2.

DIMENSIONS OF POLITICAL ECONOMY

2.1 Defining the Concepts

The term political economy is subject to multiple understandings. Its origin can be found in the work of
Adam Smiths Wealth of Nations, of David Ricardo and Karl Marx. In this body of work, the term referred
to the conditions of production organization in nation-states or what today is understood as economics. Today, the
term is defined as analysis that studies the linkages between politics and economics, drawing on theo-
ries of economics, law as well as political and social sciences. Economic theory traditionally focuses on mar-
ket decisions, where voluntary exchange leads to Pareto efficient7 outcomes. The decisions that political
economy focuses on are those where the market does not produce these desired outcomes for example, in
the case of over-exploitation of land/resources due to unclear tenure as they are influenced by political
and not economic considerations. Hence agreements on rules that govern the voluntary exchange are needed,
such as property rights or crop rotation regulations. Different disciplines such as psychology, international
relations, law or ecology have incorporated the meaning of political economy to study the interactions in their
respective disciplines. Ecologists, for instance, think of ways to change market incentives to address environ-
mental sustainability concerns.

The most common way of approaching political economy in development work tends to be from either an
economic perspective using rational choice-based models, or from a political scientific perspective through
power-based models. This work is based on the power-based approach. Since the power-based perspec-
tive is strongly linked with the economic models and a substantial number of development studies in political
economy build on those, we will briefly outline the main analytical arguments to frame our discussion of the
political economy of reform.

(a) The rational choice perspective on political economy

The rational choice approach leads economists to investigate the conditions under which rational individuals
are willing to cooperate in collective action problems. This implies the analysis of institutions, defined here as
formal and informal rules underlying political powers, bureaucratic agencies or social and private organizations. It also implies
giving recommendations to improve institutions to guide individuals behavior and exchanges so that they can
still maximize their own benefit without harming other individuals and the environment8. The most impor-
tant relevant streams of work in economics are: the theory of the development of institutions9, the agency
theory of bureaucracy10, and rent seeking in public choice theory11.

This perspective tends to inform the way that economists tackle political economy challenges such as the im-
pacts of decentralization on power relations12, public spending reforms in favor of powerful middle-classes at
the expense of less-powerful groups13, institutions and growth14, principal-agent problems (e.g. in voucher

7 Pareto efficiency is achieved when resources are allocated to maximise benefits to all individuals, but without making
any individuals worse off in the process.
8 Moe, 2005
9 e.g. North and Weingast, 1989; Buchanan, 1987
10 Niskanen, 1994
11 Mueller, 2003
12 Besley et al, 2005
13 Keefer and Khemani, 2005; Rudra, forthcoming
14 North, 1990; Rodrik 2004; Keefer and Knack, 1997; Keefer, 2004

4
systems for education15) and how rent-seeking of vested interests influences public investment, again in favor
of some at the expense of others16.
(b) A power-based approach
Critics of the rational choice perspective on political economy raise the question how and especially by whom
institutions are built and can be re-built. They question the capacity of this kind of political economy analysis
to engage effectively with political dimensions of policy issues and thus to inform decision-making17. Critics
argue that institutions are consistently created by powerful interests that favor the better-off, while losers
remain in their original state or end up even worse-off, especially in countries with weak governments.
Even an alternative approach built on Coases theorem18, they argue, does not solve the incentive problem.
Under this approach inequalities in results of policy interventions are addressed through a bargaining process
in which winners of policies have to compensate losers to arrive at a Pareto improving outcome. This as-
sumption is questioned by critics such as Moe19, who argue that there remains little incentive for actual com-
pensation since winners do not depend on the losers support to push a reform through.

The power-based model emphasizes that cooperation (as is assumed in rational choice models) does not al-
ways lead to beneficial outcomes for all. Instead, institutions might be persistently created in favor of power-
ful interests. Similarly, North20 argues while the right institutions may yield economic growth, rulers might
often tend not to choose such institutions, but rather those that favor their own interests. Following this
power-based view of political economy, some political scientists21 have argued that power is a missing per-
spective in the rational choice approach. They emphasize the potentially destructive nature that power can
have and therefore suggest integrating power into the rational choice perspective. Moe22 argues that this
might require only a shift in perspectives and analytical adjustment, instead of a new theory of political econ-
omy.

2.2 Approach Taken

The power-based model forms the basis of the political economy of reform approach taken here. It draws
upon economic, social and political theory in order to understand how political, economic and social actors,
institutions and processes influence each other. This model in turn facilitates an analysis of how political
economy factors constitute risks or opportunities for country-driven and countryowned change through
development intervention. The approach will look at how actors use their position to protect or strengthen
their political or economic interests. It can reveal the conditions and processes under which political actors or
political entrepreneurs maneuver within institutional contexts to build coalitions, negotiate, build consensus,
and bargain to generate new policies, new legislation, and new institutions.

