Mohsin Khan, Morris Goldstein, and Vittorio Corbo
Published Date:
September 1987
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Y. C. Park


Korea Development Institute

I agree with practically all of Mr. Michalopoulos’s conclusions. Nevertheless, let me raise a few questions, not necessarily directed to the author but to the audience in general.

It seems to me that the major thrust of the paper is that if you liberalize the economy, you will be all right. That is, if you liberalize your commodity markets, trade regime, and financial markets, then that sort of liberalization policy will facilitate adjustment with reasonable economic growth. If this argument is valid—and in fact this argument has been made on many many occasions—then why aren’t we doing it? Why haven’t many countries embarked on economic liberalization?

I have several answers and three observations on the lack of liberalization we observe throughout the developing as well as in many developed countries. First, the international environment is not right. If these developing countries are going to produce more exportables, then some countries must be willing to import them. And, as we all know, most countries are turning to protectionism. Given that environment, it is hard to recommend that developing countries liberalize anything. Second, economic liberalization, whether it is liberalization of a trade regime or factor markets, could cause considerable macroeconomic instability, as we have found in many instances even when inflation is brought under control. In that case, policymakers will have to take into consideration the trade-off between liberalization, the macroeconomic gains you could obtain from liberalization, and macroeconomic instability. When you add these things up, it is very hard to decide which is the right direction for economic policies.

Mr. Michalopoulos emphasized that before you embark on liberalization you must stabilize your economy. But in many cases, experience shows that in order to stabilize the economy, to reduce the rate of inflation, or to reduce the size of a current account deficit, you have to install all kinds of control mechanisms, wage price control, interest rate control, credit allocation, restrictions on capital movements, and so on. By the time you install all these controls and succeed in stabilizing your economy, you will find so many vested interest groups in your economy opposed to liberalization that you have to start dismantling all these control mechanisms to liberalize the economy. At that point you are not quite sure if you are going to destabilize your economy once again.

Given these problems, in actual policymaking it is difficult to liberalize simply because economic theory advises it. Some countries have been successful in liberalizing their economies and as a consequence have been successful in adjusting without hurting economic growth. The Korean experience has been heralded in many places as the prime example of a successful case of adjustments through liberalization. In the case of Korea at least it is not clear whether liberalization is the result of good economic performance or vice versa.

The sequencing of liberalization is again a controversial point. Here everybody agrees that the current capital account of the balance of payments should not be liberalized under any circumstances in developing countries. Should you liberalize domestic factor markets and commodity markets? And if so, which one first? I think on this issue it doesn’t matter which one you liberalize first. You will have problems any way. So the best policy is to choose the one that is most convenient and practical to liberalize first. In the case of Korea, I think we find it much more effective to liberalize the trade regime and domestic trade, and then use finance to allocate resources to those sectors in which efficiency is likely to be high. In this case the liberalization of finance is likely to be postponed for some time since at the initial stage of liberalization you are using finance as an instrument to reallocate resources.

I myself have worked on this problem in developing countries for a long time, and I still don’t understand the role of finance in the context of developing countries. In some of the most successful East Asian countries, the financial system is not notably liberalized.

In the 1970s Fund and Bank missions came to Korea and they said we had to liberalize finance, otherwise we would be in trouble. We have heard the same message throughout the last 15 years. And even last year we heard the same message, that unless you liberalize your finance you will be in trouble in a year or two. I am not so sure.

On Bank operations I have not much to say, but I agree with this greater focus on program lending, away from project financing. Finally, people are talking about the need for more effective and closer cooperation between the World Bank and the Fund. I think it is a very good beginning, as this conference shows.

And finally, I would make one comment related to the Bank’s operation. I would want the World Bank to have a little more understanding and be more careful about designing financial packages. I don’t think packages should be aimed at forcing countries to follow liberalization policies or, for that matter, any policies that the Bank would like to pursue in developing countries. Instead, once again, based on my experience as an economist living in Korea, it is neither desirable nor really feasible to use the leverage of potential loans from the World Bank to force the policymakers of receiving countries to accept the World Bank policies as they are presented.

