
nomic independence and empowerment. Marriage homogamy (on cultural grounds),
and the intergenerational transfer of gender norms resulted in the persistence of gen-
der inequity in these communities.
Some could argue that prenatal sex selection is preferable, because when available
and accessible, it can substitute for postnatal discrimination, and thereby improve
the welfare of girls born (see table 1 for overview; also see Goodkind (1999)). Yet,
estimates suggest that this substitution is not perfect: Anukriti, Bhalotra, and Tam
(2018, 19) find that for “every girl that survived due to ultrasound technology, three
girls were aborted before birth.” Furthermore, given that families with higher socioe-
conomic status (SES) are more likely to use prenatal sex selection, the average girl
born post-ultrasound (relative to pre-ultrasound) is more likely to be born into lower
SES families (Anukriti, Bhalotra, and Tam 2018; Bhalotra and Cochrane (2010)).
Kumar and Sinha 89
Table 1. Summary of Studies That Examine the Impact of Prenatal Sex Selection on Postnatal Outcomes for Girls
90
Type of
Author intervention Outcome Observed impact on Observed impact on
(Date) examined of interest Data Empirical strategy female child survival other female child outcomes
Goodkind Rising SRB Postnatal Vital registration data, Correlation study: Examine how Female infant and child survival N/A
(1996) (indicator of survival census data, and other changes in the male-female sex ratio improved after the 1980s in
rising prenatal of girls secondary data sources. of infant and child mortality correlate countries or subpopulations with
sex selection) Countries: China, Hong with changes in SRB before and after documented son preference
Kong, Japan, Rep. of the 1980s across different Asian
Korea, Malaysia, countries (with and without
Singapore, Taiwan documented son preference)
Hu and Higher and Girls’ Pooled individual data Quasi-experimental study: Triple N/A Larger reduction in % of malnourished
Schlosser increasing SRB nutritional from 1992–1993, difference-in-difference that exploits (wasted, stunted, underweight) girls in
(2012) (indicator of outcomes 1998–1999, and geographic variation in the prevalence states with increasing prenatal sex
higher and 2005–2006 Indian of prenatal sex selection over time, and selection. This result is not explained
increasing National Family Health changes in outcomes for boys vs. girls by changes in mortality
prenatal sex Survey (NFHS) across states over time
selection)
Lin et al. Access to SRB and girls’ Individual-level data Quasi-experimental study: Uses timing Reduced female neonatal mortality N/A
(2014) sex-selective neonatal from national birth and of legalization of abortion, and for higher-order births, and no
abortion in mortality death registries, Taiwan cross-sectional variation in cost of change in post neonatal mortality
1985 (1980–1996) having more children (variation in for girls
cost across birth-order and mother’s
age) to isolate treatment effect
Hu and Higher and Girls’ mortality Indian census and Quasi-experimental study: Triple No reduction in girls’ mortality or Reduction in surviving girls’
Schlosser increasing SRB and nutritional pooled individual data difference-in-difference that exploits reduction in son preference in states malnutrition (underweight and
(2015) (indicator of outcomes from NFHS geographic variation in the prevalence with increasing prenatal sex wasting). Prenatal sex selection does
higher and (1992–1993, of prenatal sex selection over time, and selection not lead to a selection of girls into
increasing 1998–1999, changes in outcomes for boys vs. girls households with more resources, but
prenatal sex 2005–2006) across states over time girls are more likely to be born into
selection) families with weaker son preference.
Also, rising SRB leads to larger
reduction in family size and increase in
breastfeeding duration for girls
Anukriti Availability Girls’ Pooled individual data Quasi-experimental study: Triple No increase in relative female Reduced son-biased fertility stopping,
et al. of ultrasound post-neonatal from NFHS difference-in-difference that combines neo-natal mortality, and and increased breastfeeding duration
(2018) technology mortality, (1992–1993, variation in supply of ultrasound convergence in post-neonatal and immunization investments for
breastfeeding, 1998–1999, scanners, a family’s incentive to sex mortality rates of boys and girls. But girls. Families with higher
and 2005–2006) select (using sex of first-born child as for every additional girl that survives socioeconomic status (SES) were more
immunization an indicator), and sex of the child until age 5 in the post-ultrasound likely to abort girls (and state son
status being observed era (relative to pre-ultrasound), three preference), so the average girl born
girls are aborted post ultrasound (versus
pre-ultrasound) was more likely to be
born into a low SES family
Note on acronyms: Sex ratio at birth (SRB); Indian National Family and Health Survey (NFHS); socioeconomic status (SES)
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This distributional pattern lowers the probability of convergence in outcomes for boys
and girls in the long run.
The other problem associated with the excess mortality of girls is the “marriage
squeeze.” A shortage of girls can lead to a decline in the number of potential mar-
riage partners for men in the future, particularly in countries with low fertility (Park
and Cho 1995; Guilmoto 2012b). This demographic scenario can have various neg-
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ative ramifications. Violence against women can increase as they can be abducted
and forced into marriage (Banister 2004; Chao 2005), or trafficked from other coun-
tries to meet the local shortage of brides (Blanchet 2005; Duong, Bélanger, and Hong
2007; Prakash and Vadlamannati 2014). Brides who are consensually bought from
other countries can also face difficulties, since they are at higher risk of isolation, mar-
ital discord, and domestic violence (Chowdhry 2005; Williams and Yu 2006; Kim
2010; Kaur 2013). Men can also be vulnerable in this scenario. With the shortage
of brides, and hypergamic marriage patterns, young males living in rural areas and
poorer provinces are likely to remain bachelors, and go on to lack spousal support dur-
ing old age (Edlund 1999; Das Gupta, Ebenstein, and Sharygin 2010). Some causal
evidence suggests that as competition for brides increases, households with sons are
likely to increase savings, and men are likely to take on entrepreneurial activities to
improve prospects in the marriage market (Chang and Zhang 2012; Wei and Zhang
2012). These shifts in household and individual behavior, while encouraging from
an economic perspective, entail competitive processes to secure a bride that further
marginalize and exclude men with lower SES. The negative ramifications spill over to
the broader society as well. For instance, Edlund et al. (2013) estimate that masculine
sex ratios and adverse marriage market conditions are responsible for one-seventh of
the rise in violent and property crime in China between 1988 and 2004.
To be sure, there is a growing body of literature that argues that the marriage
squeeze can have positive implications for females. It can result in an increase in
the bride price relative to the dowry (Francis 2011), improve certain dimensions of
women’s bargaining power (Porter 2007; Edlund et al. 2013), and improve the wel-
fare of male and female children born (Porter 2007; Francis 2011). Yet this does not
negate the importance of policies to tackle skewed child sex ratios and son prefer-
ence today. The evidence on the impact of the marriage squeeze is mixed at best,
so “the hope for an eventual, demographically induced evening of gender relations
should not divert attention from the injuries of gender that are being inflicted today”
(Greenhalgh and Li 1995, 637).4
Given these concerns, governments face a strong impetus to act. As highlighted
above, most countries with skewed child sex ratios have already banned the use of pre-
natal sex selection technology. Another direct approach that has been tried in some
countries is to provide financial incentives to families to discourage preferential treat-
ment of sons, and to increase investments in daughters. The question that follows is
whether these direct measures are easy to implement, and effective in reducing the
Kumar and Sinha 91
overall number of missing girls. Or are indirect measures that target the root cause of
sex selection – son preference – more effective in improving girls’ survival prospects
and life chances?
This review seeks to answer these questions. It draws on cross-country experiences
(especially from China, India, and the Republic of Korea, who have been grappling
with this problem for decades) to conduct a stocktaking of the direct measures used,
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and to briefly highlight the relative payoff that indirect approaches offer. The stock-
taking draws on experimental and quasi-experimental studies where available; in lieu
of causal studies, it draws on qualitative and correlation-based studies.
Sex Selection: Causes and Mechanisms
Causes
The entrenched preference for sons over daughters is the root cause of sex selection.
