IMF: How fragile states can improve their economic outlook

Already facing huge development needs, the COVID-19 pandemic is exacerbating the challenges facing fragile and conflict states—a group of currently about 40 countries trapped in cycles of low administrative capacity, political instability, conflict, and weak economic performance. Our new IMF staff working paper, which analyzes the experiences of 196 countries between 1979 and 2018, shines a light on how countries can avoid or break out of this trap.

As our chart of the week shows, weaker growth raises the probability of falling into fragility, particularly for countries in the middle-range of government effectiveness (measured by, e.g., the ability to collect taxes and enforce contracts). The top chart measures the change in the probability of entry into/exit from fragility when growth declines by 2 percentage points at various levels of government effectiveness. Weaker growth raises the probability of entering into fragility, with substantially larger impact for countries falling within the middle-range of government effectiveness (blue line), while there is a less pronounced effect on the exit probability (red-dotted line). One implication is that near-fragile countries need to implement counter-cyclical policies—such as a fiscal stimulus—to prevent sharp contractions in economic output. Counter-cyclical policies could be supported by external financing from international partners, but also needed are sound macroeconomic policies, supported by strong governance and anti-corruption measures that ensure proper use of resources to help maintain a stable economy.

To help kickstart an exit strategy, countries need to improve institutions and enhance political and social inclusion (e.g., fewer barriers to political participation, expanded access to legal systems, less corruption and discrimination in government agencies, protection of social spending). Indeed, as our chart also shows, improving government effectiveness raises the probability of exiting fragility.

The bottom chart measures the change in the probability of entry into/exit from fragility at different growth rates when government effectiveness improves moderately from a low level. Interestingly, its impact is more uniform (i.e., less bell-shaped) than the top one (red-dotted line), signifying less responsiveness to changes in growth. Improved government effectiveness would help prevent countries from falling back into fragility at a wide range of growth rates (blue line).

Our study also finds that countries that successfully exit from fragility spend more on health and education than those countries that do not escape. These observations may imply a possible virtuous cycle to escape from fragility. Protecting social spending helps enhance political and social inclusion. This, in turn, puts pressure on the government to enhance its effectiveness through a steady build-up of fiscal, legal, and civil service capacities. Effective institutions, in turn, provide a foundation for a strong economy. For example, in Uganda, improved political stability was the basis for passing reforms to strengthen economic institutions and policies, which have helped to build resilience and increase social inclusion (but some of the progress has been reversed after 2017).

Finally, countries can escape from fragility by seizing a pivotal moment—a critical juncture that presents a rare opportunity for change (e.g., after a crisis or a change of leadership). We found that countries with a pivotal moment are more likely to exit from fragility, implement critical reforms to strengthen their institutions and policy framework, and enjoy more economic resilience after their exit. For example, after Rwanda regained political stability in the early 2000s, reform efforts (backed by support from the international community) have helped improve resilience, governance and institutions, as well as social inclusion.

Where governments do not function well, peace, stability, and prosperity are rare. With an increased focus on some key actions and measures, countries can pull themselves out of the fragility trap.