The alternative is to encourage governments to develop programs themselves, as we have done, in fact, not very successfully. But we have taken many liberalization measures not because the World Bank asked us to, but because we needed to liberalize the trade regime.

In these circumstances, that is, when policymakers are very much determined and committed to a policy, whether it is liberalization or something else, then World Bank financial assistance can be very, very effective.

John Williamson

Senior Fellow

Institute for International Economics

The paper of Mr. Michalopoulos provides an authoritative exposition of most of the policies that the Bank has been advocating and the mechanisms it had been using to promote adjustment with growth. In this process, the Bank has acquired much wisdom, but I shall largely concentrate in my comment on the points in which this good sense is either inadequately presented in the paper or absent in the Bank’s practice.

I have one major complaint with the analysis, which also applies to Mr. Guitián’s paper. Neither focuses on what most of the clients of the Bretton Woods Institutions regard as the central impediment to their restoration of growth, namely the existence of a foreign exchange constraint. I concede that in some countries the need to stabilize inflation may be even more urgent. And I agree that the practice of both the Fund and Bank is less misguided than the neglect of the topic in these two papers might suggest. Nevertheless, I fear that the lack of focus on the foreign exchange constraint impedes understanding of appropriate policies for growth-oriented adjustment and jeopardizes relations with many members.

Mr. Michalopoulos certainly worries about adequate access to external finance, but he fails to emphasize the importance of the issues by basing his analysis on “resources available internally or obtainable from abroad,” with no hint that the shadow price of foreign resources may under certain circumstances vastly exceed that of domestic resources. The concept of a foreign exchange constraint is indeed recognized by Mr. Guitián, but only to be questioned:

Arguments abound to the effect that growth in an open economy is subject to a foreign exchange constraint . . . However, there is a limit … to the growth in demand that can be fostered … by excessive external borrowing . . . the fundamental point… is that trade-offs among policy objectives are more apparent than real. Under most circumstances, the only trade-offs that exist are intertemporal … It is clearly possible for a limited period … for an economy to grow at an unsustainable rate … at the expense of deficits in the current account . . . But this possibility is only a reflection of the choice that can be made between growth today versus growth tomorrow. . . .

Mr. Guitián makes similar claims with respect to inflation, and I basically agree with him in that context. But the notion that there is no meaningful concept of a foreign exchance constraint, except in the sense of an intertemporal constraint, is incorrect.

The next section of my comment constructs a simple model that provides a direct refutation of Mr. Guitián’s claim and a support for Mr. Michalopoulos’s contrary position that “additional external finance in the initial years of a reform could be an essential component of a strategy designed to restore long-term growth while also maintaining per capita consumption in the interim.” Those who do not believe that this position needs substantiation by a formal model may prefer to skip to the following section.

Consider a particularly simple version of the two-gap model that has traditionally formed the basis of Bank policy analysis. This economy produces only oranges, in a quantityY up to a limit determined by the stock K of orange trees according to an input-output coefficient α

ϒ ≦ α K.

In order to transport oranges to market, the economy needs to use imported fuel equal to β Y (measured in terms of exported oranges), where β is an input-output coefficient divided by the terms of trade (liters of fuel that can be bought with the frozen orange juice produced by a bushel of oranges). Oranges can be exported only in the form of frozen orange juice, and exports are therefore limited by the installed capacity Z of orange pulping and freezing equipment:

X ≦ γ Z

(as well as X ≦ Y).

The equipment Z has to be imported, so that the import equation is:

M = β Y + Δ Z.

The balance of payments equation is:

Δ R = X - M + B - δ D

where Δ R = change in reserves, B = new external borrowing, δ = the rate of interest plus amortization (and hence Δ D = B - aD, where a is the amortization rate).