Political economy analysis has been widely and increasingly applied to policy reform. Grindle and Thomas23
for example, categorize policy reforms and define policies in terms of their costs and benefits. They ask: who
wins, and how broadly or narrowly are those benefits distributed? Who loses and where are those losses con-
centrated? Secondly, they also stress the context of policy reform, asking: what is the impetus and motivation
for reform and how do political interests, that surround reform decisions, play out? In more recent work sup-
porting DFIDs Drivers of Change initiative, Grindle24 develops stakeholder and institutional assessment

15 Gauri and Vawda, 2003

16 Keefer and Knack, 2007
17 Frey, 1994
18 see Moe, 2005
19 Moe, 2005
20 North, 1990
21 e.g. Bates, 1989; Levi 1988; Moe, 2005; Olson, 1993
22 Moe, 2005
23 Grindle and Thomas, 1991
24 Grindle, 1999

5
matrices to assess the interests of actors and the institutional context of policy reform. The analysis of stake-
holders examines their priorities, motivation, resources, degree of influence, and actual and potential alliances.
The analysis of institutions investigates the level of access that different actors have to the policy reforms
institutional context, the rules of the game that operate in this context, the distribution of resources of
power/influence, and the degree of importance of the institutional context to the outcome of the policy re-
form. Levi25 examines the conditions under which citizens have the incentive to comply with, or disobey the
demands of democratic governments. One of her main findings is that citizens tend to comply if their per-
sonal costs are not higher than the expected benefits and also, if they find the government trustworthy26.

Theorists of policy reform are only too aware of the significance of context for determining policy reform
progress and outcomes. Pierson and Myles27 highlight the importance of existing policy arrangements as
sources of incentives and constraints to change. Grindle and Thomas28 suggest that the length of time
needed to implement a reform also has an important influence on the reaction generated to it. Bonoli29 finds
that greater concentration of political and institutional power is more likely to incline governments to pursue
radical policy reforms, while it also increases possibilities of electoral defeat and popular protest. In contrast,
in situations where power is fragmented, governments are compelled to pursue reforms through negotiation
and by providing what could be quite substantial quid pro quos. In this way, reforms are more likely to be
accepted, but they are likely to emerge with content that is considerably different to that originally envisaged.

In addition to a focus on institutions and actors, political economy analysis can also be applied to the process
of policy management. Brinkerhoff and Crosby30, for example, emphasize the significance of ownership and
dialogue, which are important process factors that become central to the effective management of policy re-
form.

Beyond the management of political economy risks to successful policy reform, a political economy perspec-
tive can also be brought to bear on the political economy risks of policy reform to equity outcomes. It does so
by assessing the likely impact of policy reforms related to institutions, actors and processes in any given in-
stance on power relations and the distribution of benefits. Will the reform process centralize power and au-
thority thus creating opportunities for elites to capture benefits in ways that were not anticipated? The institu-
tional constraints to progressive changes in power relations can be mapped across economic, political and
social spheres of life31. Economic constraints include rules that restrict access to markets, land, labor oppor-
tunities and credit. Legal constraints cover systems of property rights that favor specific social groups, or the
persistence of corrupt or unequal practices by police and judiciary. Political constraints comprise less-than-
democratic processes, such as clientelism, intimidation or censure that give rise to thin forms of democracy
and deny poor people a political voice. Finally, social constraints include forms of inequality rooted in class,
race, gender or patron-client relations.

2.3 Political Economy of Reform and PSIA

The conceptual framework for the political economy of sector reform presented in this paper builds on over
six years of Poverty and Social Impact Analysis (PSIA) experience, where institutional, political and social
analyses across several sectors and regions have been applied. The use of PSIA to examine changes in power
relations is outlined in the World Bank Sourcebook of Tools for Institutional, Political and Social Analysis of

25 Levi, 1991
26 See also Braithwaite and Levi, 1998
27 In Pierson, 2001
28 Grindle and Thomas, 1991
29 In Pierson, 2001
30 Brinkerhoff and Crosby, 2002
31 Alsop et al, 2006

6
Policy Reform.32 PSIA can be used as one possible tool to analyze political economy issues33, but not every
PSIA has to automatically include a political economy analysis. A recent review shows the usefulness of PSIA
in the agriculture sector to evaluating the influence of local level power relations on poverty and social out-
comes (see Box 1). The conceptual framework for this study, introduced in Chapter 3 below, aims to build on
this experience by providing a systematic framework for the incorporation of political economy issues into
Poverty and Social Impact Analysis.

