Supplementary Note 1: Systemic Reform Issues in Eastern Europe and the Union of Soviet Socialist Republics1
While macroeconomic stabilization is necessary for economic transformation, systemic changes to improve efficiency and flexibility can, in turn, facilitate stabilization efforts. Previous experiences with structural reforms—for example in the Western part of Germany in 1948 and more recently in New Zealand and in many developing countries—underscore this point, which is also relevant for the countries in Eastern Europe and the U.S.S.R. that are undergoing systemic change on a much larger scale. These countries differ fundamentally from most other countries that have undertaken structural reform in that they lack significant private ownership, entrepreneurial experience, and the institutions needed for a market-oriented economic system. The following discussion identifies some of the key issues currently faced by these economies, and it highlights recent reform initiatives and debates.
The process of reform in the countries in Eastern Europe and the U.S.S.R. will need to involve the explicit introduction of the basic framework required for the functioning of a market system. The establishment of a market environment requires concrete actions by the state to replace the previous system by a new and clearly defined economic order based on market principles. Simply abandoning the old central-planning system is by itself not sufficient, as illustrated by the recent coordination failures discussed in Chapter I, particularly in the U.S.S.R. Key elements of the market system that need to be fostered in a deliberate manner include competition, price liberalization, and property rights.
Competition is central to the efficient functioning of a market economy. Increased competition will generally require the entry of new firms, as discussed below, and the breakup of existing state monopolies, even if state ownership is preserved. Where companies are privatized, strong antitrust rules can help prevent private monopolies from replacing former state-owned monopolies, which is now an important issue in the German Democratic Republic. Recent experience, notably in Poland, also indicates that substantial improvements in resource allocation may not be realized without the establishment of a competitive market structure, notwithstanding the vigorous pursuit of other aspects of reform, including price reforms.
Price liberalization is necessary for competition to flourish. Without price reforms, eliminating monopolies will not, in general, improve resource allocation as prices will not be allowed to play their central role as signals of relative scarcity in a market system. Moreover, without price and factor cost liberalization, some firms that could be viable in a competitive environment may not be profitable in a system of state-administered prices. This points to the importance of a comprehensive approach to reform, in which price liberalization and competitive market structures are introduced simultaneously.
A well-functioning market-oriented system also requires well-defined and legally recognized properly rights. In this respect, the recent legalization, in principle, of private ownership in all countries of Eastern Europe and the U.S.S.R. is an important step in the reform process. The legislation of private ownership provides a necessary basis for market entry by new firms as well as for privatizing existing state-owned companies. In addition, clearly defined property rights—in this case those of the State—are required in the socialized sector to provide the framework under which management is made responsible for the performance of the enterprise.
Market entry, which has been facilitated by the recent reforms of property rights, is central to the establishment of a competitive environment. In the German Democratic Republic, Hungary, Poland, and Yugoslavia, where restrictions on private economic activity have been reduced, new entrepreneurs have provided an important stimulus to the economy. As the experience in these countries indicates, entry by domestic as well as foreign firms may have the most significant short-run impact on economic activity and employment in areas that were not well developed under the previous system of central planning—in particular, in the service, distribution, and construction sectors. While the recent legalization of private property provides the basis for entry by new participants, it may not be sufficient for entry to occur and cannot be viewed in isolation from developments in the socialized sector. As long as this sector operates under preferential conditions, and can thereby preserve a dominant market position, market entry for new firms will remain unattractive and potential efficiency gains from economic reform are unlikely to be realized.
A major challenge for all countries in the region is to create a competitive environment for the socialized sector, the current mainstay of these economies. As a first step, it is important that preferential credits, subsidies, and tax concessions are eliminated for enterprises in the socialized sector, that is, that they become subject to a binding (‘“hard”) budget constraint under the same conditions as other market participants. This requires the establishment of independent financial institutions that are also subject to profitability criteria, so that the access of enterprises to capital will be at market-determined rates of interest. Moreover, if an enterprise is not financially viable, it must be permitted to go bankrupt. As viability depends importantly on both prices and factor costs, reforms in these areas, as noted above, have to accompany the introduction of a hard budget constraint.
It is an open question whether the imposition of a hard budget constraint on public enterprises can be maintained when a large part of the economy remains under state ownership. Past experience in this area is not encouraging. Moreover, while hard budget constraints may be a necessary condition, they are not a sufficient condition for competitive market behavior even after state monopolies are split up. What is also needed is efficient management to maximize the value of the assets of the enterprise. In light of the close association and overlap between managers in large companies and the nomenclatura, it may be difficult to design and enforce efficient performance-based contracts for managers to ensure that incompetent managers are replaced in a timely manner. This suggests that comprehensive and fairly rapid privatization may be necessary for the successful implementation of a market-oriented system. So far, progress in this area has been slow, aside from a few privatizations in Hungary and Poland and some planned privatizations in Poland and in Czechoslovakia during the remainder of 1990. An exception is the German Democratic Republic, where it appears that privatization will proceed rapidly under the direction of the Trust Fund (Treuhandanstalt).2
For the privatization of state-owned companies, equity as well as efficiency considerations suggest a strategy that would spread the risks and potential rewards of privatization over a large portion of the population. This could be achieved, for example, by the sale or distribution of shares in many companies, or a pool of companies, to the citizens. By contrast, making shares available exclusively to the workers of state-owned companies would be inequitable and would concentrate the risk for each shareholder; it could also result in underinvestment and wage inflation, as suggested by the experience in Yugoslavia.3 To avoid these difficulties, a trust fund could be established—which has been done recently, as noted above, in the German Democratic Republic—or possibly several competing trust or mutual funds, and shares could be offered to the public. Another possibility, being considered in Czechoslovakia, is to issue to each citizen vouchers that could be used to acquire shares of the competing trust funds or shares in companies. In Romania, as part of the reform legislation adopted by the Parliament in late July, a voucher system is being introduced in which a National Privatization Agency will hold 30 percent of the assessed value of most state-owned companies and allocate one share to each citizen.
In July 1990, the Polish Parliament adopted a bill that provides for workers to acquire up to 20 percent of shares (or shares equivalent to one year’s wages, whichever is less) at a discount, and also makes credit available for these purchases. In addition, the Government has the authority to distribute to each citizen a privatization coupon that can be exchanged for shares in companies of their choice, and the law provides the legal framework under which mutual funds could be established. This reform bill, which is similar to those discussed in several other countries in Eastern Europe, also allows for foreign participation in the bidding for state-owned enterprises. Unless a government waiver is obtained, however, foreign ownership would be confined to a maximum of 10 percent of a company’s shares. If foreign partners can be attracted under these conditions, the associated inflow of private capital, as well as foreign technological and managerial know-how, could play an important role in restructuring the economies of Eastern Europe and the U.S.S.R.
Privatization in the housing sector could be implemented rapidly once the necessary legal framework has been established. In the U.S.S.R., several cities have initiated steps to distribute ownership in public housing units to tenants free of charge. Although this approach could result in rapid large-scale privatizations, the alternative of using some form of open auction for part of the housing stock would have the advantage of raising revenues and, if an auction were accompanied by a neutralization of the revenues, it would have the benefit of absorbing part of the monetary overhang where it exists. Regardless of the precise procedures adopted, a successful privatization of housing properties would also require a reduction, if not a complete phasing-out, of existing rent controls. This does not imply the elimination of all rent subsidies and, as in industrial countries, the State is likely to continue to provide selective subsidies to low-income groups, including the direct provision of housing.4
Systemic reforms of the external trade and payments regimes in the countries of Eastern Europe and the U.S.S.R. are needed for these countries to become integrated into the world economy and thereby to benefit fully from their comparative advantage. Some reforms have already been initiated, particularly with respect to trade with countries that are not members of the Council for Mutual Economic Assistance (CMEA). These include a reduced role for the state-owned foreign trade organizations and the introduction of currency convertibility for most current account transactions in Poland and Yugoslavia.5 In addition, Hungary has continued its trade reform program and further reduced quota restrictions and licensing requirements for imports in January 1990, and Poland has eliminated export subsidies for convertible currency trade, lowered export quotas substantially, and eliminated all import quotas.