To make this into a two-gap model one would also need to allow for the possibility of increasing K through investment, but for the purpose of studying the role of the foreign exchange constraint we simplify by turning it into a one-gap model.

Suppose that this economy is initially at full capacity output (γ = α K), in balance of payments equilibrium with export capacity fully utilized (X = γ Z) and constant debt (aD = B) and export capacity (Δ Z = 0). It is then struck at time t = 1 by a deterioration in the terms of trade (an increase in β) and/or an increase in debt service δ caused by higher interest rates, the total size of the shock being S.

In consequence,

α β K + δ D γ Z + aD,

that is the balance of payments is in deficit unless borrowing B increases or income Y declines.

In this simple model, adjustment with growth does not actually involve growth but simply the avoidance of recession, that is, a decline in the output of oranges. It is achieved by running down reserves or borrowing enough to pay the extra cost of importing the fuel needed to market the full crop of this year’s oranges, plus buying enough investment goods Z to permit additional exports to restore payments equilibrium by the next period. In the new equilibrium, consumption of oranges will decline by the amount needed to be diverted into exports to maintain payments equilibrium.

If adjustment with growth is infeasible owing to a foreign exchange constraint, that is, inadequate reserves and an inability to borrow more, the economy faces two alternatives. The first is permanent recession: cut output by S/β, enough to reduce imports of fuel to the point at which the balance of payments again balances with Δ D = Δ Z = 0. The second policy (“austerity”) involves an even sharper cutback in current consumption so as to further reduce imports of fuel and use the resulting savings to import the investment goods Z needed to increase exports of frozen orange juice. Note that this model permits expenditure switching in order to ease the foreign exchange constraint in the long run, so that it is not subject to the standard criticism that the rigid ratios of the two-gap model preclude adjustment by assumption. Indeed, once adjustment is complete, there is no foreign exchange constraint, and consumption is simply limited by resources (the stock of orange trees).

The welfare consequences of these strategies can be compared by calculating the consumption losses that they impose on the economy. In order to simplify the comparisons I shall concentrate on one particular case, in which both the austerity and adjustment-with-growth strategies involve installing all the additional equipment needed in period t1 and when the debt incurred under the adjustment-with-growth strategy is completely repaid, with interest, at time t2. It is evident that the requirement that debt be paid off in one period biases the comparison against adjustment-with-growth: a presumptively superior strategy permitted by slow repayment is to invest slightly more in t1 and avoid any recession, either at t2 or thereafter.

Permanent recession imposes a cutback in consumption of S/β for the indefinite future, unless and until the shock S is reversed.

Austerity also involves a consumption loss of S/β at t1. Consumption must also be cut back, by an additional S/γ at t1. Thereafter consumption can rise, to a steady-state level S below its pre-shock level.

Adjustment with growth maintains consumption unchanged in t1. It then falls in t2 by S (the steady-state fall in consumption needed to release resources for the more expensive imports), plus (1+ i)S/γ (to repay with interest the debt incurred at t1 to buy the needed juicemaking equipment), plus (1 + i)βS (to repay with interest the debt incurred to avoid recession at t1). From t3 onwards, consumption again rises to a level S below the pre-shock level.

Adjustment with growth certainly involves less consumption loss than permanent recession in every period except possibly t2. The condition for the consumption loss in that period to be less is

1/β > (1 + i)(1/γ + β),

a very weak condition considering that β is a fraction, typically perhaps 0.2, i is likely to be an even smaller fraction, and γ is likely to be substantially larger than β. Only if γ were very small, implying that the cost of raising exports through investment was extremely high, is it conceivable that permanent recession could be a sensible choice of strategy.

The undiscounted consumption loss involved in austerity is greater than that under adjustment with growth if

1/β + 1/γ > (1 + i)(1/γ+ β).

