- Mohsin Khan, Morris Goldstein, and Vittorio Corbo
- Published Date:
- September 1987
The last five years have been critical for a large number of developing countries in terms of both current economic conditions and prospects for future growth. During the 1960s and 1970s, when trade opportunities expanded and external financing was readily available, many developing countries achieved high rates of growth. In all too many instances, however, growth occurred despite major policy and structural weaknesses. In some countries, distorted domestic prices encouraged inefficient investment decisions; in others, large fiscal deficits led to persistently high inflation and balance of payments crises—and often saddled these economies with heavy foreign debt.
These weaknesses became evident in the early 1980s, with the advent of a series of adverse developments in the international economy, including slower growth in the industrial countries, falling prices for primary commodities, rising international interest rates, and sharp reductions in the availability of external financing to developing countries.
The combined effect of these two sets of factors—ineffective policies in developing countries plus negative international economic trends—has halted and, in some cases actually eroded, development. To survive, many developing countries have had no alternative but to design and implement major reforms to restore sustainable growth. Some have made substantial progress. Others have not. The nature, the benefits and the costs of these reform programs are the subject matter of this symposium.
The promotion of structural changes that support sustainable long-term growth is important not just to developing countries—it is indeed increasingly preoccupying policymakers in industrial countries as well. At present we in the development business are particularly concerned with problems and prospects in two groups of national economies whose need for restoring growth is most pressing: countries laboring under an especially heavy burden of external debt (mainly in Latin America), and countries whose recent development experience and future outlook are the least robust (mainly in sub-Saharan Africa).
While the underlying causes of the two groups’ difficulties have been somewhat different, and while each group is itself far from homogenous in terms of its members’ past developmental experience and current and future needs, their recent growth experience has been more or less the same. For the heavily indebted middle-income countries, average annual gross domestic product (GDP) growth dropped from a healthy 6.3 percent a year in 1965 to less than one half of 1 percent a year in 1980-86. For the lowest income countries, growth fell from 5.3 percent in 1965-80 to a negative annual average of minus 0.5 percent during 1980-86.
By facing reality and trying to adjust, some of these countries have managed to cut their current account deficits and to reestablish some of the conditions for sustainable medium-term growth. In many cases, however, investment and imports have been cut to levels where both current and future output have suffered. Not surprisingly, even after five years of adjustment and some important progress, rates of growth are still very modest. In many cases, per capita consumption remains below 1980 levels.
Meanwhile, bilateral donors and multilateral financial and development institutions, and the Bank and Fund in particular, have been heavily involved in helping these countries to plan and execute, essential reform programs. Naturally, country-specific circumstances must determine the details of individual programs, and these programs must be devised by the countries themselves. Nevertheless, over the past five years we had several success stories to evaluate and learn from, and the Bank, the Fund, and our member countries have together accumulated some collective experience about some of the critical components that are common to all successful adjustment strategies.
First, in countries in which inflation and balance of payment crises are major problems it is extremely difficult to achieve adjustment with growth. Nevertheless, the stabilization effort must be undertaken within the framework of an adjustment program that permits sustainable growth. In particular, if government expenditures need to be reduced, the cuts must be selective in order to protect investments that are growth enhancing and programs that benefit the most needy.
Second, to be successful, an adjustment program must achieve appropriate macroeconomic balance and simultaneously raise the level of output obtainable from existing resources. Production in many countries is often crippled by distorted factor and commodity prices, inefficient public sector enterprises, and incentives that are biased in favor of inward-looking uncompetitive industries that hinder the emergence of an export base. Reversing these existing adverse conditions is a sine qua non of any growth-oriented adjustment effort.
Third, to finance the higher investment required to achieve sustainable growth, it is necessary both to raise domestic savings and to obtain additional resources from abroad. Foreign direct investment has been a neglected element; it can play an important role. In middle-income countries, additional foreign borrowing on commercial terms, if utilized efficiently, can stimulate growth in output and ultimately enhance these countries’ capacity to service their foreign debt. The lowest income countries can’t do it without concessional financing.
It takes more than the most heroic adjustment efforts of the developing countries to guarantee the emergence of new potential for growth. Appropriate complementary actions on the part of industrial countries, commercial banks, and international development and financial institutions are also essential. For example, industrial countries must adopt macroeconomic policies geared to the creation of sustainable growth with low inflation and moderate interest rates. This growth is necessary to provide a market for the exports of developing countries and to sustain a more open trading system. For the developing world, trade and growth go hand in hand. In addition, commercial banks must increase their lending in support of adjustment programs in the highly indebted countries. The only alternative for developing countries is to try to finance their investment requirements solely from domestic savings and the relatively limited funds available from international development institutions. This would require further cuts in their living standards.