Societies that do not have son preference do not use discriminatory practices to alter
the sex composition of children. Therefore, long-term success in reducing excess girl
mortality is only possible when the cause(s) of son preference are understood and
eradicated.
Son preference can arise because daughters provide lower economic returns than
sons, making the relative cost of investing in girls higher, or it can arise due to cultural
practices that raise the perceived value of sons, irrespective of their economic value
to parents. Across contexts, the common practices associated with son preference are
patrilineal inheritance (inheritance through the male line) and patrilocal residence
(co-residence with husband’s family after marriage). The more rigid these traditional
kinship systems are, the less opportunity there is for girls to be valuable to parents.
In these systems, sons cultivate the land, serve as primary care-givers for aging par-
ents, and eventually inherit the land. Alternatively, daughters care for their in-laws
after marriage. A daughter’s productivity is perceived as belonging to her husband’s
household, and she is therefore deemed to be of little/no value to her parents (Dyson
and Moore 1983; Das Gupta et al. 2003; Das Gupta 2010).
Traditional kinship systems that undermine the value of daughters versus sons
are seen in all countries that have substantial sex selection. Regions of these coun-
tries that have higher levels of co-residence with sons are more likely to have higher
levels of sex selection (UNFPA Vietnam 2011; Guilmoto 2012c). Comparisons with
Southeast Asian countries that have bilateral kinship systems – where daughters and
sons have equal opportunities to contribute to parental well-being – are illustrative as
well: Southeast Asian countries with bilateral kinship systems have normal mortality
risks for girls.
While son preference is the root cause of sex selection, there are several factors
that can increase the pressure to sex select among those who have a deep-seated
92 The World Bank Research Observer, vol. 35, no. 1 (2020)
preference for sons. One such factor is the number and sex composition of existing
children in the family. The probability that girls will be aborted or die in the initial
years of life increases if she is of a higher birth order, and if none of the previous
children were of the preferred male sex. This is particularly the case if the child is ex-
pected to be the last birth, and was intended to fulfill the desired sex composition of
children (Das Gupta 1987; Duthé et al. 2012).
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Another factor that raises pressure to sex select is the small family size norm. In
a high fertility context, it is unlikely that couples will end up sonless. However, as
fertility declines, the probability of ending up sonless increases. Each additional child
has a greater marginal cost, so couples who prefer sons must rely on sex selection
(Guilmoto 2009; Jayachandran 2017).
Economic stress is also cited as a reason for increased sex selection. During the wars
in China in the 1930s, and during the famine in the 1950s, female child mortality
rose above the biological norm (Das Gupta and Li 1999). Similarly, in the South Cau-
casus countries, the collapse of the Soviet Union and the withdrawal of social and eco-
nomic protections, was followed by an increase in female child mortality (Guilmoto
and Duthé 2013; Das Gupta 2015). In both cases, economic conditions forced people
to sex select because having a son was a means of gaining security.
Mechanisms
Postnatal Sex Selection
Sex selection can take place postnatally or prenatally. The more deliberate forms of
postnatal sex selection – female infanticide and abandonment of female children soon
after birth – have a long history in parts of India and China (Caldwell and Caldwell
2005). While active efforts by various entities have helped reduce the prevalence of
infanticide/abandonment over time, claims that these practices are disappearing al-
together are dubious (for example, see the study by Li, Zhu, and Feldman (2004) on
Shaanxi province, China).
Passive postnatal sex selection refers to discriminatory attitudes towards female
children in various aspects of child care: breastfeeding, immunization, healthcare,
food and clothing access, educational investments and so on. These forms of neglect
do not require much effort on the part of parents, but if practiced in a continuous
manner, they can result in the excess mortality of girls, and alter the gender compo-
sition of children who remain alive (Chen, Huq, and D’Souza 1981; Das Gupta 1987).
Another form of passive postnatal sex selection is differential fertility-stopping be-
havior (DSB). DSB is where couples with son preference continue having children
until the desired sex composition is achieved. It is more prevalent in contexts where
more than two children per woman is the norm (so couples can afford an additional
birth to reach the desired number of sons) and where prenatal selection methods
are not accessible. With this practice, families that have only girls are more likely to
Kumar and Sinha 93
continue childbearing. This can result in girls, on average, being disadvantaged, as
they would have more siblings to compete with for parental resources (Filmer, Fried-
man, and Schady 2008). Empirical evidence from Rosenblum (2013) and Altindag
(2016) suggests that families that practice DSB allocate more resources to sons than
daughters once the son is born.
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Prenatal Sex Selection
The introduction of prenatal sex identification techniques revolutionized gender dis-
crimination practices. If available and accessible, prenatal sex selection is as an at-
tractive alternative to postnatal discrimination methods. It is easy to use, nonintru-
sive, can be bundled with modern antenatal healthcare services, and provides the
luxury of making sex selection decisions privately. Coupled with abortion methods, it
ensures that the desired sex composition of children is met as unwanted female preg-
nancies are terminated within the first two trimesters. The use of this technology is
higher in low fertility contexts as couples have fewer chances to try for a son.
Sex determination technology has evolved rapidly over the last three decades. The
initial methods – amniocentesis and chorionic villus sampling – required trained
medical personnel, and involved some degree of risk to the fetus. Since then, however,
sex determination technology has become more accurate, accessible, affordable, and
less medically invasive. Ultrasound, which became prevalent in developing countries
around the 1980s, allowed accurate identification of the sex of the fetus at 12–16
weeks of pregnancy, and was less invasive than previous sex determination methods
(Gilles and Feldman-Jacobs 2012; Bongaarts 2013). The initial users of ultrasonog-
raphy for fetal sex determination were from the upper and middle classes. Over time,
this technology spread across socioeconomic groups, and to rural areas, as the cost
of manufacturing and using the equipment declined, the density of private clinics in-
creased, and enterprising healthcare personnel tapped into the latent demand for this
technology (Guilmoto 2012a).5
In recent years, more effective methods of sex determination have emerged. For in-
stance, blood tests that analyze fetal DNA in the mother’s blood as early as the seventh
week of pregnancy have lately been available. These tests have been found to be 98
percent reliable, and are minimally invasive, as they only require a drop of blood from
the mother. The cost of acquiring these test kits is low. They can usually be ordered
online, or women can take a blood sample at home, and have it processed by qualified
labs elsewhere (Devaney et al. 2011).
Abortion methods must also be available for couples to sex select. In most coun-
tries, the availability of abortion services preceded the availability of sex determi-
nation technology. But the use of these services was/is typically restricted for pur-
poses such as when the mother’s life is at risk, the case of rape, or fetal abnormalities
(Ganatra 2008).
94 The World Bank Research Observer, vol. 35, no. 1 (2020)
More recent developments in reproductive technology – preconception and preim-
plantation methods – do not require the use of abortion methods to prenatally sex
select (Bongaarts 2013). Evaluations of preconception methods by Karabinus et al.
(2014) suggest fairly high rates of effectiveness.
Effectiveness of Direct Measures
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Regulating the Use of Prenatal Sex Selection Technology
Since the late 1980s, several countries have banned prenatal sex determination, and
sex selective abortions. Such bans are the most direct policy response to counter
skewed SRB. They seek to regulate access to methods that could be used to realize
son preference; they do not address son preference itself.
More broadly, the conditions outlined under these bans can be summarized as
follows:
(1) Healthcare personnel are prohibited from informing parents of the sex of the fe-
tus (using words or signals). They are also prohibited from performing abortions
for sex selection.
(2) Hospitals and healthcare units that provide prenatal diagnostic procedures, and
abortion services must be registered with public health authorities.
(3) Prenatal diagnostic equipment used by these healthcare units, and the practi-
tioners who perform diagnostic and abortion procedures, must be registered with
public health authorities.
(4) Healthcare facilities and practitioners are required to thoroughly document the
use of these technologies, and the medical histories of the patients who require
the use of these technologies.
(5) Advertisement of these technologies on any platform is prohibited.