This condition is even weaker than that above for adjustment with growth to dominate permanent recession in period 2. (Note that the introduction of discounting would further tilt the balance in favor of adjustment with growth.)

This example demonstrates that, contrary to Mr. Guitian’s claim, circumstances can arise in which a foreign exchange constraint imposes a deadweight loss upon the economy rather than an intertemporal trade-off. Moreover, these circumstances are not far fetched. Most Latin Americans believe that they are operating under precisely such a constraint and that their adjustment is being made unnecessarily painful and lengthy as a result. If the Fund cannot recognize this, it is not surprising that it has a bad image in so many of its member countries.

It is of course an interesting question as to why countries with the socially profitable investment opportunities hypothesized in the above model should have difficulty in borrowing. At least partial explanations are provided by the existence of a debt overhang and the limited credibility of governmental promises to honor debts in a world of sovereign states. This latter factor is especially relevant in sub-Saharan Africa, where the time-scale needed to reap increased foreign exchange receipts from additional investment is so long as to create an overwhelming presumption that repudiation would at some stage appear rational if borrowing were on commercial terms. (This lack of credibility, plus concern with distributional issues, and not low investment profitability, provide the intellectual justification for concessional aid to poor countries.)

Whatever the explanation, the fact that most priority clients of the Bretton Woods Institutions are suffering from a foreign exchange constraint seems clear. Indeed, about the only client of the Bank that is currently facing the opposite dilemma to which Mr. Michalopoulos pays so much attention, of wondering whether to liberalize the capital account before the current account and risk being flooded with a capital inflow, is Korea.

The policy priority in a country facing a foreign exchange constraint is to raise the capacity to import. As the model of the orange-growing economy formalizes, additional imports are needed to restore full capacity operation of the economy (in the real world, this is important not just for the additional consumption it permits, but also because it raises the incentive to invest), as well as to provide the ability to invest. One set of benefits of an outward-oriented strategy is its ability to generate the exports that will break the foreign exchange constraint and allow the country to exploit its domestic resources to the full. These macroeconomic benefits of outward orientation are of course supplemented by the microeconomic benefits of more efficient resource use—of production according to comparative advantage, of ability to exploit economies of scale, and of maintenance of a competitive spur. Adjustment with growth requires that countries get both their macroeconomic strategies and their microeconomic incentives right at the same time.

Unfortunately only the microeconomic benefits seem to receive any attention in current Bank analysis (unlike that of an earlier generation, which perhaps made the opposite error), including the papers prepared for this conference. In the long run this does not matter much, since outward orientation will bring both sets of benefits simultaneously. But in one important short-run respect the difference is crucial: namely, with regard to insistence on early import liberalization in a program of structural adjustment. Mr. Michalopoulos appears to reflect current Bank policy accurately when he calls for “. . . export expansion programs [to] be accompanied by significant import liberalization. . . . Experience does not in our view suggest that import liberalization should be undertaken only after export reforms have increased the supply of foreign exchange.” The nature of this experience is not described, but certainly the rationale he provides for early import liberalization—that “it is extremely difficult to reorient domestic producers toward export markets as long as heavily-sheltered domestic markets offer them sizeable assured profits”—seems to assume full capacity operation of the economy, an assumption that is by definition unsatisfied when the foreign exchange constraint is binding. Resources do not have to be squeezed out of import-competing sectors in order to permit additional output of exports as long as there are idle domestic resources. The export industries may need imported inputs—but these will be less available, not more available, if import-competing industries are forced into bankruptcy by import liberalization, except in the extreme case in which the foreign exchange cost of imported inputs exceeds the cost of the imported final goods.

