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Responding to external economic shocks: why state capacity and political incentives matter

Briefing/policy papers

Written by Marta Foresti, Leni Wild, Isabella Massa, Daniel Harris

The global financial crisis continues to affect prospects for growth and poverty reduction in developing countries. As in previous economic crises, the impact varies between countries. This reflects differences in economic structures, historical legacies and policies, and in the resulting levels of vulnerability to economic shocks. There is, however, growing recognition of the importance of the governance and institutional set up of a country in responding effectively to financial crises and other similar shocks. What is perhaps less clear is how, in reality, these affect policy responses and their implementation. There is a lack of evidence on the incentives for more sustainable and effective reform processes, beyond the immediate crisis, and on the blockages that might prevent such reform.

These issues are key to understanding the dynamics underlying developing countries’ policy responses to economic shocks, and to informing both domestic and international priorities in this area. A political economy approach to the analysis of the role of state capacity and incentives to respond to economic shocks would help to fill these knowledge gaps.

While more research is needed, this Project Briefing reviews the range of policy responses to the global financial crisis, as a first step. It sets out some useful frameworks and concepts to deepen our understanding of these issues, and to inform more effective assistance for countries affected by similar external shocks in the future.

Marta Foresti, Isabella Massa, Leni Wild and Dan Harris