Chapter

Comment

Editor(s):
Saíd El-Naggar
Published Date:
September 1987
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In his paper, Mr. Shaalan reviews the adjustment problems facing Arab countries. A typical, timely, and appropriate Fund prescription is advocated to counter the adjustment problems of these countries. Furthermore, he examines the connection between growth and adjustment and outlines recent efforts by the international community to facilitate the adjustment process.

Before offering my comment on the main ideas presented in the paper, I would like to point out three main limitations related to the scope, classification, and methodology. First, the author’s definition of Arab countries is restricted to only 15 countries, while 6 others, which mainly comprise the countries of the Maghreb, are not taken into consideration. The explanation offered for this approach is that these countries are not included in the grouping of the International Monetary Fund’s Middle Eastern Department. This is difficult to accept as a satisfactory explanation, given the title of his paper.

Second, in reviewing the adjustment problems, the paper divides Arab countries into two groups: oil and non-oil exporting countries. But in view of the stark differences within each subgroup, a better and more meaningful classification for purposes of the paper could have been deficit versus surplus countries. For instance, the Arab oil exporting countries include countries with low capital-absorbing capacity, with excess savings and balance of payments surplus, and countries with shortage in savings and high capital-absorbing capacity. Hence, their adjustment requirements are clearly different and cannot be included in the same group.

Third, the paper lacks pertinent data and empirical illustrations which could have lent much-needed support to the author’s views and further substantiated his arguments. Instead, the paper’s analysis consists of generalities based on the author’s personal convictions.

Mr. Shaalan’s paper is really about two main issues: the adjustment challenge facing the Arab countries, and what the International Monetary Fund can do to facilitate the adjustment processes through the provision of technical and financial assistance. This is because the orderly adjustment in individual countries and throughout the world is the Fund’s main function. Hence, it is essential to look into the relevance of the Fund’s prescription and strategies that the Arab countries could adopt in order to make the necessary economic adjustment.

We find it technically appropriate to start our comment by defining adjustment as essentially of two types. The first is cyclical adjustment which is of a short-term nature in which a country may find it necessary to minimize fluctuations in, for example, exports and prices, where wide fluctuations cause undesirable instability in incomes and misallocation of resources. The other is structural adjustment, in which, for example, a variable exchange rate or interest rate diverge from an equilibrium path as a result of movements in more fundamental causes. Policy measures may be taken for one or both types of adjustments simultaneously.

All Arab oil exporting countries throughout the 1970s and early 1980s suffered from structural difficulties and highly expansionary investment policies. Whatever excess demand was generated spilled over into imports that were financed from oil exports. In addition, some of the Arab oil exporting countries resorted to borrowings from the international financial markets. Moreover, consumption was strictly controlled in countries such as Algeria and Iraq. Consequently, none of these countries resorted to the Fund.

In contrast, Arab non-oil exporting countries had structural problems in addition to encountering an unfavorable international economic environment. This resulted in large and chronic balance of payments deficits and aggregate demand-related problems. To compound the difficulties of this group of countries, the servicing of external debts that were accumulated over the years for the purpose of financing imbalances in those economies required transfers of a large amount of real resources to the creditor countries, at the expense of their economic development. Despite these difficulties, only a few of these countries resorted to the Fund for financial assistance of a conditional type. Conditionality, and what it entails was precisely the reason why Fund financial assistance was avoided. Such conditionality is normally expressed in a financial program which a country must accept prior to the use of Fund assistance. The program contains objectives, targets, and a number of instruments. Its primary objective is the adjustment in the deficit of the balance of payments and, to a lesser extent, the maintenance of a specific rate of growth and price stability. This is irrespective of any other objectives and priorities of the borrowing government. For example, income distribution, which figures prominently among the objectives of most governments, is neglected in most Fund-supported programs. No consideration is given to income distribution between different income groups, especially between the urban and the rural sectors.

A typical Fund program is of a short-term duration in which a loan is drawn in a series of installments each of which is made available subject to a country satisfying a number of “performance criteria” agreed upon before the loan is granted. These performance criteria relate to specific macroeconomic targets, all of which are specified in a quantitative form. The program may contain conditions related to domestic credit control, fiscal controls to give effect to monetary restrictions, exchange rate depreciation to correct relative international prices, limitations on short-term and medium-term debt that a country may contract, price decontrols, liberalization of restrictions on trade and payments, and abolition of multiple exchange rates.

Relatively recent innovations are the extended Fund facility and Trust Fund through which the Fund provides medium-term finances for structural adjustment requirements. These facilities have been introduced as a result of the Fund’s realization that problems requiring adjustment in developing countries are mainly due to structural factors. Although the Fund, by introducing these facilities, has taken a step in the right direction, more is still to be desired.

Economic and political considerations require financial assistance of a longer term than provided by the Fund and a more gradual approach for adjustment. The shock treatment practiced by the Fund involving heavy deflation and massive devaluation of the exchange rate is economically far-reaching and politically destabilizing. The Fund’s programs drastically reduce consumption in general and that of the lower-income groups in particular. This is especially so in the case of rural and urban low-income groups. This situation has resulted in disruptive political unrest.

A serious problem of a long-term nature arises when the Fund prescribes a reduction in government expenditure. Because of the difficulty in cutting down current expenditure, the government resorts to the reduction of investment expenditure. Consequently, the Fund adjustment program most often results in retardation of economic growth that would be difficult to reverse.

Mr. Shaalan states that heavy indebtedness is the fate of “those countries that fail to take timely or adequate adjustment measures.” It is clear that taking adequate adjustment measures is difficult, if not politically impossible, especially if the domestic economic situation has deteriorated considerably. Alternatively, he advocates a timely action before a situation deteriorates appreciably. One can think of three difficulties in this regard. First, policymakers need time to assess developments before taking action in order to avoid overreaction to events whose general trend may not have taken shape. Second, with the general inadequacy of an economic statistical base in most Arab countries, it is difficult to discern an economic problem in time to justify taking the required economic measure. Third, policy measures taken, even if they are timely, may have to be reinforced by other measures in due course. Because in a real situation exogenous internal and external factors may result in more deterioration than initially predicted. The sum of all measures taken may add up to a massive deflation and a larger devaluation of the exchange rate than can be tolerated politically.

International policy coordination among industrial countries is important in order to facilitate the adjustment process in the Arab and other developing countries. Because, in the absence of that, developing countries are forced to take stringent policy measures that call for substantial sacrifices, limiting growth and adversely affecting the world economy. At present, coordination and cooperation between the main international economic groups are at a low level. Consequently, each of the developing countries has to depend on its own limited means.

Mr. Shaalan quotes the Baker Plan in detail to emphasize the steps being taken to ease the adjustment process, especially of the indebted countries. The Baker Plan and the other plans that were suggested subsequently purport to quantify the international debt problem and prescribe a role for governments of indebted countries, multinational institutions, and international commercial banks. Because the Baker Plan did not have strong leverage, it was essentially an expression of good intentions. Practically, it did not contribute much to the alleviation of the international debt and adjustment problem.

Multilateral organizations to which Mr. Shaalan attributes an important role in the adjustment process suffer from an essential handicap. They are circumscribed by the fact that they have a weaker leverage in convincing the industrial countries to adopt the appropriate policy measures than is the case with the developing countries. As a result, the onus of adjustment falls on the developing countries.

In summary, we think the Fund’s efforts contributed to the improvement of the international economic environment. However, to make its financial assistance acceptable to most Arab countries going through adjustment processes, it has to develop its conditionality to take into consideration political sensitivities of governments and the need for gradual implementation of policies.

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