As I see it, the right model is the one that, broadly speaking, Europe followed during the Marshall Plan. First, liberalize imports of critical inputs, especially of inputs needed for tradable production. Second, devalue to the point needed to gain (and maintain) a competitive exchange rate. Third, borrow anything that may be needed to restore (and maintain) full capacity operation of the economy as soon as possible. Fourth, advertise your intention to liberalize imports as circumstances permit, in order to ward off investments in uneconomic import-competing industries, and bind your promises by making international commitments so as to secure credibility of your advertised intentions with incipient local vested interests. (There is a vitally important potential role for the Bank here.) Fifth, once the economy is operating at full capacity, use payments improvements to liberalize imports across the board. When you have finished liberalizing imports, start thinking of liberalizing the capital account or appreciating the currency.

With the important exception of the priority to be accorded to import liberalization, most of Mr. Michalopoulos’s advice as to the desirable content of adjustment programs is well taken. Public sector reforms, prices that reflect opportunity costs, subsidies that are targeted on the poor, institutional reforms—these are all areas in which the Bank’s record is honorable. I did, however, miss any similar emphasis on education. After all, if the first lesson of Korea’s success is the benefit of outward orientation, surely the second lesson is the value of massive investment in human capital at an early stage of the development effort. And perhaps the third lesson is the benefit of a well-executed land reform, which appears to be a neglected subject in the Bank today. While noting sins of omission, Mr. Michalopoulos fails to acknowledge the critical importance of sensitivity to environmental issues that is increasingly recognized in at least some parts of the Bank.

I conclude by reverting to the simple model introduced earlier, which for all its simplicity (or perhaps because of that simplicity) seems to me to offer an analytical framework for identifying some of the prerequisites for designing programs for growth-oriented adjustment. That model suggests that a key requirement for securing adjustment with growth is to combine the incentive to increase the supply of tradables (to invest in Z) with the finance to permit such investment without unnecessarily curtailing consumption. That diagnosis points to some critical political questions that confront the Bank. Should it bribe countries whose governments do not really believe in them to undertake policies that the Bank believes would promote investment in Z by offering loans with lots of detailed strings? Or should it wait till a government appears that shares its convictions about the desirable policy stance, and then give it the money to have a decent chance of succeeding? Can it increase the supply of such “enlightened” governments worthy of extensive support by policy dialog? But these are topics for another paper.

Michael Bruno


Central Bank of Israel

Among many issues, I should like to discuss for a moment how one looks at policy problems from the viewpoint of individual country experience. Usually problems arise because existing ways of handling policy have become inadequate, and then it is necessary to adjust one’s way of thinking about them. My reading of both Fund and World Bank practice over the years is that both institutions have attempted to adjust the way issues are tackled. My own experience suggests that Fund missions exhibit a much more eclectic approach than is shown in official policy documents and declarations.

The problem I had with Mr. Guitián’s paper is its defence of a certain orthodox position, which I would hope is not a definitive summary of what I would like to consider the Fund view. I have always had the highest regard for Mr. Guitián’s many contributions to the Fund’s work, but if I may sound somewhat critical, I had some difficulty with the emphasis of the present paper. I failed to find in the paper what I would regard as sufficient emphasis on the tradeoffs between adjustment and growth.

I agree that, when a country is fundamentally out of balance, it has to, for example, remove the sources of high inflation first before it can hope to start growing. But there I would stop. How it adjusts is important, because adjustment depends, first of all, on the nature of the imbalance and will have a bearing on future growth prospects.

To my mind Mr. Guitián’s paper overemphasizes demand management in short-term adjustment, although it is obvious that internal and external disequilibria have to be cured by using a mix of fiscal, monetary, and exchange rate policies. These are important tools, but it is important also to look at the source of disequilibrium that may affect both the mix and the choice of policies.

The underlying assumption of the macroeconomic model that puts all the emphasis on demand management is that in the short run prices and wages adjust, there is lack of friction, and there is full market clearing. All of these assumptions may be true for the long run, but they don’t necessarily hold in the short run.

I would like to give two examples that bear this out. One is the experience of the 1970s in which the source of the imbalance in many cases was on the supply side, raw material prices were rising, wages were rigid, real interest rates were high, and long-term investment was down. Demand management by itself could not solve these problems. Moreover, demand managment may also have supply management effects which run counter to structural change and growth.