Penalties for breaking these regulations are imposed on the offending medical prac-
titioners and, at times, on the women or the family members who coerce women
into these practices. The penalties involve fines, confiscation of ultrasound machines,
temporary suspension or possible revocation of medical licenses, and imprisonment.
Penalties are higher for repeat offenders. Community members are often offered fi-
nancial incentives to act as whistle blowers. Awareness-raising campaigns are con-
ducted to inform and educate individuals about the law.
In theory, such interventions can seem effective in tackling sex imbalances as they
would make access to, and provision of, prenatal sex selection methods prohibitively
costly. However, when implemented, these interventions draw their fair share of crit-
icisms. From an ethical perspective, there are concerns about whether the implemen-
tation of a ban on prenatal sex selection impinges on women’s reproductive freedoms.
On the one hand, it can be argued that a ban on prenatal sex selection puts legislators
Kumar and Sinha 95
on a slippery slope as it personifies the fetus, and this can be particularly dangerous
in settings where abortions rights are contested to begin with. On the other hand, it
can also be argued that sex selective abortions are notably different from abortions
for other purposes because in the former case the pregnancy is wanted until parents
realize it won’t result in the birth of the desired male child. From this perspective, sex
selective abortions are a function of the inequitable status of women, and a ban on
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the practice is a means (or even a symbolic gesture by the government) to protect a
group that has been and continues to be discriminated against (Balakrishnan 1994).6
Moreover, when claiming that a ban on prenatal sex selection restricts women’s re-
productive choices, the context in which women make the “choice” to prenatally sex
select must be considered. In a rigid patriarchal setting, where the sex of a child has
economic and social consequences for women, prenatal sex selection is not necessar-
ily an act performed out of free will, but rather an act resulting from the pressure to
bear sons (Oomman and Ganatra 2002).
But even if one were to abstract from the ethical ambiguities associated with its
implementation, bans are criticized for failing to achieve their stated goals. There is
only limited evidence to suggest that they are effective in normalizing SRB; in fact, the
existing literature suggests that they are counterproductive to improving the status
of girls and women. Bans have also proven difficult to implement. These criticisms are
discussed further in the following subsections.
Challenges with Implementation
One of the primary reasons why enforcement of these bans is challenging is because
it is difficult to procure evidence of the “crime.” The practice of prenatal sex selec-
tion involves collusion between both parties involved in the transaction. The couple
who seek out the service and the service provider are invariably working together to
achieve a mutually beneficial outcome. The individual gets to abort the unwanted
fetus, while the doctor benefits financially (Guilmoto 2012a).
Furthermore, in contexts where using prenatal diagnostic methods and abortion
for other reasons is legal, it can be difficult to prove that the technology was used for
sex selection. The ultrasound, for example, is often used as part of routine antena-
tal checkups. While performing routine scans, it is possible for doctors to break the
law, and discretely signal the sex of fetus to the parents. Women and their health
practitioners can cite other socioeconomic or medical reasons to abort the unwanted
female fetus. Couples may also be able to detect the sex of the fetus in one hospital,
but have the abortion performed in another hospital. Offenses, when they occur in
this manner, become very hard to detect, let alone prosecute. It comes as no surprise
that authorities who are under pressure to catch offenders resort to sting operations
(Guilmoto 2012a; Das Gupta 2016).
Successful enforcement requires the convergence of various factors. It requires
careful monitoring of different interventions and their associated performance
96 The World Bank Research Observer, vol. 35, no. 1 (2020)
indicators; capacity development targeted at medical personnel, local authorities,
and the public at large; and coordinated efforts by different stakeholders. See, for ex-
ample, the case of the widely praised Nawanshahr Model:
In 2001, Nawanshahr District in Punjab, India had the worst sex ratio in the coun-
try. In response, local authorities launched an aggressive campaign in 2005, which
combined monitoring and awareness building efforts. Personal details of all pregnant
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women in the district were electronically registered, and these women were followed
up with phone calls on a weekly basis. The use of ultrasound machines and abor-
tion services in local clinics was also strictly documented and monitored. To aid lo-
cal authorities in catching offenders, monetary rewards were offered to community
members who acted as “informers.” For the awareness building effort, local NGOs
were roped in, and teachers and students were recruited as “ambassadors of the drive
against female feticide.” One of the unique and controversial approaches used as part
of this effort was to publicly shame couples considering sex selection by “mourning
the death of unborn girls” in front of clinics. When the SRB started to normalize in
the following year, the model was hailed for its success. However, with a new district
collector in 2007, the monitoring efforts and related schemes retracted, and the SRB
rose again (Ganatra 2008).
This example highlights the challenge involved in sustaining or replicating suc-
cessful programs. Li (2007) highlights similar implementation problems for China’s
monitoring and evaluation program, particularly given the lack of coordination be-
tween different departments in specific geographic areas, and difficulties tracking the
country’s floating population. These efforts also raise ethical problems about the ex-
cessive intrusion into women’s lives that is required for such monitoring exercises to
work. Even simple monitoring efforts to calculate the SRB at the regional level are
challenging due to poor vital registration systems, particularly in economically dis-
advantaged areas (WHO 2011; Guilmoto 2012a).
Unnecessarily harsh measures can also alienate key stakeholders in countering sex
imbalances. For example, the Indian Radiological and Imaging Association has re-
peatedly complained about the enforcement of the Prenatal Diagnostic Techniques
(PNDT) Act. Practitioners argue that they are harassed by local authorities for mi-
nor clerical errors, their equipment is unfairly seized, and, in some extreme cases,
their licenses revoked for paperwork discrepancies. In 2016, members of the as-
sociation even held a nationwide strike to protest the implementation of the Act
(Indian Express 2016).
The ability of keep up with the pace of developments in sex determination tech-
nology is another concern. For example, in 2015 Chinese authorities had to enforce
a new ban preventing the smuggling of mother’s blood samples to Hong Kong for fe-
tal DNA tests (Global Times 2012; Rui and Jiayi 2015). Moreover, even if countries
manage to ban the specific technologies, affluent individuals who actively want sons
Kumar and Sinha 97
can travel to regions that have legal access to these methods. This is evidenced in the
case of affluent Asians who travel to the Europe or Thailand for prenatal sex selection
(Guilmoto 2012a).
Unintended Consequences of the Ban
Bans are a common legal tool used by governments to restrict social “wrongs.” But if
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underlying preferences do not change, bans are particularly likely to be self-defeating.
Bans push individuals to circumvent the law and seek alternatives that can pose
greater risks for the very individuals bans seek to protect (Sunstein 1994). Bans
against child labor exemplify this. In a perfect world, such bans can force employ-
ers to stop using child labor. But in reality, they simply lower the wages children are
paid and consequently compel poorer families to supply more child labor at the cost
of the child’s education (Edmonds and Shrestha 2012; Bharadwaj, Lakdawala, and
Li 2013). Similarly, policies that prohibit employers from asking about job applicants’
criminal histories as a way of reducing racial disparities in employment are found
to be counterproductive. Agan and Starr (2018) examine the effectiveness of “Ban
the Box” policies in the United States , and their results suggest that these policies
actually encourage racial discrimination as applicants with distinctly black names
received fewer call-backs than applicants with distinctly white names.
Bans against the use of prenatal sex selection technology are no different. They
can result in unintended consequences for the women and girls they intend to pro-
tect. First, strict enforcement of bans could mean that women who want to abort
unwanted female fetus would seek clandestine services, and risk unsafe abortion pro-
cedures (Nie 2010). In-depth interviews with healthcare providers in Nepal suggest
that medical personnel are aware that their patients may seek illegal abortion services
in India if they are not available locally. These healthcare workers note feeling caught
between respecting the law, and ensuring that their patients’ receive safe healthcare
services (Lamichhane et al. 2011).
Strict enforcement could also make medical practitioners reluctant to provide legal
reproductive health services that require the use of restricted technology. Access to
ultrasound scans for antenatal checks and access to safe abortion for reasons other
than sex-selective purposes could potentially be limited. The case of the Republic of
Korea illustrates how strict enforcements can restrict women’s access to legal health
care services altogether. In 2010, the government introduced an action plan to crack
down on illegal abortions (arguably in a bid to raise the low birth rate in the coun-
try). The prosecution of the arrested doctors following this crackdown was widely
publicized, and in response many obstetricians reportedly became fearful of offering
abortion services even for legal reasons (Korean Women’s Association United 2011).