Countries in sub-Saharan Africa face acute problems of structural adjustment on top of many severe long-term development problems. These countries’ governments must address such fundamental issues as weak physical and human capital infrastructure, inadequate institutions, rapid rates of population growth, and depletion of natural resources. For the highly indebted countries, on the other hand, the primary long-term problem is to use their existing assets in ways which will restore creditworthiness. On the external financing side, sub-Saharan Africa is in special need of concessional assistance, while restoration of support from commercial sources is essential for the heavily indebted countries.
On the multilateral front, the establishment of the structural adjustment facility at the Fund and the successful agreement for the IDA 8 replenishment at the World Bank are encouraging developments. Beyond these, additional resources are needed to ensure that sufficient financing is available to sustain adjustment programs in countries that are making, or are willing to make, true appropriate reforms.
Clearly, strong and sustainable growth is the surest guarantee for improving life for the poorest people of our developing member countries—and comprehensive programs of adjustment are the best hope of strong and sustainable growth. Nevertheless, the international development community must recognize the painful reality that adjustment programs will result in some temporary unemployment, and in real and difficult short-term reductions in living standards—which sometimes affect the poorest segment of the population most harshly. We must therefore be ready to assist member countries in framing specific targeted programs designed to alleviate the short-term impact of adjustment programs on the poor.
Finally, it is essential that we keep in mind the fundamental point that adjustment programs, however essential, are no more than instruments in the process of fostering economic development. Thus we must make every effort to ensure that preoccupation with the means of adjustment does not overshadow our vision of the ends of long-term development objectives. In the final analysis, the very best that we can do is to be faithful stewards and facilitators in the progressive process of helping the peoples of the developing world realize their capacity for growth, in order to liberate them from the tyranny of poverty, hunger, and underdevelopment.
International Monetary Fund
It is a great pleasure to welcome you to this Joint IMF-World Bank Symposium on “Growth-Oriented Adjustment Programs.” I am delighted that we were able to attract such a distinguished and experienced group of participants, and I am looking forward to a stimulating exchange of ideas. I hope that all participants will feel free to speak candidly about existing or emerging policy problems and about possible solutions. Indeed, it was to assure the right atmosphere for such a frank dialogue that we decided against asking representatives from the financial press to join us.
I would put the key issue facing the symposium as follows: how can we help the developing countries to achieve balance of payments viability and a return to normal debtor-creditor relationships in a way that promotes sustainable economic growth, open and growing international trade, and international monetary cooperation? During the next days, we shall be discussing the “lessons” that seem to emerge from earlier adjustment strategies; the combination of macroeconomic and structural policies that offers the best prospect of combining adjustment with durable growth; and the roles that a healthy global environment and adequate external financing need to play in a growth-oriented adjustment strategy. I am here to benefit from your diagnoses and prescriptions. They are of critical importance for me at the beginning of my mandate in the Fund. I am here to learn from you. Nevertheless, perhaps I can at least get our discussion started by sharing a few thoughts with you on these issues.
My first point is that in analyzing the relationship between adjustment and growth, we should reject two—let us say—simplistic arguments. One is that there is an inherent conflict between adjustment and growth. The other is that growth follows automatically from adjustment. Allow me to elaborate.
Economies that suffer from rampant inflation, large budget deficits, pervasive trade restrictions, misaligned exchange rates, unrealistic interest rates, heavy external debt, and repeated bouts of capital flight just cannot and do not grow rapidly for any sustained period of time. Put in other words, you cannot maintain good growth performance by attempting to avoid adjustment. Equally, we should recognize that when adjustment is delayed to the point at which a country’s reserves and creditworthiness are depleted, it is likely to involve excessive cuts in investment, in imports, and in other productive expenditures. Such chaotic or “anarchic” adjustment can mortgage future growth.
I would propose an alternative hypothesis: the extent to which adjustment is conducive to growth depends in good measure on the quality of adjustment. Specifically, growth can best be combined with adjustment if adjustment takes the form of increases in export capacity, in savings, and in economic efficiency, and if high-quality investment projects are allowed to survive. Look at the experience of the past four years. The indebted developing countries have achieved an enormous improvement in their current account position—their combined deficit had fallen from roughly 18 percent of exports in 1982 to about 4 percent in 1984, before rising somewhat under the pressure of falling commodity prices to almost 5 percent last year. What is noteworthy is that the countries that were best able to protect growth during this difficult adjustment period were those that maintained strong export performance, that kept domestic savings and investment rates from falling sharply, and that shared the adjustment burden between increased aggregate supply and reduced aggregate demand.
The right kind of adjustment will not, of course, take place by chance. It requires that developing countries put in place a set of macroeconomic and structural policies that encourages exporting, saving, sound investment decisions, and cost-saving techniques, and that establishes an environment of overall financial stability. It also requires that creditors assist this effort by providing adequate financing, by maintaining an open and growing market for developing country exports, and by fostering an appropriate structure of exchange rates and interest rates. The important thing is that we have the capacity collectively to manage the adjustment process in a way that gives growth the consideration it deserves. But the reality is that we have not yet consistently done so. Perhaps this symposium can help us identify how we can more successfully mobilize the major parties into action.