The foreign exchange reserve position of several countries in Eastern Europe remains weak. A continuation, and possibly a further expansion, of efforts to liberalize trade could result in additional pressure on these reserves, and net inflows of foreign capital into the region are likely to be needed in support of the reforms. In this respect, private capital, in particular foreign direct investment, can play an important role; but the scale of these capital inflows will depend primarily on conditions in the reforming countries, especially the anticipated pace of reform and the degree of economic stability. In several countries, foreign direct investment could benefit from recent joint-venture legislation, which often also applies to 100 percent foreign-owned investment. To make these initiatives effective, it is necessary to assure the repatriation of profits and compensation in the event of nationalization or expropriation.
The reform of the trading system that is envisaged within the CMEA will present formidable challenges to the countries of Eastern Europe.6 The use of world prices for all external transactions would result in a substantial deterioration of these countries’ terms of trade vis-a-vis the U.S.S.R. The recent rise in oil prices means that this deterioration will be even more severe than previously projected since crude oil is a major export of the U.S.S.R. to the region. And while the raw material exports of the U.S.S.R. can be sold readily on the world market, the quality of many of the goods exported to the Soviet Union by CMEA countries, especially intermediate goods and machinery, is not up to world standards; hence these goods are likely to experience difficulties in finding a niche on world markets. Nonetheless, the recent success of Hungary, Poland, and Yugoslavia in penetrating Western markets suggests that the countries of Eastern Europe might be able to adjust their trade to world prices without experiencing severe balance of payments difficulties, at least if the trade-price reforms are phased in gradually over several years.
It has been suggested that the establishment of a regional payments arrangement modeled on the European Payments Union of the 1950s could facilitate the transition to a trade regime based on world market prices.7 The aim of such a payments system would be to promote the expansion of trade during the transition by enabling countries to consolidate bilateral trade imbalances into a single net balance and by linking the settlement of those balances to a multilateral system of credits and adjustment rules. A number of issues would have to be addressed, however, before a proposed payments union could be viable. First, in contrast with the situation in Western Europe in the early 1950s, the Eastern European countries are adopting a variety of exchange regimes and are taking different approaches in moving toward convertibility of their currencies; this diversity would make it difficult to agree on a single multilateral payments arrangement. Second, whereas there were clear gains to be expected from the stimulation of trade among Western European countries in the 1950s, an important objective of current reforms is to enhance trade with the established market economies. If a payments union were to provide preferential conditions for trade among the CMEA countries, as opposed to trade with the rest of the world, it could hinder the integration of these countries into the world economy based on their comparative advantage.
A third issue concerns the role of the U.S.S.R. If the U.S.S.R. were to be excluded from an Eastern European payments union, a major portion of the likely trade imbalances of the member countries would not be covered, and the usefulness of the arrangement would thereby be limited. On the other hand, if the U.S.S.R. were to be included, some means would have to be found to ensure that the arrangements did not contribute to a continuation of regional imbalances and that, in the interim, sufficient resources would be available for payments to clear. If other countries provided financing for the payments union’s credit arrangement, those funds would ultimately support payments to the member countries with trade surpluses; without a major change in the current pattern of trade, those payments would be made primarily to the U.S.S.R.8
In addition to the restructuring of CMEA trade, there have been several other reform proposals in the U.S.S.R. The process toward systemic change gained momentum in mid-1990 when the Parliament approved some reform measures and provided the Government with far-reaching powers for their implementation. These included a plan for the breakup of industrial monopolies into joint stock companies, improved conditions for the operation of small-scale businesses, income and enterprise tax reform, and the introduction of a commercial banking system.
There have also been more radical reform initiatives in a number of the Republics of the U.S.S.R. and at the local level. These alternative plans raise important coordination issues and the question of which level of government can exercise the ownership rights over state-owned property. The most significant reform plan is the one passed in the Russian Republic in mid-September 1990 that envisages the transition to a broadly market-oriented system within about 500 days. The new plan assigns an increased role to the regional governments at the expense of the central authority, and it entails a demonopolization and privatization of many state enterprises immediately after the adoption of the necessary legislation and a determination of the value of state assets. In contrast to the proposal by the Prime Minister of the U.S.S.R. discussed in Chapter I, price adjustments and price liberalization would follow only after a substantial proportion of state enterprises had been privatized, which could absorb part of the existing monetary overhang. And the plan abandons the earlier proposal to increase the prices of selected basic consumer goods, such as bread, and instead includes a price freeze for about 100-150 “essential” goods even after other prices are liberalized. If implemented, this could have the detrimental effect of perpetuating existing price distortions or even creating new ones. Aside from some absorption of the monetary overhang through privatization, inflation pressure would be reduced under the new plan through a rapid reduction in the government budget deficit, mostly reflecting subsidy cuts and reductions in public investment and security outlays.
By mid-September 1990. the Parliament of the U.S.S.R. had not agreed upon a precise reform package, nor was there a timetable for specific actions. Moreover, it remains to be seen how the central Government will exercise its broad mandate and how the competing plans for economic reform will be reconciled. There were, however, clear indications that the Parliament might adopt a reform plan similar to the one of the Russian Republic.
Supplementary Note 2
Sustainability of Fiscal Policy in the Major Industrial Countries
Introduction
In the first half of the 1980s, the net debt of the government sector increased much faster than GNP in all the major industrial countries except the United Kingdom (Table 19). The rapid accumulation of debt reflected, in part, a cyclical slowdown in revenue but it also resulted from the continued strong growth of government expenditure in Canada, France, Italy, and the United States. The improvement in fiscal positions that occurred in most countries during the second half of the 1980s resulted in either a stabilization of the public debt/GNP ratio (in Canada, the Federal Republic of Germany, France, and the United States) or a sizable reduction in this ratio (in Japan and the United Kingdom). Only in Italy did the debt ratio continue to rise significantly after 1986, although the rate of increase slowed substantially. While there is no generally accepted view regarding the level of public indebtedness appropriate for an economy, the medium- and long-term sustainability of fiscal policy is often assessed in terms of the evolution of the debt ratio. Specifically, in several countries with large fiscal deficits, interest has centered on whether a given fiscal policy would result in a stable debt ratio.
This note adopts the concept of “sustainability” used by Blanchard in his study of fiscal indicators.1 According to that concept, a fiscal plan is considered sustainable if, together with a plausible set of assumptions about key macroeconomic variables, it results in a terminal value of the debt/GNP ratio that is equal to the initial debt ratio. Thus, a sustainable fiscal plan could entail a rise or fall in the debt/GNP ratio initially, as long as subsequent changes in fiscal policy, interest rates, or economic growth were sufficient to fully reverse the initial change by the end of the planning period. This definition of sustainability does not directly involve the level at which the debt ratio stabilizes. However, the subsequent analysis shows that, other things being equal, the higher the initial level of the debt ratio, the less sustainable is a given fiscal plan. Similarly, the higher the interest rate paid on the debt, the higher is debt service and the less sustainable is the fiscal plan.
It should be emphasized that fiscal sustainability, as it is defined by Blanchard, implies nothing about optimality. The optimality of fiscal policy would have to be judged on the basis of a comprehensive analysis that would encompass economic, social, and political factors, including considerations of intergenerational equity. For example, there might be a need to increase national saving, which would justify a more stringent setting of fiscal policy goals than would be suggested by the debt sustainability criterion alone. Alternatively, if there were reasons to believe that the existing capital/output ratio was too low in a particular country, there might be a case for reducing the public debt/GNP ratios, at least for a period of time.2 Third, an important objective in setting fiscal policy over the longer term might be to smooth the intertemporal or intergenerational tax burden associated with a need to raise expenditures at a later stage, for example, in response to prospective demographic shifts. In this case, a more restrictive fiscal policy might need to be instituted earlier than would appear to be warranted on the basis of medium-term considerations of sustainabiiity.
Major Industrial Countries: Net Public Debt of the General Government, 1980–891
(In percent of GNP/GDP)
The concept of general government is used for purposes of international comparability; definitions of central government and the public sector vary widely across countries. Net debt is defined as gross liabilities less gross financial assets. Net debt is used to ensure comparability between the debt stock and the cumulation of fiscal balances over time. A major share of gross financial assets at the general government level in most countries is accounted for by the assets of the social security system. Since these assets are sizable in many countries there may be substantial differences between the levels of gross and net debt in individual countries; for example, in Japan gross debt of the general government was roughly equivalent to 71 percent of GNP in 1989, while the corresponding level of net debt was about 16 percent of GNP. Moreover, the concept of general government does not include public enterprises, whose financial positions can have an important impact on the financial balance of the public sector in some countries, for example, in Japan.
Estimates.
Financial assets exclude corporate shares.