Fiscal adjustment, I think all will agree, is a necessary part of the adjustment process. What kind of fiscal adjustment, I mean what particular mix, will have an effect on the supply side? For example, typically in the 1970s, if fiscal adjustment included raising wage taxes, that ran against what it was desirable to achieve on the supply side, since it worsened labor costs. Likewise, cutting investment in infrastructure is a way of solving the short-term fiscal imbalance, but it harms long-run investment prospects. Much depends, of course, on how you define a deficit. If you define it to include investment expenditure, then by definition cutting investment is a way of adjusting your budget. But it will harm growth prospects. There is always a trade-off involved that cannot be ignored.

I might also note parenthetically that there are other policy tools not mentioned in the paper, such as the use of incomes policy and tripartite agreements between trade unions, employers, and government to keep wages and prices from rising.

The second example is the more recent experience of high inflation countries. In this regard I can mention my own country’s experience. In the debate there are two extreme views, neither of which is valid. One takes the orthodox view that if there is an imbalance—and high inflation is always caused by basic fiscal deficit, and there’s no argument about that—one must cut the deficit, restrict money, and the rest will take care of itself. That is one polar view.

The other polar view, called the structuralist view, maintains that the budget doesn’t matter. All you have to do is to freeze prices and wages. The exchange rate will be quickly brought in line. Inflation is mainly a bubble that the wage and price freeze will burst. That view, of course, is invalid. Examples abound in which either one of these polar approaches would have produced either disaster or something close to it.

So the answer is you need both. If you say you need both, then you have to do certain unconventional things, such as using price controls or pegging the exchange rate. Under certain circumstances you want to peg the exchange rate because the foreign exchange that comes as a capital reflow will help you solve the balance of payments problem even if the current account may worsen for a short time.

Now I would also like to warn against the use of such unconventional methods to justify anything. You can justify any fiscal excesses or distorted price levels by appealing to such arguments. I am not making a plea for any unconventional thinking of that sort.

I have two final points. One has already been made by the Managing Director. It is to try to refrain from having one set solution that is applicable to all countries under all circumstances. We know that the choice of exchange rate regime, whether it is pegged, crawling, or floating is not independent of the structure of markets in an economy. If you have a certain type of labor market you don’t want to use the crawling peg. Or if your financial markets are not developed, you don’t want to use a certain type of float. It is important to bear this in mind. But more important is to try to see whether governments that one deals with are motivated to set their own house in order.

The second point has to do with the time horizon. In at least one place in the paper the statement is made that the trade-off between the balance of payments and inflation and the balance of payments and growth should not allow one to even move one inch from keeping foreign exchange balanced at all times. That is a statement which I am sure the author did not really mean, judging by his oral presentation. But it is written in the paper. Financial adjustment, like the response to high inflation that I mentioned, can be achieved within a short time. But real adjustment includes structural reform and is a prolonged process, requiring a policy formulation with a medium-term and a long-term framework. That is where Fund short-term programs can help: as part of an overall short-, medium-, and long-term plan. I can only finish with that.

Gerald K. Helleiner

Professor of Economics University of Toronto

The Managing Director’s opening address offers hope for fresh Fund approaches in the new search for growth-oriented adjustment programs. Mr. Guitián’s paper, on the other hand, has a certain Bourbon flavor. (The Bourbons were the ones who learned nothing and forgot nothing.) It stands in contrast to Mr. Michalopoulos’s paper from the Bank, which addresses such issues for the prospects for adjustment with growth as the current adequacy of resource flows, the Bank’s own prior experience with related programs, professional limitations in respect of medium-term sequencing and dynamics, equity, poverty, and the political problems of transitional states, the likelihood of negative growth during stabilization efforts, and the need for country specificity of approaches. One can quarrel with many of the elements of the Bank paper but it deals with the real problems, including those relating to the design of appropriate policy packages, of recovery and balance of payments adjustment in Latin America and sub-Saharan Africa, the problems that have brought us to this conference.