Second, having unwanted girls could affect how mothers are treated in the house-
hold and in the community at large. In patrilineal societies, bearing a son mat-
ters for women, as it can improve their position within the household. For example,
98 The World Bank Research Observer, vol. 35, no. 1 (2020)
Li and Wu (2011) use pooled data from the China Health and Nutrition Survey
(CHNS) and multivariate regressions to show that women whose firstborns were sons
had more decision-making power, and better nutritional intake. More starkly, Milazzo
(2014), using pooled data from the Indian National Family Health Survey (NFHS) and
exploiting the randomness in the sex of the firstborn child, finds that women whose
firstborns were girls were more likely to suffer maternal and adult mortality. These
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studies are backed by the findings of ethnographic studies (Das Gupta et al. 2003). In
recognition of the heightened vulnerability of sonless women, the Chinese govern-
ment in 2002, prohibited ill-treatment of women who give birth to girls or who are
infertile (Li 2007).
There is also evidence to suggest that the adoption of ultrasound technology – a
key innovation in helping those with son preference prenatally select the sex of their
baby and avoid unwanted daughters – improves women’s welfare. Ebenstein, Li, and
Meng (2013), combine data from various Chinese surveys and the Local Chronicles,
and exploit the timing of ultrasound diffusion across counties to find causal evidence
that the adoption of ultrasound technology increases the probability of having a son
at second parity, and this in turn leads to lower family size, an increase in labor mar-
ket employment outside agriculture, an increase in intrahousehold bargaining power,
and a decrease in suicide rates for women in rural China. While this study does not
view such improvements in women’s welfare – which are conditional on having a
male child – as related to improvements in women’s status overall, it does argue that
ultrasound bans are likely to worsen women’s outcomes in the absence of interven-
tions that change the intrinsic value of females.
Having a son seems to improve a women’s circumstances during old age too. For ex-
ample, Cain (1986) draws on survey data from rural Bangladesh and India and uses
a correlation-based approach to find that older women without sons in these con-
texts were at greater risk of economic uncertainty and mortality. Similarly, Rahman,
Foster, and Menken (1992) use data from the Matlab, Bangladesh, and discrete time
hazard models (correlation-based approach) to find that women ages 45 or more who
had an adult son living with them had lower mortality risk. In the absence of any
other substitute, those women who would rely on sons for old-age security are likely
to be worse off due to ultrasound bans.
Third, since bans do not change the underlying preference for sons, couples who
actively want sons will use postnatal discrimination as a substitute if prenatal sex
selection methods cannot be accessed. Table 1 provides a summary of studies that
examine how the postnatal welfare of girls (versus boys) changes when prenatal sex
selection becomes accessible. Broadly, the studies cited in table 1 suggest that the post-
natal survival of girls improves, and investment in girl children increases when pre-
natal sex selection increases.7 The use of prenatal sex selection results in fewer un-
wanted daughters being born, and this improves postnatal investments in girls. This,
of course, is not to suggest that governments should ignore sex selective abortion. The
Kumar and Sinha 99
practice remains blatantly discriminatory irrespective of the positive outcomes, and
as Anukriti, Bhalotra, and Tam (2018) highlight, the substitution effect is not per-
fect (ultrasound access improves the postnatal survival of girls, but also increases the
total number of missing girls), and the SES distribution of female versus male births
lowers the probability of convergence in outcomes in the long run (see table 1). In-
stead, this evidence suggests that bans, as they are currently being implemented, may
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not be the ideal means of improving female child welfare.
Are Bans Effective in Normalizing Sex Ratios at Birth?
It is difficult to evaluate the effectiveness of bans in normalizing SRBs since the bans
are not randomly assigned and enforced. The nonrandomness in the assignment of
the “treatment” (the ban in this case) makes the construction of the counterfac-
tual scenario of what might have happened in the absence of the ban difficult. The
country-specific studies below outline some of the attempts at estimating this treat-
ment effect (for an overview, see table 2)
India. The Indian government, concerned with the implications of increasing ac-
cessibility of prenatal sex diagnostics in the 1980s and 1990s, passed the Prenatal
Diagnostic Techniques Act (PNDT) in 1994. The Act went into operation in 1996.
It prohibited medical professionals from using prenatal diagnostic techniques for sex
selection; these techniques could only be used for detecting genetic or sex-linked dis-
orders, or congenital malformations. The Act was amended in 2003 to prohibit the
use of pre-conception sex selection techniques as well (Ministry of Health and Family
Welfare 1994).
Nandi and Deolalikar (2013) conducted a rigorous ex post examination of the im-
pact of the PNDT Act. They measured changes to the child sex ratio following the
PNDT Act by exploiting spatial variation in the timing of the ban across Indian states.
For the state of Maharashtra, the ban on prenatal sex selection was implemented in
1988, nearly a decade before the passage of the national PNDT Act. This allowed
Nandi and Deolalikar (2013) to use Maharashtra as the pretreated or control state
that was not affected by the national ban. They conducted a difference-in-difference
analysis that compared the difference in child sex ratios between Maharashtra and its
neighboring states before and after the passage of the PNDT Act.
The key assumptions of this empirical strategy were that (a) Maharashtra and its
neighboring states were on similar trajectories before 1988, that is, they had parallel
trends in child sex ratios before 1988; (b) couples in Maharashtra did not go to vil-
lages in neighboring states seeking sex selective abortions between 1988 and 1994,
that is, there were no spillover effects; (c) the national ban did not affect enforcement
in Maharashtra; and (d) the ban was similarly implemented in Maharashtra and its
neighboring states.
100 The World Bank Research Observer, vol. 35, no. 1 (2020)
Kumar and Sinha
Table 2. Summary of Studies That Examine the Impact of a Ban on Prenatal Sex Selection on Sex Ratio at Birth (SRB)
Author (Date) Ban (details) Data Type of study Observed impact on SRB
Nandi and Prenatal Diagnostic Techniques Village and town-level Indian Quasi-experimental Less imbalanced child sex
Deolalikar (2013) Act, India, 1994 census data, 1991 and 2001 (difference-in-difference) ratio, but can’t discern
impact on SRB
Park and Cho Ban against prenatal sex Vital statistics and World Correlation-based/Trend Drop in SRB in 1991, but
(1995) selection, Rep. of Korea, 1987 Fertility Survey analysis this was more likely due to
(suspension of medical licenses parents’ adherence to the
of miscreant doctors in 1990) Lunar calendar
Guo, Das Gupta, Care for Girls Program, China 2000 and 2010 Chinese Correlation-based/Trend Less imbalanced SRB for
and Li (2016) (cracking down on prenatal sex census analysis second-order births, but
selection by monitoring second more imbalanced SRB for
birth-order pregnancies) first-order births
101
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The data for this study came from village- and town-level longitudinal data from
the 1991 and 2001 Indian censuses. To account for spillover effects, the authors
compare villages in Maharashtra to villages in neighboring states that are not located
along the border of Maharashtra. This way, the newly treated villages are culturally
similar to Maharashtrian villages but are geographically distant enough to prevent
spillovers. The evaluation results suggest that after controlling for individual- and
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community-level factors, and spillover possibilities, the PNDT Act caused a 14 to 26
points increase in the female-to-male child sex ratio.8 The ban resulted in 106,000
more surviving girls in the 0–6 age groups in the newly treated rural areas.
While these results suggest that the ban was effective in achieving a less imbal-
anced sex ratio, caution must be used when interpreting them. First, the outcome
variable in this study is the child sex ratio (which is affected by prenatal and postnatal
sex discrimination), so the authors cannot isolate the effect of the ban on prenatal
sex selection or SRB. Second, as the authors argue themselves, evidence on parallel
trends in sex ratios before 1988 is not conclusive. Third, the available data does not
allow the authors to test the assumption that the Maharashtra ban and the national
ban were similarly implemented, or that the national ban did not affect enforcement
in Maharashtra.