On the basis of 1987 GNP/GDP weights and exchange rates.
Major Industrial Countries: Net Public Debt of the General Government, 1980–891
(In percent of GNP/GDP)
| 1980 | 1981 | 1982 | 1983 | 1984 | 1985 | 1986 | 1987 | 1988 | 19892 | |
|---|---|---|---|---|---|---|---|---|---|---|
| Canada | 12.9 | 10.0 | 16.5 | 22.5 | 26.1 | 32.8 | 37.2 | 37.6 | 37.1 | 37.5 |
| United States | 19.0 | 18.7 | 21.7 | 24.3 | 25.2 | 27.2 | 29.4 | 30.8 | 30.6 | 30.2 |
| Japan3 | 17.3 | 20.7 | 23.2 | 26.2 | 26.9 | 26.6 | 26.4 | 21.9 | 19.3 | 16.4 |
| France3 | 14.3 | 14.2 | 17.8 | 20.0 | 21.1 | 22.9 | 25.2 | 25.5 | 25.2 | 24.7 |
| Germany, Fed. Rep. of3 | 14.3 | 17.4 | 19.8 | 21.3 | 21.5 | 21.9 | 21.5 | 22 9 | 23.7 | 22.1 |
| Italy | 53.6 | 57.8 | 63.4 | 68.7 | 74.4 | 81.3 | 86.2 | 90.1 | 92.3 | 95.0 |
| United Kingdom | 43.5 | 42.8 | 42.1 | 42.4 | 43.5 | 42.3 | 41.0 | 38.4 | 33.7 | 28.9 |
| Average (seven Countries)4 | 21.5 | 22.6 | 25.5 | 28.2 | 29 5 | 31.1 | 32.6 | 32.4 | 31.7 | 30.6 |
The concept of general government is used for purposes of international comparability; definitions of central government and the public sector vary widely across countries. Net debt is defined as gross liabilities less gross financial assets. Net debt is used to ensure comparability between the debt stock and the cumulation of fiscal balances over time. A major share of gross financial assets at the general government level in most countries is accounted for by the assets of the social security system. Since these assets are sizable in many countries there may be substantial differences between the levels of gross and net debt in individual countries; for example, in Japan gross debt of the general government was roughly equivalent to 71 percent of GNP in 1989, while the corresponding level of net debt was about 16 percent of GNP. Moreover, the concept of general government does not include public enterprises, whose financial positions can have an important impact on the financial balance of the public sector in some countries, for example, in Japan.
Estimates.
Financial assets exclude corporate shares.
On the basis of 1987 GNP/GDP weights and exchange rates.
Major Industrial Countries: Net Public Debt of the General Government, 1980–891
(In percent of GNP/GDP)
| 1980 | 1981 | 1982 | 1983 | 1984 | 1985 | 1986 | 1987 | 1988 | 19892 | |
|---|---|---|---|---|---|---|---|---|---|---|
| Canada | 12.9 | 10.0 | 16.5 | 22.5 | 26.1 | 32.8 | 37.2 | 37.6 | 37.1 | 37.5 |
| United States | 19.0 | 18.7 | 21.7 | 24.3 | 25.2 | 27.2 | 29.4 | 30.8 | 30.6 | 30.2 |
| Japan3 | 17.3 | 20.7 | 23.2 | 26.2 | 26.9 | 26.6 | 26.4 | 21.9 | 19.3 | 16.4 |
| France3 | 14.3 | 14.2 | 17.8 | 20.0 | 21.1 | 22.9 | 25.2 | 25.5 | 25.2 | 24.7 |
| Germany, Fed. Rep. of3 | 14.3 | 17.4 | 19.8 | 21.3 | 21.5 | 21.9 | 21.5 | 22 9 | 23.7 | 22.1 |
| Italy | 53.6 | 57.8 | 63.4 | 68.7 | 74.4 | 81.3 | 86.2 | 90.1 | 92.3 | 95.0 |
| United Kingdom | 43.5 | 42.8 | 42.1 | 42.4 | 43.5 | 42.3 | 41.0 | 38.4 | 33.7 | 28.9 |
| Average (seven Countries)4 | 21.5 | 22.6 | 25.5 | 28.2 | 29 5 | 31.1 | 32.6 | 32.4 | 31.7 | 30.6 |
The concept of general government is used for purposes of international comparability; definitions of central government and the public sector vary widely across countries. Net debt is defined as gross liabilities less gross financial assets. Net debt is used to ensure comparability between the debt stock and the cumulation of fiscal balances over time. A major share of gross financial assets at the general government level in most countries is accounted for by the assets of the social security system. Since these assets are sizable in many countries there may be substantial differences between the levels of gross and net debt in individual countries; for example, in Japan gross debt of the general government was roughly equivalent to 71 percent of GNP in 1989, while the corresponding level of net debt was about 16 percent of GNP. Moreover, the concept of general government does not include public enterprises, whose financial positions can have an important impact on the financial balance of the public sector in some countries, for example, in Japan.
Estimates.
Financial assets exclude corporate shares.
On the basis of 1987 GNP/GDP weights and exchange rates.
It should also be stressed that sustainability is essentially a medium- and long-term concept. Thus, it does not take account of short-term considerations, such as the cyclical position of the economy. Therefore, even if a given fiscal plan would result in a sizable decline in the debt/GNP ratio over the medium term, it might be inappropriate to loosen fiscal policy in the short run if the economy’s resources are already fully employed. Finally, fiscal sustainability is defined in different ways in other studies. For example, an alternative definition considers fiscal policy sustainable if it stabilizes the debt/GNP ratio over some reasonably short time horizon, even though that ratio might be higher than the initial level. There could also be instances where the fiscal situation is unsustainable even though the debt/GNP ratio is broadly constant, for example, because the high level of debt gives rise to excessively high interest payments.
Concept of the Budget Gap
The question of whether present and planned levels of public spending and taxation can be maintained without a buildup of debt relative to national income—given the expected rate of economic growth and the level of interest rates—-was recently formalized by Blanchard in a “forward-looking” indicator of fiscal policy sustainability.3 This approach begins with the definition of the change in the level of net public debt as the overall fiscal deficit (if negative) or surplus (if positive), which, in turn, equals the primary deficit (or surplus) plus net interest charges on the existing public debt. When all variables except the interest rate and the growth rate are expressed as ratios to GNP, this relationship can be written algebraically as:4
or,
where: b = net public debt
g = government spending on goods and services plus net transfers
t = tax revenues
d = the primary deficit (a negative number indicates a surplus)
db = the change in the debt/GNP ratio
r = the rate of interest
y = the rate of growth of GNP
Equation (2) shows that if the interest rate on debt is greater than the rate of growth of output (r > y), as has typically been the case in the 1980s in contrast with previous decades, the government must run a primary surplus sufficient to offset the effect on the debt ratio of the excess of the interest rate over the growth rate; otherwise, the debt ratio would grow without limit. Defining fiscal sustainability over a given time horizon as achievement of a terminal debt/GNP ratio equal to the initial debt/ GNP ratio highlights the fact that the debt cannot be serviced indefinitely by issuing new debt. Of course, if the interest rate is lower than the rate of growth of output (r < y), the public debt ratio would continue to fall without limit unless the government were to run a primary deficit sufficient to offset the effects of the excess of the rate of economic growth over the interest rate.5
The approach specified above permits an assessment of both the sustainability of a given fiscal plan and the extent to which it departs from the sustainable path—in other words, the extent to which fiscal policy would need to be altered in order to achieve sustainability. Given an initial debt-to-GNP ratio and projections for r and y and for government revenues and expenditures, the sustainability of a fiscal plan can be gauged by comparing the projected primary budget balance with the budgetary position, which, if it were maintained throughout the planning period, would prevent the public debt from growing more rapidly than national income. The difference (if positive) between the projected budget deficit and the sustainable budget deficit—the “budget gap”—provides an indication of the need to tighten fiscal policy in order to stabilize the debt ratio.6 Of course, this change could be achieved in various ways: by raising taxes, by reducing spending, or through some mix of revenue and spending measures.
The formula for the budget gap defined over a single time period can be derived directly from equation (2). Let
Thus, for the special case of a single year, the budgetary gap is simply equal to the change in the debt-to-GNP ratio projected over the year on the basis of the planned fiscal policy.