Let me now turn to my second main point: the characteristics of a successful growth-oriented adjustment program. I would lay particular stress on three features: the need for country-specific program design, for a comprehensive medium-term framework, and for popular support.
Developing countries are too diverse—in economic structure, in the size of existing debt burdens, in their relations with creditors, in political sensitivities, and in the nature of existing imbalances—to allow a “standard” policy package to be effective. In some cases, the first order of business may be fiscal strengthening paired with exchange rate action and deindexation. In other cases, the pressing need may be for trade liberalization, reform of tax systems, overhaul of public enterprises, relaxation of price controls, and financial-sector reform. And in yet others, increases in producer prices, export diversification, and efforts to unlock more concessional finance may take priority. The case-by-case approach is not a slogan. It is merely sensible program design. I know that some observers see the Fund as seeking to impose a uniform, mechanistic approach to adjustment on all its member countries. I must tell you that in my few weeks in the Fund I have searched carefully through the cupboards for such a policy straitjacket. I have not found it. And if I had found it, I would have destroyed it.
The underlying conditions for durable growth can rarely be achieved in the short run. This is especially the case where the state’s role in the economy has been allowed to become overextended during a period of decades and where the structure of goods, labor, and financial markets is in need of alteration. Such structural reforms often require far-reaching preparation and take time to realize their intended effects. Yet little is to be gained from delay. Recourse to on-again, off-again demand-management programs within an outmoded and uncompetitive structure of production is hardly an attractive alternative. Wanting to grow faster is not enough. It has to be backed up by an integrated program of macroeconomic and structural policies implemented with perseverance over the medium term. I might add that poor countries, despite their difficult circumstances, cannot be exempt from such policy reforms. Indeed, it is precisely because their living standards are so low that they can least afford to tolerate weak policies. More and more, leaders in poor countries understand this and we are strongly committed to cooperate with them.
No program can succeed without the support of governments and of public opinion. Yet this support will be progressively harder to maintain the longer adjustment continues without growth. That is why the 4 percent average growth performance of the indebted countries in 1984-86 is welcome. Even so, and reflecting the slow growth of the 1981-83 period, it is striking that real per capita gross domestic product in the indebted countries as a group has risen on average by only about 1 percent a year since 1980—a far cry from the 3 percent average annual rate of increase of the 1960s and 1970s. If one uses real national income per capita as the relevant indicator, the picture is still worse. The period ahead is thus likely to be one where growth is just as necessary to sustain adjustment as adjustment is to sustain growth.
Effective policies in the developing countries—central as they are to a successful growth-oriented adjustment program—are not sufficient. This is my third point. Industrial countries can and should provide crucial support by following sound monetary and fiscal policies that are compatible with healthy, noninflationary growth of world demand, lower international interest rates, and an appropriate pattern of exchange rates; by rolling back protectionism; and by providing increased official development assistance and adequate official export credit. Clearly, it will be more difficult to make progress in reducing debt burdens if the real interest rate on debt exceeds the growth rate of developing-country exports, and if the incentives to adopt more “outward-looking” policy reforms are sapped by protectionist barriers. To work well, the adjustment process must be symmetric. We cannot have two standards of adjustment—one for industrial countries and the other for developing countries.
Banks too need to play their part. They are fully justified in asking their developing-country clients to undertake genuine policy reform so as to underpin any new net lending. This attitude on their part is much sounder than that which prevailed during the 1973-81 period when private lending expanded at an unsustainable rate. But we have to be careful not to now overdo things in the opposite direction. Major changes are taking place in the developing countries. But this progress is put at risk when there is inadequate support and understanding from creditors—to say nothing about endangering their own claims in these countries. Commercial banks cannot do the job alone. Other creditors and investors have to be brought more squarely into the action, and we must make full use of the considerable inventiveness of financial markets to design financial instruments that meet the needs of lenders and borrowers.
Finally, I come to the role of the Fund. Working in close collaboration with our colleagues in the World Bank, the Fund will continue to cooperate with countries in designing growth-oriented adjustment programs and in mobilizing the finances needed, including our own, to carry them out. I chose the word “cooperate” carefully. The Fund can help members to make better-informed decisions about the balance of payments, growth, and inflation implications of their policy choices. But the final choices must rest with the country itself. The Fund is also continuing its efforts to improve the effectiveness of multilateral surveillance, with particular emphasis on strengthening economic policy coordination among the largest industrial countries. The developing countries—no less than the industrial ones—have a vital interest in the outcome of those efforts.
Adjustment for durable growth in our membership is a central mission of the Fund. No one, I think, still challenges the precept that effective adjustment and sound finance are the allies—not the enemies—of growth and development. I hope that your suggestions will help us in the Fund and the Bank to adjust our own policies and procedures so as to serve better the evolving needs of our membership. After all, institutions, much like countries, cannot be static if they are to thrive. Just as countries sometimes need external expertise and support to help them adjust, we in the Bretton Woods Institutions welcome your ideas in helping us to adjust.