Republic of Korea. In the Republic of Korea, prenatal sex determination technology
was introduced in the mid-1980s. Following the introduction of this technology, the
country saw an increase in its SRB that continued until the mid-1990s. In response
to the growing sex imbalances, the government enforced a ban on the use of prena-
tal sex identification in 1987. This ban, in combination with the restrictions on the
use of abortions services, was expected to curb the practice of prenatal sex selection.
In 1994, the government strengthened the provisions of the 1987 Act by imposing
stricter penalties on medical professionals who broke the law. There is no specific in-
formation on how strong the enforcement of the ban was. Reports suggest that in
1990, the licenses of eight physicians were suspended on grounds that they had per-
formed sex-determination tests. These arrests were widely reported in the media as
well (Park and Cho 1995; Ganatra 2008; Boer and Hudson 2017).
Some observers claim that the momentary drop in SRB in 1991 could be attributed
to the suspension of miscreant physicians in 1990. However, Park and Cho (1995)
argue that this interpretation is flawed, as it does not account for parents’ adherence
to the Chinese lunar calendar. The year 1990 was the Year of the Horse (a zodiac sign
deemed unfavorable for girls), so the greater number of girls registered in 1991 may
have simply been 1990 female births that were registered a year later to ensure that
the girl born could avoid the stigma of being born under the Horse sign. Further, they
argue that the 1992 sex ratio lies between the rates of 1990 and 1991. In fact, SRB
in the Republic of Korea did not reach biologically normal levels until the late 2000s,
that is, nearly 20 years after the ban of prenatal sex determination. Up until 2002,
102 The World Bank Research Observer, vol. 35, no. 1 (2020)
the sex ratio for birth order three or higher was 141 girls per 100 boys − suggesting
that the technology to exercise son preference was available for couples who actively
wanted to use it (Das Gupta 2016).
Beyond this, there are no evaluations of the ban; it is difficult to isolate the treat-
ment effect because of the simultaneity of other socioeconomic and legal develop-
ments. Yet an examination of trends strongly suggests that the decline in Korean
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SRB was the result of normative change that followed years of urbanization and
industrialization. These broader forces resulted in a shift from extended families to
nuclear ones, it allowed individuals to save for retirement, it shifted women’s employ-
ment opportunities and their ability to care for their parents, and it changed par-
ent’s valuation of daughters. Broadly, it decreased adherence to patriarchal norms
and decreased son preference. Between 1991 and 2003, the proportion of women in
the same birth cohort who reported that they “must have a son” halved (Chung and
Das Gupta 2007).
Furthermore, legal amendments to promote gender equality followed these nor-
mative shifts. While Family Law was revised in 1989 to provide girls and boys with
equal inheritance rights, the family head system, which was the basis of patrilineal
succession, was not abolished until the 2000s despite significant efforts by women’s
groups to do so (Chung and Das Gupta 2007). It could be argued that the Republic
of Korea would have seen an earlier turnaround in SRB if this significant piece of
legislation had been enacted in the 1990s.
China. Under the Care for Girls program, the government of China made one of the
most vigorous attempts to implement the ban on sex selection practices in the 2000s.
Women whose first child was female, and who were pregnant with their second child,
were regularly monitored by local family planning workers and Women’s Federation
workers. This group was targeted, as it was believed that they were under the most
pressure to ensure the second child was a boy. Strict penalties were imposed if an indi-
vidual was found to be practicing sex selection. Doctors would lose their licenses, clin-
ics would be fined, scan equipment would be confiscated, and whistle-blowers would
be rewarded. In areas where a second child was permitted, target couples who were
found to be practicing sex selection would not be allowed to try for a second child
again. Between 2011 and 2012 alone, as many as 6,700 cases were investigated, of
which 2,400 individuals were punished (Guo, Das Gupta, and Li 2016).
To assess the impact of this effort, Guo, Das Gupta, and Li (2016) observe changes
in the SRB between the 2000 and 2010 censuses. They note that while there was a
sharp decline in the sex ratio of second births between 2000 and 2010, there was
also an increase in the sex ratio of first births (first births were not being monitored).
Since first births form nearly two-third of all births in the 2010 census, there was no
fall in the overall SRB. The inference is that with the strict monitoring and penalties
in place, parents who wanted sons simply ensured that their first child was a son to
avoid the monitoring of second pregnancies.
Kumar and Sinha 103
These efforts by Chinese authorities were successful in that they did reduce SRB
among the target group, that is, women having their second child. However, the fi-
nancial and logistical costs of the program must be considered, particularly if the
program were expanded to monitor first pregnancies as well. The replicability of these
efforts in other contexts is also dubious. Various government agencies were mobilized
to monitor second pregnancies in China; not many other countries have the adminis-
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trative capacity and manpower to carry out such an operation (Guo, Das Gupta, and
Li 2016).
While the analysis of Guo, Das Gupta, and Li (2016) provides suggestive evidence
of the impact of the ban’s enforcement on SRB, it does not statistically isolate the
treatment effect of the ban. It is difficult to disentangle the impact of ban enforcement
efforts from the broader Care for Girls efforts taking place simultaneously.
Other Countries. In Vietnam, sex selection was outlawed in 2003. However, enforce-
ment has thus far been lax, largely because of difficulties in monitoring the misuse of
technology (UNFPA Vietnam 2011). A similar reason has been provided for Nepal’s
difficulties in implementing the ban (Puri and Tamang 2014).
The South Caucasus countries have banned prenatal sex selection as well. How-
ever, there have been no monitoring or sanctions imposed for breaches, no orga-
nization of an ethics body consisting of relevant medical personnel, and limited
awareness-raising campaigns for the general public (Liisanantti and Beese 2012).
Conditional Cash Transfers
Another direct approach that has been tried in India and China is to provide condi-
tional cash transfers (CCTs) to parents who have daughters. The idea behind CCTs is
to discourage preferential treatment of sons over daughters by subsidizing the “cost”
of daughters, and encouraging investments in daughters.
Table 3 provides an overview of the studies that evaluate the effectiveness of such
CCT programs. Further discussion of these studies follows in the subsections below.