Estimates of Budget Gaps
Medium-Term Baseline
The extent to which fiscal policies in the major industrial countries can be said to be sustainable in terms of the budget gap approach is summarized in Table 20. The budget gaps are calculated for both the medium term (g6) for the period 1990—951 and the long term (g30) for the period 1996–2025).7 These estimates of budget gaps are based on the net debt of the general government (see note 1 of Table 19). The concept of general government is used because data on this basis are readily available for all seven major industrial countries. It should be noted, however, that the use of this concept for the purpose of international comparisons has certain limitations. In the case of Japan, for example, the assessment of the overall fiscal position in terms of the general government could be misleading because of the importance of the public enterprises in the area of public investment, as these enterprises are not included as part of the general government. In addition, the use of the concept of net debt complicates the interpretation of medium-term fiscal indicators in countries like Japan, where the net public debt reflects the large surplus in the social security fund, which represents future government liabilities. This difficulty is reflected in the sharp contrast between the medium-term and the long-term fiscal indicators for Japan, which is discussed below.
The six-year budgetary gaps (Table 20, column 1), calculated on the basis of the staffs medium-term baseline projections, suggest that fiscal policy over this horizon is broadly sustainable in all countries except Italy.8,9 The magnitude of the permanent budgetary measures that appear to be required to achieve sustainability through 1995 in Italy is on the order of 3¼ percent of GNP. This result highlights the difficulty of stabilizing the debt ratio when interest rates and the initial level of the debt ratio are high.10 By contrast, the projections for Japan suggest that, in the period through 1995, taxes could be lowered or expenditures raised by the equivalent of nearly 4 percent of GNP while keeping the debt ratio unchanged from 1989 to 1995. In the other major countries, sustainability would be consistent with increases in the primary deficits ranging from about ¼ to ¾ of 1 percentage point of GNP.
Major Industrial Countries: Medium- and Long-Term Indicators of Fiscal Sustainability1
(Annual averages, in percent of GNP/GDP)
The medium-term indicators are based on Fund staff projections through 1995 of general government revenues and expenditures, nominal GNP and interest rates, and on OECD staff estimates of general government net debt outstanding at the end of 1989. The long-term estimates in column (6) are based on the projected debt ratios in 1995, average market yields on 30-year bonds during the first half of 1990, extrapolations of medium-term trends from 1996 through 2025, and simulations of the macroeconomic consequences of expected demographic shifts, which are described in World Economic Outlook, May 1990, Supplementary Note 3 (“Population Aging: An Attempt to Quantify the Long-Term Macroeconomic Effects”). Specifically, the 30-year budget gaps shown are those associated with the “no tax rate change” scenario in Table 26 of Supplementary Note 3.
Column (2) reflects the impact on the calculated budget gaps (g6) of lowering the rate of growth of output (y) by 1 percentage point in each year during 1990–95, without taking into account any indirect effects through government revenue or through any decline in interest rates that could result from lower growth. Column (3) includes the direct impact plus the indirect impact via lower budgetary revenues based on individual country estimates of the elasticity of general government non-interest receipts with respect to GNP.
Column (4) reflects the impact on the calculated gap (g6) of raising the interest rate by 1 percentage point in each year during 1990–95, without taking into account any indirect effects through the budget or the rate of growth of GNP that would result from a lower interest rate. Column (5) includes the direct impact plus the indirect effects through both the budget and the rate of growth of GNP on the basis of a simulation performed with MULTIMOD. In the simulation, monetary policy was t6ightened in all countries to the degree necessary to achieve a 1 percent rise in interest rates during 1990–95.
Major Industrial Countries: Medium- and Long-Term Indicators of Fiscal Sustainability1
(Annual averages, in percent of GNP/GDP)
| Six-year Budgetary Gaps (g6)(1990–95) | ||||||
|---|---|---|---|---|---|---|
| Change in the Budgetary Gap Resulting From: (deviations from baseline budget gap) |
30-Year Budgetary Gaps (g30) (1996–2025) |
|||||
| One Percentage Point Lower Growth2 | One Percentage Point Higher Interest Rate3 | |||||
| Calculated on the Basis of Fund Staff Medium-Term Baseline Projections (1) |
Direct Impact Only |
Direct Plus Indirect Revenue Impact |
Direct Impact Only |
Full Impact | (reflecting the macroeconomic effects of prospective demographic shifts) |
|
| (1) | (2) | (3) | (4) | (5) | (6) | |
| Canada | 0.4 | 0.4 | 0.8 | 0.4 | 0.8 | -1.5 |
| United States | -0.3 | 0.3 | 0.7 | 0.3 | 0.7 | -0.7 |
| Japan | -3.9 | 0.2 | 0.4 | 0.2 | 0.3 | 4.5 |
| France | -0.7 | 0.2 | 0.8 | 0.2 | 0.4 | 1.5 |
| Germany, Fed. Rep. of | -0.7 | 0.2 | 0.6 | 0.2 | 0.4 | 4.3 |
| Italy | 3.3 | 1.0 | 1.2 | 1.0 | 1.6 | 4.0 |
| United Kingdom | -0.1 | 0.3 | 0.8 | 0.3 | 0.3 | 1.3 |
The medium-term indicators are based on Fund staff projections through 1995 of general government revenues and expenditures, nominal GNP and interest rates, and on OECD staff estimates of general government net debt outstanding at the end of 1989. The long-term estimates in column (6) are based on the projected debt ratios in 1995, average market yields on 30-year bonds during the first half of 1990, extrapolations of medium-term trends from 1996 through 2025, and simulations of the macroeconomic consequences of expected demographic shifts, which are described in World Economic Outlook, May 1990, Supplementary Note 3 (“Population Aging: An Attempt to Quantify the Long-Term Macroeconomic Effects”). Specifically, the 30-year budget gaps shown are those associated with the “no tax rate change” scenario in Table 26 of Supplementary Note 3.
Column (2) reflects the impact on the calculated budget gaps (g6) of lowering the rate of growth of output (y) by 1 percentage point in each year during 1990–95, without taking into account any indirect effects through government revenue or through any decline in interest rates that could result from lower growth. Column (3) includes the direct impact plus the indirect impact via lower budgetary revenues based on individual country estimates of the elasticity of general government non-interest receipts with respect to GNP.
Column (4) reflects the impact on the calculated gap (g6) of raising the interest rate by 1 percentage point in each year during 1990–95, without taking into account any indirect effects through the budget or the rate of growth of GNP that would result from a lower interest rate. Column (5) includes the direct impact plus the indirect effects through both the budget and the rate of growth of GNP on the basis of a simulation performed with MULTIMOD. In the simulation, monetary policy was t6ightened in all countries to the degree necessary to achieve a 1 percent rise in interest rates during 1990–95.
Major Industrial Countries: Medium- and Long-Term Indicators of Fiscal Sustainability1
(Annual averages, in percent of GNP/GDP)
| Six-year Budgetary Gaps (g6)(1990–95) | ||||||
|---|---|---|---|---|---|---|
| Change in the Budgetary Gap Resulting From: (deviations from baseline budget gap) |
30-Year Budgetary Gaps (g30) (1996–2025) |
|||||
| One Percentage Point Lower Growth2 | One Percentage Point Higher Interest Rate3 | |||||
| Calculated on the Basis of Fund Staff Medium-Term Baseline Projections (1) |
Direct Impact Only |
Direct Plus Indirect Revenue Impact |
Direct Impact Only |
Full Impact | (reflecting the macroeconomic effects of prospective demographic shifts) |
|
| (1) | (2) | (3) | (4) | (5) | (6) | |
| Canada | 0.4 | 0.4 | 0.8 | 0.4 | 0.8 | -1.5 |
| United States | -0.3 | 0.3 | 0.7 | 0.3 | 0.7 | -0.7 |
| Japan | -3.9 | 0.2 | 0.4 | 0.2 | 0.3 | 4.5 |
| France | -0.7 | 0.2 | 0.8 | 0.2 | 0.4 | 1.5 |
| Germany, Fed. Rep. of | -0.7 | 0.2 | 0.6 | 0.2 | 0.4 | 4.3 |
| Italy | 3.3 | 1.0 | 1.2 | 1.0 | 1.6 | 4.0 |
| United Kingdom | -0.1 | 0.3 | 0.8 | 0.3 | 0.3 | 1.3 |
The medium-term indicators are based on Fund staff projections through 1995 of general government revenues and expenditures, nominal GNP and interest rates, and on OECD staff estimates of general government net debt outstanding at the end of 1989. The long-term estimates in column (6) are based on the projected debt ratios in 1995, average market yields on 30-year bonds during the first half of 1990, extrapolations of medium-term trends from 1996 through 2025, and simulations of the macroeconomic consequences of expected demographic shifts, which are described in World Economic Outlook, May 1990, Supplementary Note 3 (“Population Aging: An Attempt to Quantify the Long-Term Macroeconomic Effects”). Specifically, the 30-year budget gaps shown are those associated with the “no tax rate change” scenario in Table 26 of Supplementary Note 3.