Mr. Guitián argues, at length, that short-term stability—how much is unclear—is helpful to growth. Was this ever or is it now at issue? The sum of his advice appears to be “Do everything and do it as soon as possible.” This is of dubious value as a contribution to current debate over the construction of growth-oriented adjustment programs.

Let me group my comments on the paper under three headings: the international context, the overall analytical approach and related conditionality issues, and the question of adjustment and growth through external liberalization.

But first permit me to make a parenthetical comment on the conference as a whole—perhaps an obvious one but one which I believe is important. The majority of the Fund’s current programs are with low-income countries, most of them in sub-Saharan Africa. It is there that the most intractable problems of adjustment and of growth are found—and where the Fund’s recent record has been particularly bleak. There are brief references to these countries here and there in the papers for this conference, but they deal mainly with middle-income countries. The problems of Turkey and middle-income Latin America are qualitatively different from those of low-income Africa. Perhaps another conference is required for addressing low-income countries’ problems—including the optimal means of writing down debt to official creditors that cannot and should not now be serviced.

International Context

Severely underplayed, if not quite totally missing from Mr. Guitián’s paper, is an appreciation of the international context within which adjustment efforts in debtor countries now must take place. The Fund’s emphasis upon domestic monetary and fiscal policy, and the efficiency of resource use is, as always, praiseworthy. But this paper’s one-sided approach to the adjustment problem—focusing upon “the adjustment problems of members seeking access to Fund resources”—implies the very asymmetry of approaches and adjustment processes that Mr. Camdessus warned us against. The rate of global growth, the monetary-fiscal policy mix in the United States and elsewhere, the state of world primary commodity markets, OECD protectionism, policies with respect to capital exports from major surplus countries, and the treatment of the external debt cannot sensibly be assumed “given.” The Fund’s own global projections underline their importance to balance of payments and growth prospects in the developing countries. Constructive approaches to them are fundamental to the formulation of symmetric and sensible overall adjustment policies.

Mr. Guitián even argues that the issue of the appropriate extent of external financing for growth-oriented “adjustment” tends to revolve more frequently around the efficiency of resource use than around the amount of resources. When most of the members in question are suffering from severe foreign exchange scarcity and liquidity squeezes, this is a remarkable and unlikely proposition for which one would like to see some evidence. There is plenty of evidence to the contrary.

Mr. Guitián’s “blind spot” on the international context extends to his treatment of the sources of the relevant member countries’ current problems. The Michalopoulos paper notes in its opening sentence the fact of unfavorable external shocks (the most severe such shocks for most developing countries in 50 years) and the need to adjust to them. The Guitián paper, on the other hand, is still couched in terms of overexpansion of domestic demand and the frequent difficulty of ascertaining soon enough whether it exists. The size of shock surely has something to do with the capacity to adjust promptly to it—but Mr. Guitián offers only admonitions not to let problems accumulate and to keep efforts synchronous with adjustment need.

In this context, he returns to the traditional distinction between “temporary” and “permanent” shocks as an important element in appropriate policy design. But does anyone now think that we have a traditional Fund-style “temporary” problem in Latin America and Africa? Rather, there is now a need to elasticize the concept of “temporariness” for countries with prolonged use of Fund resources, not to speak of the growing number of African countries that, barring new approaches, will also become “ineligible” over the next few years. The time horizon for “temporariness” was, after all, always an arbitrary one—determined by the Fund’s own self-created lending rules rather than by any objective reality. What Mr. Guitián calls “historically normal” (he refers to capital flows but the proposition is a general one) is equally arbitrary.