India. Since the 1990s, several Indian states have introduced CCT programs to dis-
courage son preference. Comparison of the different programs is complicated by the
fact that the programs in different states have different objectives, and different el-
igibility criteria. However, some of the common features of these schemes can be
delineated. Most schemes are targeted at families below the poverty line. They pro-
vide immediate financial incentives for female births, and long-term support for fam-
ilies with girls starting from birth until age 18. The cash transfers are conditional on
the provision of health and educational investments in girls, and are typically made
into the mother’s bank account or the beneficiary child’s bank account. The main
104 The World Bank Research Observer, vol. 35, no. 1 (2020)
Table 3. Summary of Studies that Examine the Impact of Conditional Cash Transfer (CCT) Programs on Female Child Outcomes
Author (Date) CCT program Program aims Data Type of study Observed outcomes
Kumar and Sinha
Holla, Jensen, Apni Beti Apna Dhan, Balance child sex ratio, Pooled birth-history data Quasi-experimental Reduced SRB, but positive
and Oster Haryana, India delay age of marriage from first two waves of the (difference-in-difference) effects for girl children erode
(2007) for girls, improve the NFHS (1992–1993; over time
valuation of, and 1998–1999)
investments in, girls
Sinha and Apni Beti Apna Dhan, (See above) Pooled birth-history data Quasi-experimental No change in preference for
Yoong (2009) Haryana, India from all three waves of the (difference-in-difference) girl children; some positive
NFHS (1992–1993; effects observed in terms of
1998–1999; 2005–2006) female child survival and
educational attainment
Sekher (2010) Different CCT See Annexures section In-depth interviews with key Qualitative (desk Short-term and long-term
Programs across India of Sekher (2010) stakeholders evaluation of operational operational problems
aspects of CCT programs) associated with CCT
programs. Concerns of
public trust in these
programs
Sekher and Ram Dhanlakshmi Scheme Balance child sex ratio, Survey data from 4,000 Mixed methods. Some immediate positive
(2015) in seven Indian states improve investments in beneficiary and Quantitative element was gains; no change in
(Andhra Pradesh, girls, change families’ non-beneficiary households quasi-experimental preference for girl children
Bihar, Chhattisgarh, mindsets towards girls in eight blocks across five (propensity score
Jharkand, Orissa, states (Punjab, Bihar, Orissa, matching)
Punjab, and Uttar Andhra Pradesh, and
Pradesh) Jharkand). In-depth
interviews and focus group
discussions
105
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106
Table 3. Continued
Author (Date) CCT program Program aims Data Type of study Observed outcomes
Anukriti (2018) Devi Rupak, Haryana, Reduce family size and Pooled birth-history data Quasi-experimental No change in son
India balance child sex ratio from the NFHS and the (difference-in-difference) preference; increase in SRB
District Level Household
Survey of India
Li (2007) Care for Girls Program Support girl-only China censuses Descriptive statistics; Success of benefits program
(benefits component), families; improve (1950–2005), survey data literature review is contingent on local
China investments in girl from government bureaus, development. Scope to
children; change previous studies improve design, and
preference for sons implementation of
legislative measures that
indirectly raise value of girls
Murphy (2014) Care for Girls Program (See above) Key informant interviews; Qualitative Program has failed to deal
(benefits component), analysis of policy documents with the underlying causes
China and newspaper articles of gender inequity. Material
benefits are conditional on
local development
Note on acronyms: Sex ratio at birth (SRB); Indian National Family and Health Survey (NFHS)
The World Bank Research Observer, vol. 35, no. 1 (2020)
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implementing agencies are either the Department of Health, or the Department of
Women and Child Development (Sekher 2010; Sekher and Ram 2015).
The initial evaluation of these schemes, conducted by Sekher (2010), focused on
operational aspects. It was based on interviews with state government officials, pro-
gram managers, and NGOs. The main findings from the study were that:
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(a) the stipulations associated with the schemes were complicated, and guidelines for
implementation were poorly understood by local staff;
(b) there was limited involvement of key stakeholders like village councils and
women’s groups who could have helped state officials in identifying beneficiaries
and monitoring implementation;
(c) there was poor coordination between the health, education, social welfare, and
financial sector. Beneficiary households faced delays in collecting the documen-
tation required, opening zero-balance bank accounts, and receiving benefits;
(d) there was no monitoring of operations at the field level, leaving little scope for
remediation;
(e) some schemes were discontinued before the beneficiary child reached adulthood
(i.e., the schemes were discontinued before the beneficiaries received all the bene-
fits promised). Consequently, families in those states lost faith and interest in such
CCT schemes (also see the evaluation by Sharma, Goel, and Gupta (2003) of the
Rajalakshmi scheme implemented in Rajasthan in 2002).
Following the desk-review of CCT schemes in 2010, Sekher and Ram (2015)
used the Dhanlaksmi scheme as a case study to examine the impact of CCT pro-
grams on parents’ attitudes and behavior towards girl children. The Dhanlakshmi
scheme was sponsored by the Government of India, and the pilot program was im-
plemented in 2008 in select blocks in seven Indian states (see table 3) Between 2008
and 2013, 336,770 girls were enrolled in the scheme. To evaluate the effectiveness
of the scheme, Sekher and Ram (2015) conducted surveys with 4,000 beneficiary
and nonbeneficiary households in eight blocks across five of the seven states in 2013
and 2014. They use propensity score matching (PSM) to estimate the effect of the
scheme; PSM isolates the treatment effect by controlling for factors that predict ben-
eficiary status. This analysis was supplemented with key informant interviews, and
focus group discussions with select survey respondents.
The study found that girls in beneficiary households fared better − they were more
likely to be enrolled in school, and their parents were more intent on them pursuing
higher education. Parents in beneficiary households were also more willing to delay
their daughter’s marriage, and less likely to view their daughter as a liability. However,
many parents in beneficiary households also saw the terminal benefits of the scheme
as means to meet their daughter’s marriage costs, and there is no evidence that
the program changed families’ preference for girl children. From a program design
Kumar and Sinha 107
perspective, a major drawback was that there were no incentives for girls to complete
secondary education (Sekher and Ram 2015).
Impact evaluations of other CCT programs also provide important policy lessons.
Anukriti (2018) conducts an evaluation of the Devi Rupak program that was imple-
mented in the state of Haryana in 2002–2003. This program had the dual aim of
reducing fertility and balancing the SRB in the state.9 To isolate the treatment effect
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of the scheme on the number and sex-composition of children, Anukriti (2018) uses
a difference-in-difference approach that exploits variation in the year and state of pro-
gram commencement, and variation in future incentives by the composition of exist-
ing children who were born before the program was launched. Her results suggest
that while families responded to the incentives to reduce fertility, they did not forgo
their preference for sons despite the higher benefits provided for having daughters.
The incentives provided for one-boy only were sufficient for couples to cease childbear-
ing or sex-selecting at first birth. However, the higher incentives provided for one-girl
only were not sufficient for couples to forgo their demand for sons; these couples did
not cease childbearing after the first child and sex-selected for a son at second birth.
The net result was a reduction fertility, but an increase in the SRB (Anukriti 2018).
Some would argue that short-term improvements in programs like Devi Rupak
could be achieved by not providing benefits to one-boy-only families. However, pro-
grams that do not provide benefits for male children, also show mixed results in low-
ering son preference. Evaluations of the Apni Beti Apna Dhan scheme that was imple-
mented in Haryana in 1994 are a case in point.
The evaluation by Holla, Jensen, and Oster (2007) of the scheme draws on pooled
birth-history data from the first two rounds of NFHS, and a difference-in-difference
approach that uses variation in the eligibility criteria, and the implementation of the
program in Haryana versus neighboring states. The results suggest that the program
had a positive effect on SRB (probably due to the cash payment that is made quickly
after the female child’s birth). However, the positive effect of the program for girl chil-
dren erodes over time despite the staggered payments that are promised if the girl
remains alive, unmarried, and fulfils educational and health requirements by age 18.
Vaccination rates for girl children did not improve following the initiation of the pro-
gram, and as a result, the program had a negligible effect on improving child sex
ratios.
Sinha and Yoong (2009) identify more successes of the program, but they also find
that these successes were limited. They use pooled birth-history data from the NFHS,
but from all three rounds (with three rounds of data they can evaluate outcomes for
girls in the short and medium term), and a difference-in-difference approach that ex-
ploits variation in the eligibility criteria. Their results suggest while beneficiary house-
holds were more likely to give birth to girls, and to ensure their survival, there is mixed
evidence on whether these girls saw improvements in their quality of life. Beneficiary
households made more health investments in their young daughters, but this did
108 The World Bank Research Observer, vol. 35, no. 1 (2020)
not necessarily translate into better health status for the girls in the medium term.
Furthermore, school-age girls in beneficiary households were not more likely to at-
tend school than their counterparts in nonbeneficiary households (although, if they
did start attending school, they were more likely to continue attending school). The
program did not have a clear, positive effect on mother’s preference for girl children
either.
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China. In 2000, China introduced a comprehensive program, titled Care for Girls, to
reduce sex selection. After setting up a pilot project in Anhui province in 2000, and
then pilots in 24 other provinces in 2003–2005, a national plan was developed for
this program in 2005–2006. The national plan focused on advocacy, providing family
planning services, cracking down on sex determination and sex selective abortions,
building monitoring and evaluation capacity, and providing benefits to families with
only girls. The benefits component focused on providing financial and other assis-
tance to parents in daughter-only families via low interest loans, social security ben-
efits, and educational scholarships. For families to be eligible for benefits, they must
meet strict criteria: they must have had only one child or two daughters (including
adoptees), they must be girl-only families, one member of the couple must be steril-
ized, and the wife must be 45 years old or younger (Li 2007; Murphy 2014; Guo, Das
Gupta, and Li 2016).