Column (2) reflects the impact on the calculated budget gaps (g6) of lowering the rate of growth of output (y) by 1 percentage point in each year during 1990–95, without taking into account any indirect effects through government revenue or through any decline in interest rates that could result from lower growth. Column (3) includes the direct impact plus the indirect impact via lower budgetary revenues based on individual country estimates of the elasticity of general government non-interest receipts with respect to GNP.
Column (4) reflects the impact on the calculated gap (g6) of raising the interest rate by 1 percentage point in each year during 1990–95, without taking into account any indirect effects through the budget or the rate of growth of GNP that would result from a lower interest rate. Column (5) includes the direct impact plus the indirect effects through both the budget and the rate of growth of GNP on the basis of a simulation performed with MULTIMOD. In the simulation, monetary policy was t6ightened in all countries to the degree necessary to achieve a 1 percent rise in interest rates during 1990–95.
Sensitivity Analysis
The forward-looking nature of the fiscal sustainability indicator is a distinct advantage compared with more conventional measures of the budgetary position. At the same time, it is clear that this indicator is only as good as the underlying projections. In order to assess the sensitivity of the estimated budget gaps to changes in the underlying economic assumptions, several experiments were conducted.11 The results are illustrative and should not be generalized into all-purpose “rules of thumb.” Indeed, the exercise highlights the limitations of partial equilibrium analysis and the importance of understanding the factors giving rise to changes in the underlying projections. For example, the impact on the sustainability indicator of lower-than-expecled economic growth depends on whether only the direct effects on the debt/GNP ratio are considered, or whether the indirect effects, for example, through lower tax receipts, are also taken into account. The results also underscore the importance of the level of the initial debt/GNP ratio in determining fiscal sustainability. Moreover, the impact on the budget gap depends crucially on the reasons for the slowdown in growth.
The first two experiments seek to gauge the impact on the budget gap of a 1 percentage point downward revision in the staff’s medium-term baseline projections for GNP growth in each year during 1990–95 (Table 20, columns 2 and 3). As is apparent from equation (3), the direct adverse impact on the budget gap of a decline in the rate of growth of GNP, all other things equal, will be proportional to the size of the outstanding debt.12 The direct effect of a 1 percentage point reduction in GNP growth during 1990–95 is to raise budgetary gaps in most of the major countries by around ¼ of 1 percentage point of GNP (Table 20, column 2). In Canada, where the debt/GNP ratio is relatively large, the impact is close to ½ of 1 percentage point of GNP; and in Italy, where the debt ratio is much larger, the budget gap rises by a full percentage point of GNP.
A lower rate of GNP growth also would affect the budget gap indirectly through its impact on the government’s primary balance. Since the elasticity of tax revenue with respect to GNP is typically greater than the elasticity of public expenditure with respect to GNP, a reduction in GNP growth can be expected to raise the government’s primary deficit (or lower its surplus), thereby contributing to a further widening of the budget gap. Taking this effect into account roughly doubles the estimated impact of lower GNP growth on the medium-term budgetary gaps in most of the major countries (Table 20, column 3). The smaller impact in Italy reflects a substantially lower estimated tax elasticity for that country.13 It is noteworthy that in Canada, the United Kingdom, and the United States, fiscal plans that were deemed to be sustainable on the basis of the baseline projections are now unsustainable. Similarly, in France and Germany, lower growth eliminates the clear sustainability of fiscal plans.
The results presented in columns (2) and (3) of Table 20 do not incorporate the effect of lower economic growth on interest rates, which would depend upon the underlying reason for lower growth. For example, if, under conditions of full employment, the growth of potential output were lower than anticipated but the projected expansion of nominal demand were to be maintained, pressure on resources would result in a rise in prices and, assuming unchanged monetary policy, a rise in interest rates. The rise in interest rates would raise debt-service costs and widen the budget gap, reinforcing the adverse impact of lower growth through the other two channels. If, however, potential output were to expand as expected but the growth in nominal demand were lower than projected, interest rates would fall, lowering debt service and reducing the budget gap. The net effect on the budget gap arising from the different channels (a reduction through the interest rate effect, and a rise through the lower growth of GNP and budgetary revenues) would depend on their relative strength.
A second set of experiments is aimed at calculating the effects on the budget gap of a 1 percentage point rise in the interest rate relative to the baseline projection, assumed to be brought about by a reduction in the growth of money supply (Table 20, columns 4 and 5). In this experiment, there is first a direct, positive link: a rise in the interest rate raises debt service and the budget gap in proportion to the size of the debt/ GNP ratio. The magnitude of this effect (Table 20, column 4) is the same as that of the direct effect of lower economic growth. Second, there is an indirect effect to the extent that the higher interest rate reduces GNP in the short run. This effect would tend to disappear over the long run as lower inflation would be accompanied by lower interest rates, stimulating demand and raising GNP. However, over the six-year period considered here, the higher interest rate leads to higher budgetary gaps in all countries. The results presented in Table 20, column (5) were derived from a simulation performed with MULTIMOD.14 The estimated increase in the budgetary gaps ranges from about ¼ to ¾ of 1 percentage point of GNP in most of the major countries; again, the sustainability of fiscal policies in Canada and the United States, and to a lesser extent in the United Kingdom, is reversed, while the rise in unsustainability in Italy is much larger, about 1½ percent of GNP.
Long-Term Budget Gaps
The assessment of fiscal sustainability beyond the medium term is subject to considerable uncertainty, as long-term rates of interest and economic growth—as well as the long-term evolution of government revenues and expenditures—cannot be projected with any degree of precision. However, it may be useful to consider the macroeconomic and budgetary effects that might result from prospective shifts in demographic structure—in particular, the relatively rapid aging of the populations of most industrial countries—that are expected to occur over the next 30–50 years. Column (6) in Table 20 presents the estimated budgetary gaps calculated on the basis of the long-term demographic simulations presented in the May 1990 World Economic Outlook.15 The results highlight the substantial budgetary pressures that most countries are likely to encounter early in the next century owing to both higher expenditures (on medical services and pensions) and lower potential output growth (attributable to slower labor force growth). In particular, the unsustainability of Italy’s fiscal position appears unlikely to be reversed over the longer term, and an unsustainable budgetary situation appears likely to develop in Japan and Germany and, to a considerably lesser extent, in France and the United Kingdom.16 The more sustainable fiscal positions in North America partly reflect the fact that substantial increases in dependency ratios in Canada and the United States are projected to occur only after 2025, much later than in Europe and Japan; through the first decade of the next century, the dependency ratios for Canada and the United States are even projected to decline.17
Summary
In conclusion, fiscal sustainability, as defined in this note, does not appear to be a significant problem over the medium term for the major industrial countries, with the notable exception of Italy. However, this conclusion is quite sensitive to the underlying projections of interest rates and output growth. A 1 percentage point reduction in the rate of output growth or a 1 percentage point increase in interest rates over the medium term would substantially worsen the fiscal sustainability problem in Italy and would make unsustainable fiscal policies in Canada, the United Kingdom, and the United States. Similar changes in growth or interest rates would raise questions about the sustainability of fiscal plans in France and in the Federal Republic of Germany.
Moreover, sustainability over the medium term is a poor indicator of longer-term sustainability. Indeed, it would appear that expected demographic shifts after the turn of the century are likely to intensify fiscal pressures in Italy and give rise to such pressures in Japan and Germany, and to a lesser extent in France and the United Kingdom. The shift in the budget gap between the medium and long term is particularly striking in the case of Japan. By contrast, in North America fiscal positions would appear to be sustainable through the first quarter of the next century. It should be emphasized, however, that this does not imply that current fiscal plans in North America are in any sense “optimal,” as discussed in the introduction to this note.
