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Editor(s):
Paul Streeten
Published Date:
September 1988
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The author has discussed the international economic environment and its bearing on Asian countries in the first section of the paper. The slow growth of industrial countries, the escalation of inflation, the two oil price hikes, increased protectionism, and high interest rates are among the adverse international developments that affected the developing countries of Asia in the 1970s. Despite this international economic environment, many Asian countries have been able to achieve impressive growth rates. The countries of East Asia and the Pacific achieved higher growth rates.

Although the author’s categorization into East Asia and the Pacific, and South Asia and China, brings out interesting contrasts in performances, the categorization focuses on the results achieved rather than the differences in policies pursued by the countries. Further, as in any broad categorization, within each group of countries there are widely different economies. In the East Asia group there are both oil exporters (Indonesia and Malaysia) and oil importers. Therefore, the oil price hikes had opposite impacts on these countries. In the South Asia and China group, India and China pursued different economic systems and hence their being lumped together is not very useful analytically. Perhaps China is best considered separately. Again, India is so large that it may not be comparable to its small neighbors, especially Nepal and Sri Lanka. While Sri Lanka may be placed with South Asia until 1977, since then its liberalization policies have been more akin to those of the East Asia group.

Any broad categorization of countries leads to difficulties. Yet the point I wish to make is that the structure of the economies and the differences in policies pursued were the factors responsible for the results achieved. The author’s categorization is largely based on geographic and ex post results and highlights these, rather than the policy differences.

The higher investment rates of East Asian countries are no doubt an important reason for their growth. The issue that should be discussed is why their savings rates are higher. Is it because the initial economic conditions were better? Is it because of policies that encouraged savings? Is the higher savings volume related to investable opportunities—in other words, were savings investment-led and goal-directed? Is the pattern of income distribution an important factor? Are there cultural reasons? These are factors that should be discussed more fully if we are to understand the differences in economic performance among these countries. In the same context, the higher savings rate in India compared with its neighbors merits discussion.

The analysis of the investment-savings gap uses the data of a single year (1984). This could be somewhat misleading, since unexpected or abnormal price developments could change the ratio. It would have been more reliable if the average for a number of years had been used. The higher savings ratio in the South Asian region in 1984 may not reflect average conditions.

The high growth rates of exports of East Asian countries merit further discussion, since they are not only results of the policies pursued but are also an important factor responsible for the economic performance of these countries. The fact is that these countries pursued a policy of export-led growth in the face of adverse international developments. Further, the policy response of East Asian countries to the harsh international environment was one of liberalization, in contrast to the inward-looking policies pursued by South Asian countries. The export-led growth was possible in the former group of countries, owing to their trade-liberalization policies and structural adjustments of their economies.

In Section II, the author summarizes the overall experience of external financing for the two groups of countries. The external financing needs and sources of financing are, however, specific to the countries of Asia. The choice of policies and the policy mix in each country have an important bearing on external financing. Since foreign-funded adjustment programs are in fact complex packages and are geared to particular circumstances, it is difficult to aggregate the experiences of countries meaningfully. Only case studies of countries could elicit more useful insights on the resources for the types and quantum of external financing.

In Section III, the author is basically critical of adjustment policies. He has summarized the problems with and limitations of adjustment policies: their deflationary bias; preoccupation with short-term stabilization rather than long-term growth; lack of appreciation of rigidities in developing countries’ economies, which do not make it realistic to attain the expected objectives with the adjustment programs; and the lack of appreciation of internal social realities and political constraints. Further, he points out that the burden of adjustment falls unfairly on the developing countries, and that for adjustment to be meaningful deficit and surplus countries must have mutual obligations.

The international experience so far provides evidence that adjustment policies have the potential and capacity to attain economic growth and, ultimately, economic development. Yet the burden of such adjustment tends to fall on the poorer groups in a society and consequently creates difficulties in pursuing these policies to their logical conclusion. Apart from this, long-run attainment of objectives is no answer to the deprivations and difficulties that sections of a community have to face in the short run. Further, these deprivations may affect the quality of life and affect the quality of human capital in the future. As the author points out, while this position is generally agreed, in fact the formulation of adjustment policies in most cases has not given adequate attention to this aspect. In fairness it may also be pointed out that the lack of concern with maintaining human capital investments may not necessarily be an imposition of the Fund but may be considered a condition by countries making their adjustment programs. It is not very clear whether in negotiations between the Fund and developing countries there is an insistence on curtailment of social expenditure or whether countries implementing adjustment policies interpret the Fund’s stance as requiring such curtailment. This is an area which merits discussion at this seminar.

In this connection, it may also be argued that if the financial discipline that is a condition of Fund programs is adhered to, then this would, itself, release adequate resources for human investment. For instance, in many countries the wastage in government expenditure and losses incurred by public corporations would release more than adequate funds for needed social expenditure. In any event, if adequate investments are not made in human capital, long-run economic growth surely cannot be a reality. It is, therefore, very essential that adjustment programs be neither undertaken at the expense of such expenditure nor conceived of as requiring the curtailment of essential investment that would permit long-run economic growth and development.

In analyzing the effects of externally supported adjustment programs on the level or rate of growth of output, it is important first to consider the circumstances in which such programs were introduced. Typically, the need for a stabilization program, whether supported by the Fund or any other agency, arises when the country experiences an imbalance between aggregate domestic demand (absorption) and aggregate supply which is reflected in a worsening of its external payments position. Many countries in Asia experienced such situations and resorted to foreign financing with a view to undertaking structural adjustment programs. As pointed out in the paper, it is true that in many cases external factors, such as the deterioration in the terms of trade and rising foreign interest rates, have been responsible for the basic demand-supply imbalances. Yet often, this imbalance can also be traced to inappropriate domestic policies that expand aggregate domestic demand too rapidly in relation to production in the economy, thereby leading to distortions in relative prices. If foreign financing is available, the expansion in domestic demand can be extended over a period, albeit at the cost of a widening current account deficit.