In some provinces, daughter-only families are partnered with local officials. The
officials help families by obtaining subsidies for school tuition and housing improve-
ments, and microloans to start small businesses (Li 2007; Murphy 2014). In some
provinces, parents with daughters are offered conditional benefits under schemes
such as the Sunshine Education Assistance Project that was started in 2008. Under
this program, families that fulfill the eligibility requirements are given 1,000 yuan
per year for three years, conditional on the funds going to the girls’ high school edu-
cation. Furthermore, these scholarships are provided to girls at public ceremonies to
foster public awareness of the value of daughters. Progress under this project is a key
government priority, as highlighted by the fact that it is part of the local family plan-
ning officials’ work evaluations. Another example of an education-centered benefits
scheme is the Spring Buds program that allocates money for girls in rural families to
continue their education.
There are no rigorous evaluations of the causal impact of these benefits pro-
grams on SRB, female child survival, and son preference. It is difficult to isolate
the cash transfers’ effect from the other programs bundled into the Care for Girls
effort. However, there are some criticisms of the program that need to be noted.
The criticisms of the program draw on observational data, key informant interviews
at various administrative levels, government policy documents, and other policy
reviews.
Kumar and Sinha 109
First, while the funding for most Care for Girls efforts come from central, provin-
cial, and local authorities, the funding for the benefits program comes solely from
local authorities. This makes the liquidity of the program contingent on local eco-
nomic development; poorer counties are less likely to implement such schemes. The
design of the programs is also determined at the county level. The effectiveness of
these schemes in changing child sex preferences is contingent on how local author-
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ities prioritize and manage the issue (Li 2007). For example, in some counties, local
businesses are obliged to donate to the Care for Girls foundation fund, and this fund
is used to cover the benefits provided to girl-only families (Murphy 2014). Whether
local businesses are required to participate in these efforts, and if so, how much they
donate and how they are made to comply with the requirements for donations, will
vary across counties.
Second, the program is focused on girl-only families. The program effectively leaves
out girls with a male sibling, who are arguably vulnerable in their own way, given
that they must face tough competition for parental resources. Take the case of the
Spring Buds program. This program, initially managed by the provincial and county
women’s federation groups, allocated money to poor families with girls to assist with
educational attainment. However, in many counties, this program was co-opted by
the Care for Girls effort, and the assistance to girls with male siblings stopped (Murphy
2014).
Third, the notion that families need to be “compensated” for having a girl needs to
be examined. Does a CCT program tacitly agree that boys and girls are unequal, with
girls being more a liability to families? What message does this framing send to young
girls in their early years? Even if we argue that the CCT is intended as a more imme-
diate measure to curb discrimination against girls, we must ask whether it changes
parents’ gender preferences. In-depth interview data from the qualitative study by
Murphy (2014) suggests that girl-only families who receive financial assistance dis-
play gratitude towards the government, but they do not display a change in attitude
towards daughters. Evaluations of India’s CCT programs come to similar conclusions
on this.
The Promise of Indirect Approaches
Existing evidence suggests that compared to direct measures, indirect measures of-
fer more promise in changing unbalanced child sex ratios and improving the status
of women and girls in the long term because they address the main causes of son
preference. Indirect measures can include reform in areas such as property rights,
old-age support, political participation, education, and employment (these measures
are considered good policy choices irrespective of their impact on son preference).
Indirect measures also include advocacy efforts.
110 The World Bank Research Observer, vol. 35, no. 1 (2020)
Legislative Measures
In theory, legislative reforms, like the ones outlined above, empower women econom-
ically and politically, and reduce their dependence on male kin. They offer sons and
daughters equal opportunities to care for their parents, and encourage parents to see
their daughters as worth investing in.
In practice, many of these legal measures achieve the stated outcomes. For ex-
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ample, in patrilineal societies, married women prefer having sons because sons can
inherit family property and provide support during old age (Das Gupta et al. 2003;
Jayachandran 2015). However, if inheritance laws are amended to provide sons and
daughters equal claim to family property, older women’s dependence on sons can be
reduced. Daughters would be willing and able to care for parents, and parents would
be encouraged to invest in daughters. As evidence, Deininger, Goyal, and Nagarajan
(2013) find causal evidence (quasi-experimental study) that the expansion of inher-
itance rights to women in India increased daughters’ educational attainments and
the likelihood that they would inherit family property. Similarly, Ebenstein and Le-
ung’s (2013) quasi-experimental study suggests that the introduction of the state-
sponsored pension program in rural China in 1991 suppressed the upward trajec-
tory of SRB. The availability of alternate sources of material support during old age
obviated some of the need for sons.
The presence of women in the political sphere is shown to have positive impli-
cations as well. Various experimental studies (Beaman et al. 2009; Beaman et al.
2012; Kalsi 2017) exploit the random assignment of reservations for women in vil-
lage councils in India to demonstrate this. Following the reservation law, the sur-
vival prospects of higher-birth-order girls and the educational attainments for adoles-
cent girls increased. Young girls saw a shift in aspirations, and in parent’s aspirations
for daughters changed as well. Female political leaders broke gender stereotypes for
young girls and their families by serving as role models.
Other measures that empirically result in positive outcomes for girls include the
expansion of educational opportunities (see, e.g., Murthi, Guio, and Drèze 1995; Ren
1995; Pande and Astone 2007), and financial opportunities (see, e.g., Duflo 2000;
Qian 2008; Luke and Munshi 2011) for women. These measures provide women with
economic independence, provide young girls and their parents with role models, and
foster gender egalitarian ideas.
There is also some evidence to suggest that these legislative measures may not nec-
essarily bring immediate positive change in parents’ valuation of daughters (see, e.g.,
the quasi-experimental study by Rosenblum (2015) on how changes in inheritance
law in India increased mortality risk for girls; and Amin’s (1990) correlation-based
study and Das Gupta’s (1987) ethnographic study for how initial improvements in
socioeconomic status increase the pressure and ability to sex select). But these unex-
pected findings do not call for the continuation of legal practices that systematically
Kumar and Sinha 111
exclude women. They suggest that legal reforms could be bolstered with advocacy ef-
forts to change social norms and achieve more immediate positive outcomes for girls.
The case of the Republic of Korea is illustrative here. It shows how the relationship
between socioeconomic development and sex selection can evolve with shifts in social
norms:
Soon after industrialization and improvements in individual economic status,
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South Korea saw an increase in sex ratios from the early 1980s to the mid-1990s. Ini-
tial economic mobility increased the pressure to sex-select, and with the introduction
of prenatal sex selection technology in the 1980s, individuals could afford effective
means to sex select. Over time, however, the conditions of urban life brought about
societal level shifts in gender norms and eroded son preference. By the late 1990s, sex
ratios in South Korea had reached normal levels. Normative changes also led to leg-
islative reforms to promote gender equality, e.g., the abolishment of the family-head
system in the 2000s (Chung and Das Gupta 2007).
Advocacy
Mass-media campaigns can be particularly effective in altering people’s awareness of
a social issue, and their values and behaviors associated with that issue, because they
introduce people to situations that are different from their own. Furthermore, the
popularity and geographic reach of media such as radio, television, and the Internet
make media campaigns cost effective in bringing about normative change. Research
highlights how access to these media bring about attitudinal and behavioral shifts on
environmental issues (Jacobsen 2011) and family planning adoption (Rogers et al.
1999; La Ferrara, Chong, and Duryea 2012). Similarly, studies illustrate how access
to different media platforms shift gender-specific attitudes and behavior (for quasi-
experimental studies that examine the positive causal impact of television exposure
on gender norms and son preference see Jensen and Oster (2009), Ting, Ao, and Lin
(2014), and Lin and Adserà (2013)). Observation studies have noted that fictional
dramas on gender issues can be especially effective in reaching out to young women
(the target audience) because they are entertaining and instructional without being
condescending to the viewer (Naqvi 2006).