Supplementary Note 3
Uruguay Round: The Present State of the Negotiations
General Issues
The Uruguay Round of GATT negotiations, launched at Punta del Este in September 1986, is far more ambitious and complex than the seven previous rounds of multilateral trade negotiations. It aims to devise trading rules and disciplines that will not only adapt the GATT to the future, but also bring into the system areas of trade that in the past have largely escaped the multilateral framework.1 These include, most notably, agriculture and textiles and clothing, as well as areas that are entirely new, such as services, trade-related investment measures (TRIMs), and trade-related aspects of intellectual property rights (TRIPs). Success in these areas requires not only reductions in border measures but also major changes in national policies affecting trade.
In July 1990, the Round’s Trade Negotiating Committee (TNC) met at the official level in Geneva to take stock of what remained to be done in order to conclude the Round on time in early December 1990.2 According to the schedule initially set in July 1989, and subsequently reconfirmed, the TNC was to have before it basic negotiating texts from each of the 15 negotiating groups to allow it to consider a clear profile of the final outcome of the Round. The TNC was then expected to provide a political push toward the resolution of some of the difficulties that had emerged.
In the event, although a Chairman’s draft was produced on schedule for each of the groups, many of these texts represented individual national positions. As a result, most delegations expressed their disappointment at the degree to which the negotiations had fallen behind and at the apparent lack of political will to resolve the basic difficulties, and they called for substantive bargaining to begin without delay. This situation led the Chairman of the TNC to identify two requirements for the work to proceed as needed: first, governments should provide new and more flexible instructions to their negotiators in the key areas of the Round; and, second, linkages across subjects should be used positively to push the process forward, rather than negatively as hitherto, which had resulted in gridlock in many areas. The Chairman proposed a tight work program to allow the Uruguay Round to be completed on schedule at the ministerial meeting during the first week of December, but it was clear that this would be a formidable task.
At this stage, there are major differences on how to proceed in agriculture and in textiles and clothing. This is not surprising since, in these sectors, the introduction of multilateral disciplines to liberalize trade confronts deeply embedded structural problems and opposition from protected domestic producers. These difficulties are also evident in steel, machine tools, electronics, and automobiles, where protectionist trade policies take the form of measures that are not covered by GATT disciplines, such as voluntary export restraints (VERs). Solutions to these problems need to be compatible with the development of guidelines for trade in the new areas and with efforts to integrate developing countries more fully into the multilateral trading system. The latter also involves political questions related to developing countries” views of their developmental needs and concerns about sovereignty.
The developing countries are participating more actively in the Uruguay Round than in previous negotiations. In the past, they had little direct impact on the outcome of the negotiations and largely benefited under the GATT’s “most favored nation” (MFN) provision from trade liberalization negotiated among industrial countries without making concessions in return. This time, with export-oriented growth strategies having paid off for some and many others adopting them, developing countries increasingly recognize that integration into a more liberal and strengthened trading system is essential to the success of their policies.3 This recognition is also related to integration moves—in the trade area, or along broader economic lines—among industrial countries.
The principal interest of the developing countries lies in improved market access generally, and particularly in agriculture, textiles and clothing, and tropical products, as well as a reduction in tariff escalation.4 In addition, these countries stress that their specific concerns should be a key factor in determining the degree of initial liberalization and the extent of subsequent commitments. In return, industrial countries seek genuine commitments from developing countries in the new areas, increased tariff bindings, reductions in nontariff barriers, and greater discipline in the use of trade restrictions for balance of payments reasons.
The complexity of the Round was already evident when the mid-term review, initiated at the ministerial meeting in Montreal in December 1988, could be concluded only four months later in Geneva. In Montreal, participants reached agreement on: (i) the establishment of a trade policy review mechanism; (ii) administrative streamlining of the GATT’s dispute-settlement procedures; (iii) implementation of some tariff reductions for tropical products; and (iv) procedures for the continuation of the negotiations in most areas, including services. But the basic disagreement on agriculture forced a “stopping of the clock.” In addition, fundamental differences of view remained on textiles and clothing, safeguards, and TRIPs. The problems in the three traditional areas underscore the difficulty of dealing with entrenched interests that have resulted from years of protection; and those relating to TRIPs reflect the sovereignty concerns of developing countries, as well as the way linkages have been used in the Round, with a number of countries no doubt tying agreement on TRIPs to advances in agriculture.
The timetable established after the mid-term review envisaged that countries would put their positions on the table by the end of December 1989 (Phase 1), that negotiating texts would be provided by the end of July 1990 (Phase 2), and that final compromises would be worked out and legal form given to agreed texts in the remaining period up to the completion of the Round in December 1990. In the event, the work did not advance as planned. In Phase 1, participants presented and discussed country positions, but issues that were basic to the difficulties encountered in the mid-term review continued to hamper progress. Moreover, slippages occurred in some areas, most notably tariffs, where the negotiating process began seven months later than had been envisaged, essentially because of difficulties in agreeing on the procedures for exchanging concessions. This delay spilled over into the negotiations on tariff-related areas and nontariff measures. Progress was made on clarifying issues elsewhere, such as in TRIPs and services. But it was only in Phase 2 that potential trouble spots took on clearer definition, resulting in apparent backward movement in a number of areas, notably services. With the negotiations behind schedule, the time available for reaching difficult compromises has been reduced to the 15 working weeks remaining between the TNC meeting and the Round’s conclusion in December.
Status of Individual Groups
Market Access Areas
Agriculture is the key to a successful conclusion of the Round by December. Without success in this sector, the very raison d’être of the Round for a number of efficient agricultural producers would be compromised, with consequences for other parts of the negotiations, particularly the new areas. The major problem is how to deal with export subsidies. Viewing them as the most distorting of all trade measures, the Cairns Group5 and the United States, with wide support, seek commitment to their elimination according to an agreed time schedule. Rather than addressing export subsidies as a separate issue, the European Community (EC) would prefer to rely on reductions in internal support to narrow the disparity between domestic and world prices and discourage production, thereby reducing the amount of export subsidies.
The Chairman’s draft agreement on agricultural reform, endorsed by the Houston Economic Summit as a means for intensifying the negotiations, suggests three elements: (i) progressive reduction of internal support, based on an agreed method to quantify the effects of price supports and production-related direct payments; (ii) tariffication of existing border measures, which would then be bound and gradually reduced; and (iii) phased reduction of export subsidies at a faster rate than that of internal support. Participants are to list all support and border measures by October 1, 1990, with offers for reduction to be submitted by October 15. There is agreement in principle on tariffication, but difficulties may still arise because the EC wishes to maintain part of its variable levy system to protect against exchange rate changes and large fluctuations in world prices.
More than half of the trade in textiles and clothing is regulated through the Multifiber Arrangement (MFA), under which bilateral import quotas are set, mainly on imports from developing countries.6 The main difficulties in the negotiations on textiles and clothing lie in agreeing on a method for integrating this sector into the GATT. Most parties, including the European Community, favor phasing out the MFA over a yet-to-be-agreed period, while the United States favors conversion of MFA restrictions to a global quota system to operate during the transition period. Opposition to the U.S. proposal rests on the view that, first, the global quota system could be more restrictive than the current MFA and, second, it would put restrictions on producers currently not adversely affected by the MFA (for example, the EC and some of the least developed countries). There is also scope for restriction in the EC proposal, which would allow the use of bilaterally agreed import restrictions until the end of the transitional period. Although there is a consensus on the need to integrate textiles and clothing into the GATT, the insistence of large importers on lengthy transition periods—at least ten years—and unspecified transitional safeguard mechanisms, even though monitored by a surveillance body, gives rise to doubts about the potential for significant liberalization. The recent TNC made clear that, unless progress is made in this sector, the developing countries are unlikely to make significant concessions elsewhere.
In the other market access areas, the outlines of a final package also remain to be clarified. The commitment (at the mid-term review) to an average one-third cut in tariffs is proving hard to achieve, in part because previous Rounds have left some participants, mainly industrial countries, with tariffs concentrated in sensitive sectors. So far, the weighted average of offers is about 15 percent, with some countries silent on agriculture, and several developing countries have not yet made any offers.
On tropical products and natural resource-based products, tariff escalation is the main issue. For tropical products, the exclusion of agriculture from some participants’ offer lists also causes difficulties, as does the fact that developing countries enjoying regional preferences (for example, under the Lome Convention) are seeking compensation from other producers for any eventual narrowing of their margin of preference. In natural resource-based products, matters are complicated by the EC’s insistence on including access to fishing rights; this is opposed by most other participants as having been covered elsewhere (Law of the Sea). On nontariff measures, several participants have tabled requests, but responses have been slow and are dependent on a clear view of agreements on tariffs. All this may be helped by the fact that the four traditional market access groups (that is, tariffs, tropical products, natural resource-based products, and nontariff measures) will hold some joint meetings from now on. However, some issues are closely linked to discussions in other groups, for example, agriculture and safeguards (for nontariff barriers), where basic decisions have yet to be made. Countries have until October 15, 1990, to present their offers, after which line-by-line negotiations, a technically demanding and time-consuming process, will proceed.