Many types of imbalances can give rise to the need to implement adjustment programs, but by far the most common is the emergence of an adverse balance of payments position. Disruptive inflationary pressures are also a reason for adopting an adjustment program. In many Asian countries, the Philippines in particular, the two problems were encountered simultaneously, resulting in a loss of creditworthiness that triggered the need for implementation of an adjustment program.

In Sri Lanka, for example, the fourfold rise in energy prices during 1973/74, the weak performance of the industrial countries and hence the lower demand for exports, and the second oil price hike during 1979/80 were the factors that resulted in a persistent adverse balance of payments position. The international output, weaker demand-management policies, restrictions on trade and payments, and the dual exchange rate policies pursued prior to 1977 contributed to the loss of competitiveness and added to balance of payments difficulties.

The criticism that external financing programs are in some sense inimical to growth can be decomposed into two specific areas. First, a number of policy recommendations contained in externally financed programs, in particular the Fund programs, relate to the restraint on aggregate domestic demand and to alterations in the exchange rate. These are thought to interfere with economic growth and the level of activity. Second, policy recommendations are unduly harsh, leading to a greater worsening of the performance of the economy than is, in fact, necessary to secure the objectives of the stabilization effort. Therefore, the basic issues that arise with respect to adjustment of finances would be the following:

  • (1) What are the short-run effects of externally funded adjustment programs on the level or rate of growth on output in the countries concerned?

  • (2) Are these effects larger than they need to be to achieve the principal objectives of the programs and, in particular, are they significantly larger than the effects that would result from an alternative set of policies?

  • (3) What are the effects of externally funded adjustment programs on the long-run rate of growth of the economy, and how do these relate to the short-run effects?

Perhaps the discussion could deal with some of these issues.

The availability of empirical evidence is limited on each of these issues. Although there are some studies, done both by the Fund and outside agencies, the comparison of the programs and the policies would have to be based explicitly on the disequilibrium that the country faced at the time the stabilization program was introduced. Similarly, the alternative set of policies against which to compare a given externally funded program would have to be precisely defined. This is important because this alternative could presumably differ in the mix of policies consistent with the same objectives (more emphasis on demand management or on structural policies) or in terms of policy instruments (controls and imports versus devaluation).

Little empirical evidence exists on the long-run effects of the externally funded programs, and most of these studies do not analyze the effects of stabilization policy on economic development. While many countries in Asia have achieved both price stability and high growth by adopting prudent financial policies, others managed to combine a high rate of inflation with strong rates of growth for extended periods of time. At the same time, many countries have experienced high inflation and low rates of growth.

The external position of Sri Lanka deteriorated over the decade prior to 1977 owing largely to the worsening of the terms of trade and the stagnation of the export-oriented agricultural sector. Rapid expansion in monetary aggregates and rising inflationary pressures moved domestic real costs out of line with levels in international markets. Similar economic conditions have been experienced by many Asian countries.

Illustrative of an adjustment program in South Asia was the fundamental shift in Sri Lanka’s overall development strategy in November 1977. The basic objective of the policy package was to lay a foundation for rapid and balanced economic growth. The initial adjustment package, therefore, included the dismantling of direct and indirect controls on prices, imports, and external payments; retrenchment of government operations in processing and distribution of basic commodities; provision of adequate incentives to producers; unification of the exchange rate at a depreciated level; and the introduction of a flexible exchange rate policy.

The adjustment of current account deficits to sustainable levels sometimes ignores the adverse international effects. Thus, while adjustment is supposed to take account of the circumstances of the (developing) countries, it does not give adequate weight to the transmission of balance of payments problems, owing to the policies followed by industrial countries. For instance, the influence of persistent budget deficits in drawing reserves away from Europe and reducing the demand for developing countries’ exports has not been given adequate weight. In fact, deficits in developing countries are the counterparts of surpluses in developed countries. There is, therefore, a need to stress the need for more responsible international fiscal/financial discipline when adjustment measures are recommended.

Concerning the role of the Fund in adjustment, it is necessary to stress the revolving character of the Fund’s reserves, the temporary nature of its financial support based on quotas, and the linking of that support to policies designed to correct payments problems over the short-to-medium term. However, countries facing balance of payments difficulties have adopted measures that have been insufficiently vigorous and comprehensive, leading to larger adjustment periods and more extended use of Fund credit. The report of the Group of Twenty-Four concluded that the Fund had not been successful in developing countries and that program periods had been too short, the amount of financing inadequate, and insufficient consideration had been given to the effects of adjustment measures on growth, income distribution, and short-term inflation. Too much attention is given, in Fund programs, to demand restraint and too little attention to structural policies needed to address the underlying payments disequilibria in developing countries.

This paper has been successful in raising a large number of issues that require detailed discussion. Owing to the differences in resource endowments, initial conditions, and policies pursued, it is difficult to be conclusive about the impact that adjustment policies and external financing have had on the economic development of Asian countries. Adjustment policies could, if pursued logically with the required financial discipline, lead to economic growth. Yet for-mulators of such policies should be mindful of political realities and social goals, which are themselves extremely important for the long-run development of Asian countries. Further, the burden of adjustment should be borne by both developed and developing countries, and international institutions should endeavor to assist developing countries both in coping with their short-run problems and in achieving long-run economic and social development.

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