The media can also be effectively used to disseminate technical reports that can
spur public awareness of the consequences of sex selection. Reports on census results,
cross-country and over-time sex ratio comparisons, the local impact of excess males
and bride scarcity, the resulting trafficking of women, and so on can be circulated.
Vietnam is an example of a country where observable sex imbalances in statistical
surveys was immediately conveyed by the media to the public. As a result, sex selection
soon became a national issue (Guilmoto 2012a).
Efforts to strategically draw international attention to growing social problems
in a country and to lackluster government responses to those problems can also be
112 The World Bank Research Observer, vol. 35, no. 1 (2020)
effective. For example, the resolution of the Council of Europe (2014) seems to have
been successful in shaming South Caucasus countries about the unfettered rise in sex
selection, and in pressuring these countries to strengthen policies (including banning
prenatal sex selection) to counter it (Guilmoto 2012a).
Advocacy efforts can be strengthened with support from community leaders, po-
litical leaders, celebrities, youth organizations, and religious organizations. Involving
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these groups is key as they can bring about trickle-down effects. It is also important to
actively involve the medical community − members of whom often feel criminalized
in efforts to manage sex selection − as they play critical roles as points of access to
reproductive technology (ibid).10
Conclusion
The purpose of this article is to conduct a stocktaking of the different policies that
have been used to tackle sex selection, and son preference more broadly. Having eval-
uated the different direct and indirect measures used, this review argues that govern-
ments would be better suited to managing imbalanced child sex ratios by:
(1) Strengthening data collection and monitoring efforts
Access to data on child sex ratios at the subnational level are relatively easy to ob-
tain from censuses and surveys. However, reliable data on SRB are harder to obtain
given that they require the establishment of comprehensive vital registration systems.
Currently, such systems are not in place – particularly in economically disadvantaged
areas – making it harder to assess the extent of prenatal sex selection. Without good
vital statistics, it is hard to monitor and evaluate regional programs aiming to curb
SRB as well.
(2) Evaluating the costs of direct measures to reduce sex selection
As sex selection rises, governments feel compelled to do something about it, and
a ban on prenatal sex selection technology is the most immediate step they can
take. Not surprisingly, most countries grappling with rising SRB and child sex ratios
have implemented such bans. These measures raise ethical concerns surrounding
women’s reproductive freedoms, but even after setting aside these considerations, ev-
idence suggests that these such are difficult and costly to implement. In China, the
stringent implementation of the ban in the 2000s called for a tremendous effort on
the part of various local authorities and family planning workers. Women who were
pregnant with their second child were frequently monitored as part of the program,
and even then the overall SRB did not decline between 2000 and 2010. With second
pregnancies being monitored, families that wanted a son deferred sex selection to the
first birth. Scaling up such a program to ensure monitoring of all births would be a
Kumar and Sinha 113
financial and logistical challenge, and evidence from the Nawanshahr model in India
suggests that sustaining such efforts is difficult.
Moreover, there is evidence to show that bans can be self-defeating in improving
outcomes for women and girls. Bans can make access to legal reproductive healthcare
services difficult, and can push couples with strong son preference to use postnatal
discrimination as a substitute. Having unwanted girls can also worsen the treatment
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of mothers in the household.
CCT programs do not seem like a viable alternative either. Evidence from India
and China suggests that these programs are ridden with implementation challenges,
deliver short-term gains at most, and do not change underlying gender preferences
among parents.
(3) Using legislative and other indirect measures to improve gender equity
Reform in areas such as family law, social security, workplace policies, educational
polices, and political reservations, can undermine some of the institutional under-
pinnings of son preference and bring about normative change. These reforms can
potentially provide women with more bargaining power within the household, pro-
vide young adolescents with female role models, and encourage parents to invest in
daughters. To be sure, legal reforms do not always bring about immediate shifts in
gender norms, but they can be bolstered through mass-media campaigns and other
advocacy efforts that bring that bring together a diverse set of partners. Compared to
bans on prenatal sex selection and CCT programs, such indirect measures offer more
promise by undermining the root causes of son preference and producing a perma-
nent shift away from sex selection.
Notes
Sneha Kumar is a PhD candidate in development sociology at Cornell University (email:
sk2586@cornell.edu). Nistha Sinha is a Senior Economist in Poverty and Equity Global Practice,
World Bank (email: nsinha@worldbank.org). The authors thank Monica Das Gupta, Elizaveta Perova,
and three anonymous reviewers for their helpful comments and suggestions on previous drafts of this
paper.
1. The phrase “missing girls” or “missing women” was coined by Amartya Sen in his widely cited
article (Sen1990) on the dire consequences of systematic gender discrimination in parts of Asia.
2. In China, the excess mortality of girls today is as high as it was in the 1930s.
3. When boys and girls have similar access to resources and care, girls have a survival advantage over
boys. As overall mortality declines during the epidemiological transition, this female survival advantage
during infancy and childhood increases. In the case of India and China, however, the male-to-female
ratio of infant mortality (probability of dying between age 0 and 1) and male-to-female ratio of child
mortality (probability of dying between ages 1 and 4) is less than 100, indicating excess female infant
and child mortality. In countries without documented son preference, the sex ratio of infant and child
mortality is more than 100 (see United Nations 2011).
4. Reviewing the literature on the full range of potential welfare consequences associated with sex
selective practices is outside the scope of this study as the focus is on whether the policies governments
have adopted to manage skewed child sex ratios have been effective.
114 The World Bank Research Observer, vol. 35, no. 1 (2020)
5. In 2007−2008, 21.2 percent of currently married women age 15−49 in rural India and 50.7
percent of currently married women age 15−49 in urban India received a sonography (ultrasound
scan) as part of their antenatal check-up (IIPS 2010). Please refer to the fact sheets from the District
Level Household Surveys for India for further information on ultrasound availability at district hospitals
across Indian states (Ministry of Health and Family Welfare n.d.). For China, most researchers draw in-
formation on ultrasound diffusion using the Local Chronicles, but data on rural vs. urban availability of
this technology is not cited in their papers.
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6. One could argue that protection for females in the prenatal realm would justify demands for sim-
ilar protection by other discriminated groups that have been the target of prenatal sex selection, such
as those with congenital disabilities (Goodkind 1999). However, this argument ignores the fact that sex
does not impose the same limitations on daily life that certain disabilities would. This is not to suggest
that extensive social support cannot improve the lives of those with disabilities as it can for girls. Rather,
this is to suggest that some of the limitations imposed by disabilities or genetic disorders cannot be ame-
liorated by societal change or support (Wertz and Fletcher 1998).
7. Hu and Schlosser (2015) find that health investment in female children improves, but that female
child survival does not change. Anukriti, Bhalotra, and Tam (2018, 24−25) provide an explanation for
why Hu and Schlosser’s empirical strategy results in this divergent conclusion.
8. According to figure 2 of the Nandi and Deolalikar (2013) paper, the female-to-male child sex ratio
in Maharashtra decreased from 978 in 1981, to 954 in 1991, to 930 in 2001. Comparably, the female-
to-male child sex ratio in Maharashtra’s neighboring states (the newly treated areas) decreased from 973
in 1981, to 952 in 1991, to 929 in 2001. Nandi and Deolalikar’s calculations suggest that the PNDT
Act suppressed some of the decline in the child sex ratio in the newly treated areas between 1991 and
2001. For more information on the child sex ratio in the rural and urban subsamples in Maharashtra
and its neighboring states, please refer to tables 1 and 2 in Nandi and Deolalikar (2013).
9. Eligible couples who opt for sterilization after the first child would receive monthly benefits, with
higher benefits provided for families with only daughters. Eligible couples who go on to have a second
child and then opt for sterilization, would receive additional benefits only if the first and second child are
girls.
10. In Nepal, for example, the Society of Obstetricians and Gynecologists developed a story-based
documentary film to caution the public about the repercussions of sex selective abortions, and to draw
awareness to the larger issue of gender equity. The organization also put up informational posters in
hospitals and clinics (Puri and Tamang 2014).
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