Rule-Making Areas
Improved market access goes hand in hand with strengthened trade rules to ensure predictability of market access with agreed conditions for temporary limitations. The negotiations have made some progress but difficulties remain in the areas of antidumping measures, subsidies, safeguards, the use of restrictions for balance of payments purposes, and dispute settlement.
The difficulties regarding antidumping measures are all the more important as the frequency of their use is on the rise.7 There are two problems regarding the current use of antidumping actions. First, countries against which actions are taken are concerned that the antidumping process is unpredictable and can result in harassment of their exporters and increase the cost of exporting. Second, there are the concerns of countries levying duties to prevent circumvention, including the location of assembly operations in importing countries or third countries. A proposed Chairman’s text would have greatly tightened the rules to guard against harassment, at the same time providing new rules against circumvention. Although this would appear to have met both concerns, the proposal found little support. As neither the EC nor the United States is likely to move on textiles and clothing unless their concerns about circumvention are allayed, the need to resolve these problems is urgent.
While there is general agreement regarding the classification of subsidies into three groups—those that would be prohibited outright, those against which countervailing actions would be appropriate, and those that would be freely allowable—there is little agreement on the composition of each category. Industrial export subsidies are prohibited under the GATT Subsidies Code; and the United States would also ban agricultural export subsidies and those that severely distort trade (for example, subsidies that encourage the use of domestic inputs). The EC maintains that domestic subsidies should generally be allowed, but if negative trade effects can be demonstrated, they should be subject to more stringent and better defined countervailing measures.8 The EC would include in the definition of industrial export subsidies any subsidy that relates to export performance; it argues, however, that agricultural export subsidies should be part of the negotiations on agriculture. Few developing countries have accepted the Subsidies Code, and most resist any outright prohibition, arguing that subsidies are an essential instrument in the development process. In this regard, other participants maintain that acceptance of obligations should be consistent with a country’s level of development (that is, they insist on progressive graduation).
On safeguards, the use of grey area measures—such as voluntary export restraints—against import surges is the most important concern.9 Predictably, the most critical issue remaining is whether safe-guard measures should be applied on a nondiscriminatory basis, or selectively. The EC argues that stricter GATT control without selectivity cannot be sustained and would lead to renewed outbreaks of grey area measures. Opponents, including the smaller industrial countries and the developing countries, are concerned about their vulnerability vis-a-vis major market countries and the potential use of selective safeguards to undercut successful shifts of resources toward exports by countries in the process of structural adjustment.
Under the GATT’s Articles, there are provisions for a contracting party to introduce import restrictions to deal with balance of payments problems.10 It is in this area that GATT collaboration with the Fund is closest, with the Fund playing an accepted and established statutory role in the GATT’s Balance of Payments Committee regarding the assessment of the balance of payments justification for the introduction or maintenance of import restrictions. At issue is whether these balance of payments provisions meet current circumstances, and this question has become the only broad-based North/ South issue of the Round. Industrial countries stress that the provisions should be rationalized and tightened, particularly to give preference to price-based measures and to shorten their period of application. Developing countries maintain that there is no need for change.
A sound multilateral trading system requires effective dispute settlement. Although the mid-term review put in place administrative procedures to speed the process, two problems remain: lengthy delays in adopting dispute panel findings, as adoption is by consensus allowing any one party to block the process; and lengthy lags in implementation. With regard to adoption, there is growing support for an appeals procedure with proposals ranging from a binding pronouncement by an expert appeals body to normal Council procedures, on a consensus basis, following the appeals procedure. With respect to implementation, suggestions have been made for strict time limits followed by withdrawal of trade concessions by the complainant. Many participants also seek a commitment to multilateralism, including the assurance that GATT members will refrain from imposing GATT-inconsistent trade measures unilaterally or bilaterally. At issue here is the operation of Section 301 of the U.S. Omnibus Trade Act, as well as the question of voluntary export restraint. The United States holds that strong, enforceable rules arrived at in the context of the Uruguay Round would obviate the need for unilateralism or bilateralism.
In other rule-making areas, draft negotiating texts have been agreed for licensing (to reduce discretion), customs valuation (to prevent “false” pricing), government procurement (to increase the participation of developing countries), and technical barriers to trade (to bring transparency to standards). In addition, there is provisional agreement on strengthening procedures on supplying information on duties and charges and on state trading enterprises; on placing time limits and stricter surveillance on the use of GATT waivers; and on phasing out the GATT’s “grandfather clause,” under which countries have maintained GATT-inconsistent measures that predate their GATT membership. However, final acceptance of the latter two agreements is conditional on achieving success in agricultural reform.
The New Areas
In the new areas of TRIPs and TRIMs, the shape of a possible agreement is emerging, although tough problems remain. In services, earlier relatively fast progress appears to be unwinding as basic problems emerge.
The essential problem concerning TRIPs is to balance protection for the holders of intellectual property rights with developing country concerns regarding the free flow of technology transfer. The Chairman’s text reflects two opposing approaches based on proposals by a number of industrial countries and by a group of 14 developing countries.11 While industrial countries share a common approach to TRIPs and would integrate it into the GATT, some important differences remain, which may be time-consuming to resolve.12 By contrast, the group of 14 developing countries calls for only incorporating directly trade-related aspects of intellectual property rights into the GATT (that is, trade in counterfeit and pirated goods), but would leave the standards issue to the World Intellectual Property Organization (WIPO). As this body has no real enforcement powers, this solution would meet the insistence by developing countries that standards be administered flexibly so as to fit countries’ policy objectives, including development and transfer of technology. This proposal, however, is not seen as representing the general view of developing countries; in particular, some large Asian trading nations appear to accept, with qualifications, the approach of the industrial countries.
On TRIMs, basic differences fall along country lines in much the same manner as in TRIPs. The United States would prohibit all TRIMs that by their nature restrict trade, but would allow a transition period, graduated by level of development, for their elimination. This position, with the qualification that some TRIMs could be handled under existing GATT disciplines, is supported by most other industrial countries. At the other end of the spectrum, another group of 14 developing countries13 rejects any prohibition of TRIMs, arguing that their development needs require almost total flexibility on investment policies. The Chairman’s text contains both proposals and suggests a compromise, which reflects extensive informal consultations. Based on existing GATT Articles on national treatment and quantitative restrictions, the text could lead to prohibition of a number of TRIMs (for example, local content rules and linkage of imports to export earnings). It also includes the option that other TRIMs (for example, minimum export requirements) would either be prohibited through new provisions, or compensated for under GATT rules to redress trade distortion.
Industrial countries and many middle-income developing countries have accepted the Chairman’s text as the basis for further negotiations, albeit with reservations. Many industrial countries consider the draft’s prohibition of TRIMs to be too narrow; by contrast, nearly all developing countries consider that it has gone too far and does not take their development concerns into account. However, many delegations believe that numerous brackets in the text can be eliminated fairly easily once there is progress elsewhere in the Round. Thus, the linkages with progress in agriculture, tropical products, and textiles and clothing—particularly if coupled with lengthy transition periods for phasing out existing TRIMs—are the key to bringing about broad acceptance of a limited prohibition approach.
Deliberations on services—after the initial success of a broad acceptance that the Round should include a services agreement—have raised fundamental problems that remain unresolved. There is still no agreement on the basic approach to the negotiation, the use of the principle of MFN, and the scope of coverage. It appears that an earlier EC-United States compromise on the basic approach is unraveling, partly because of attempts to introduce flexibility to reach agreement with some developing countries. A major problem concerns upfront liberalization: even a standstill would not be acceptable for some developing countries as they believe that their development concerns require flexibility to tighten the regulatory system as needed. By contrast, countries with very open systems would not simply accept a freeze. With regard to MFN treatment, there are two problems: the first involves the question of different national regulatory standards, which could perhaps be resolved by qualifications to the MFN principle as contained, for example, in health and other quality standards in the goods area; the second question is whether, under MFN treatment, those advantages inherent in bilateral economic treaties (relating, for example, to investment or landing rights) should be conveyed to all signatories. On coverage, most participants argue for the inclusion of all sectors on the basis that there could be extensive reservations, at least initially. However, the fact that major trading nations may reserve certain sectors is considered too large a breach of the concept of universality by others.