Box 1: PSIA and distributional equity in agricultural sector reform

A recent review of twenty three PSIA studies in the agriculture sector examined the contribution and experience of con-
ducting social analysis as a part of multidisciplinary poverty and social impact analyses of agricultural reforms. The re-
view found that efficiency and performance were the most common motivations for implementing agricultural reforms,
although distributional impacts and equity concerns were also mentioned as significant drivers. Stakeholder analysis
conducted for these PSIAs was effective in analyzing the social fault lines amongst rural communities of consumers
and producers and unpacking the power relations between different interest groups. The stakeholder analysis helped
identify likely winners and losers while broadening perceptions of who might have an interest or stake in reforms. The
analysis revealed that much behavior under policy reform was based on capture and control of rents. Also, in many
cases, the analysis gave better insight into the relationship between the political interests of elites and their influence on
the reform proposal, showing how political forces could slow down the reform process. The PSIA process helped iden-
tify institutional weaknesses that could hamper successful implementation of a reform. A key concern of several PSIAs
was the response of the private sector to the declining role of the state, particularly in agricultural marketing.

In the most effective cases, PSIAs both identified and helped the process of managing political economy risks by
prompting changes in the design or timing of the proposed reforms. In particular, the early and inclusive involvement
by the stakeholders with most at stake had a significant impact on design and ownership. The findings of this report
suggest that the political economy of reform processes should be a major focus for social analysis methods and prac-
tice in the next generation of PSIAs.

Source: World Bank (2006e). Stakeholder, Power relations and Policy Dialogue; Social Analysis in Agricultural Sector Poverty and Social
Impact Analysis, Washington D.C., World Bank, November

2.4 Demand for the Analysis of Power Relations in Practice

In 2004, the Operations Evaluation Department (OED) of the World Bank hosted a Conference on the Ef-
fectiveness of Policies and Reforms34. A key finding was that reforms are never linear and that sustained
reform is more like a marathon than a sprint in nature. This finding emphasized the process aspect of
reforms. In a process, selectivity, timing, and sequencing matter a great deal. The conference also confirmed
the intuitive insight that home-grown reforms have a greater chance of success than externally imposed ones.
One key recommendation that holds for all development partners, was to be patient, as reforms may take
longer than planned and often run into unexpected obstacles. Development partners should persuade rather
than prescribe, pay more attention to social and environmental impacts and negative impact mitigation meas-
ures, carry out better risk analysis and management, and should encourage ownership. In 2005 the World
Banks Operations Evaluation Department evaluated the Banks development effectiveness35. The evaluation
found that even the best technocratic designs can wither in infertile political soil and therefore that develop-
ment partners need to pay much more attention to the political economy involved in their work. The political
risks, costs, and benefits, as well as the economic implications of proposed reforms must be assessed. Cus-

32 The other PSIA transmission channels are employment, prices, access, assets and transfers and taxes (seeHolland,

2007)
33 Others, for instance are, SIDAs Power Analysis, DFIDs Drivers of Change, the German Development Corporations

institutional and capacity development approach, and the World Bank approaches to political (economy) analysis in re-
gard to growth, governance, and equitable and sustainable development through its Institutional and Governance Re-
views (IGRs), Country Governance Assessment Processes (CGAP) or Country Social Analysis (CSA).
34
Conference on the Effectiveness of Policies and Reforms. World Bank Headquarters, Washington DC. World Bank
Operations Evaluation Department, 2005
35 World Bank, 2005b

7
tom-fitting reform interventions to the political economy are as important as custom-fitting reforms to the
real economy:

Reforms work if you have a good sense of who the winners and the losers are, and if you have a good platform for deal-
ing with the negative impacts of policy changes []. Economists like to look at the net welfare gain in societies, whereas
politics is about winners and losers. 36

The political economy work presented here complements an increasingly important agenda within interna-
tional development debates on good governance37. Within the World Bank country-level Governance and
Anti-Corruption work, encompassing both national and sector institutions, is a key part of this. Policy discus-
sions are geared to promoting and monitoring institutions that enforce good governance, for instance
strengthening sectors to promote accountability and probity through citizen empowerment. The political
economy approach presented here by systematically combining an operational approach towards equity
with power-based models of change incorporates governance concerns into an understanding of how to
promote pro poor policy reforms.

36 Danny Leipziger, speaking at the PREM Knowledge and Learning Forum 2007: How to Reconcile Economics and
Politics?, World Bank, Washington DC, April 16, 2007
37 see e.g. World Bank, 2007a; 2008a