As these problems go to the core of any agreement, and with no resolution currently in sight, many participants believe the Round would do well if agreement in principle can be reached by the time ministers meet in December. In contrast to the standstill, and even rollback, of progress in the general services negotiations, advances appear to have been made in some sectors that initially were considered to be among the most difficult—namely, financial services and telecommunications. This reflects the success of intensive discussions at the expert level in defining the problems and indicating a range of solutions. Nevertheless, the question of how to fit these sectors into an overall services agreement remains, particularly since some major participants still prefer agreements, if any, to be free-standing, especially in the case of financial services.
The jurisdiction of the Fund is relevant in the area of services, most particularly in financial services. All participants accept that any eventual agreement would need to specify that nothing in its provisions should contradict or contravene the Fund’s Articles or their intent. In addition, participants are also discussing the Fund’s role in helping to assess the appropriateness of restrictions on service-related payments and transfers for balance of payments reasons under the GATT.
The GATT System
Finally, discussions regarding the functioning of the GATT system have revealed a wide divergence of views, and little further progress is likely without decisions at the political level. The main points concern the GATT’s contribution to better coherence in global economic policymaking, including the question of how to strengthen collaboration between the GATT and the Bretton Woods institutions, and what form, if any, increased ministerial participation should take.
With regard to the links between the GATT and the Fund and the World Bank, two approaches are under discussion. The first involves a bottom-up approach to allow cooperation to develop pragmatically in response to those issues that need to be addressed jointly. The second approach mandates formal institutional links from the top down, including formal meetings at different levels; exchange of personnel; and periodic joint reports on global economic issues falling within the mandates of the three institutions. In addition, the EC has proposed adopting at the end of the Uruguay Round a joint GATT/ Fund/Bank Ministerial Declaration on “Coherence between Trade, Monetary, and Financial Policies.”
On the question of ministerial involvement in guiding a strengthened GATT, little agreement exists, as many of the participants do not want to create another restricted group, which they fear would inevitably be dominated by the major countries. On all these issues, almost all participants feel that decisions need to be deferred until a clearer outline of the shape of the future GATT has emerged. This view is held particularly strongly by the developing countries, which see most proposals in this area as attempts to tighten multilateral disciplines on them.
On the institutional shape of the GATT, two participants have proposed an agreement in principle at the end of the Round to establish a new body—a World Trade Organization (WTO), proposed by Canada, or a Multilateral Trade Organization (MTO), proposed by the EC. This organization would bring under one administrative umbrella the existing multilateral trade agreements (GATT and the Tokyo Round Codes) and those expected to be developed in the context of the Uruguay Round (the new areas). Others believe that the proposed organization could go further. There is virtual consensus that detailed consideration of such an organization at the present time would divert attention from the large number of issues yet to be resolved. But there is broad acceptance—if not actual support—for some such organization if the Uruguay Round is a success. At the same time, many hold the strong view that moves toward any such organization should not be used to disguise a failure of the Round to achieve structural changes in the trading system and significant liberalization.
Concluding Remarks
The deep sense of concern that emerged from the recent TNC meeting is evidence that a failure to achieve a substantive outcome in the Uruguay Round is not acceptable to participants. The Chairman, in concluding the meeting, set out clearly what is at stake in terms of disruption to the growth of cross-border flows of goods, services, and investment. With the intensification of cross-border links during the past two decades, no participant in the Round is too large or small to walk away from it without suffering considerable costs to domestic employment and income; these costs obviously would be significantly higher if the Round were not to fulfill its goal of setting the guideposts for a liberal, multilateral trading system for the decades ahead.
Uruguay Round: Structure of the Negotiations
The negotiations are conducted by the Trade Negotiations Committee (TNC), with the subsidiary bodies, the Group of Negotiations on Goods (GNG), and the Group of Negotiations on Services (GNS). The GNG has 14 negotiating subgroups.
The Negotiating Groups and the Main Issues
A. Traditional Market Access Areas
| (a) Tariffs | One-third, trade-weighted reduction agreed at the midterm review. |
| (b) Nontariff measures14 | Significant reductions by all participants. |
| (c) Natural resource-based products | Substantially reduce tariff escalation. |
| (d) Tropical products | Eliminate duties on unprocessed products and deal with tariff escalation on semi-processed and processed products. |
| (a) Tariffs | One-third, trade-weighted reduction agreed at the midterm review. |
| (b) Nontariff measures14 | Significant reductions by all participants. |
| (c) Natural resource-based products | Substantially reduce tariff escalation. |
| (d) Tropical products | Eliminate duties on unprocessed products and deal with tariff escalation on semi-processed and processed products. |
B. Nontraditional Market Access Areas
| (e) Textiles and clothing | Integrate the sector into the GATT. |
| (f) Agriculture | Establish a market-oriented agricultural trading system through a substantial and progressive reduction in support and protection. |
| (e) Textiles and clothing | Integrate the sector into the GATT. |
| (f) Agriculture | Establish a market-oriented agricultural trading system through a substantial and progressive reduction in support and protection. |
C. Rule-Making Areas
| (g) GATT Articles | Activities of state-trading enterprises, waivers, the grandfather clause, negotiating rights in renegotiating tariff bindings, and the use of trade measures for balance of payments reasons. |
| (h) MTN agreements and arrangements | Clear and improved rules on the use of antidumping measures. |
| (i) Safeguards | Agreement on appropriate restraint in the use of temporary restrictions to guard domestic producers against import surges. |
| (j) Subsidies | Restrain the use of subsidies and produce clear rules on countervailing measures. |
| (k) Dispute settlement | Shorten delays on the adoption of findings and assure their implementation. |
| (g) GATT Articles | Activities of state-trading enterprises, waivers, the grandfather clause, negotiating rights in renegotiating tariff bindings, and the use of trade measures for balance of payments reasons. |
| (h) MTN agreements and arrangements | Clear and improved rules on the use of antidumping measures. |
| (i) Safeguards | Agreement on appropriate restraint in the use of temporary restrictions to guard domestic producers against import surges. |
| (j) Subsidies | Restrain the use of subsidies and produce clear rules on countervailing measures. |
| (k) Dispute settlement | Shorten delays on the adoption of findings and assure their implementation. |
D. The New Areas
| (l)Trade-related aspects of intellectual property rights (TRIPs), including trade in counterfeit goods | Develop rules to protect intellectual property rights so they do not themselves become barriers to trade. |
| (m)Trade-related investment measures (TRIMs) | Disciplines to avoid the adverse trade effects of investment measures. |
| (n)Services | Establish a multilateral and comprehensive framework for trade in services. |
| (l)Trade-related aspects of intellectual property rights (TRIPs), including trade in counterfeit goods | Develop rules to protect intellectual property rights so they do not themselves become barriers to trade. |
| (m)Trade-related investment measures (TRIMs) | Disciplines to avoid the adverse trade effects of investment measures. |
| (n)Services | Establish a multilateral and comprehensive framework for trade in services. |
E. The GATT System
| (o) Functioning of the GATT system | Enhance GATT surveillance, improve the GATT’s overall effectiveness, and increase its contribution to coherence in economic policymaking. |
| (o) Functioning of the GATT system | Enhance GATT surveillance, improve the GATT’s overall effectiveness, and increase its contribution to coherence in economic policymaking. |
Linkages in the Negotiations
The breadth of the negotiations gives rise to numerous linkages:
Political and tactical linkages relate substantial liberalization in agriculture, especially for developing countries, to agreement in the new areas; progress on agriculture, together with movement on textiles, may unblock developing country acceptance of greater discipline on the use of temporary import restrictions and concessions on tariff reductions and bindings.
Natural linkages relate results in agriculture to tariffs, tropical products, natural resource-based products, GATT Articles (for time limits on waivers and the phasing out of the grandfather clause), and subsidies. Advances in textiles are linked to negotiations on antidumping and countervailing rules; this in turn could determine the readiness of some major traders to agree to nonselectivity for safeguards. Improved rules, giving greater certainty to enhanced market access, will be important in achieving a commitment in dispute settlement to adherence to multilateralism. All these elements will outline the future role of the GATT and condition the decisions needed on the functioning of the GATT system.