In his conclusion, Mr. Guitián does address some of the external issues, but he does so in a very odd manner wholly different from the forthright comment of the Michalopoulos paper which says outright that “reforms . . . without financial support. . .alone cannot go far in restoring growth,” “still more funding is clearly needed,” and explicitly recommends “debt relief.” Mr. Guitián calls for “decisive action to eliminate [external arrears] within an appropriate period of time.” He appears to mean that they should be paid off. How this is to be achieved in the current context, and with what assistance, is not addressed. He then concludes with some general comments on external capital that are difficult to interpret: “. . . at present international capital movements have yet to resume their historical patterns . . . severe problems remain in this area . . . Continued efforts . . . will be required, including, where appropriate, external assistance in amounts and on terms consistent with the nature and magnitude of the required internal adjustment effort.”

What this means in terms of Fund positions on the need for external resources for adjustment is less than clear.

Nothing is said in this paper about the many elements of Fund practice that might be expected to have some influence on external constraints, where they exist, for example, overall Fund net lending, SDR issues, the duration over which Fund loans can and should revolve, contingency arrangements in performance targeting, necessary external financing commitments, the degree of front-ending on lending, the degree of conditionality in overall lending, and a Fund role in the resolution of debt problems.

Overall Analytical Approach and Conditionality

Mr. Guitián does not distinguish between stabilization and adjustment, as do Mr. Michalopoulos and most of those development economists who seek analytical clarity. This reflects the Fund’s traditionally very aggregative (not to say primitive) approach to supply-side issues. For Mr. Guitián and the Fund, adjustment is a matter of getting aggregate demand back into balance with aggregate supply, with primary emphasis upon the achievement of external balance. “Structural” issues do not arise in this formulation of the current problem. Yet it is structural change—in the sense of increasing the role of tradables in the structure of overall production to overcome a foreign exchange constraint—that is of the essence of what most others describe as “adjustment.” For Mr. Guitián, stabilization and adjustment are all one—and make for a substantial package.

Balance of payments objectives aside, Mr. Guitián’s stated adjustment objectives—“sound” growth rate, “appropriate” level of employment, “a measure of domestic price and exchange rate stability”—are so vague as to be nonoperational. This is not criticism. It is simply to make the point that his stated “economic” objectives are no more precise or generalizable than the many “noneconomic” ones he mentions (and leaves for domestic policymakers).

One can plausibly argue that the details of stabilization and adjustment packages are not the business of the Fund or the Bank, and that all that matters is results—results in this instance relating to the early restoration of external balance (preferably with internal balance, political as well as economic, at the same time). Mr. Guitián seems to lean towards such an approach for the Fund. Certainly his paper is far less forthcoming with its recommendations than the Bank paper is. Why the Fund should not participate in the analysis of transitional costs, poverty effects, sequencing, and the like, however, is not immediately obvious. It is striking that Mr. Guitián’s Fund is prepared to advise on the economic and balance of payments implications of “domestic priorities” but does not offer alternative policy packages, including ones with characteristics on which the international community has views, such as those protective of child welfare, from which these priorities may be chosen. Is the Fund professional staff really so limited in its abilities or proclivities?

Mr. Michalopoulos and the World Bank appear to be ready not only for more detailed analysis but also for greater intrusion into internal policy matters than Mr. Guitián and the Fund. Such a Fund-Bank distinction regarding the degree of respect for national sovereignty would seem to make little overall political or economic sense.

But is it a real distinction? I think not. The Fund does not even target the relevant variables (balance of payments ones) in its purportedly hands-off approach. Its concentration on and targeting of particular monetary variables already involves the taking of a position on controversial domestic issues. Mr. Guitián’s approach to the stabilization (cum adjustment) question is unrepentantly monetary. He relies upon “the important and well-established relationship that prevails under most circumstances between the demand for money balances and the level of global income in an economy.” This approach is subject to all the usual objections—short-run unpredictability, definitional problems with money, unrealistic assumptions about price and wage flexibility and the stability of real income, and misplaced concreteness with respect to the sources of overall imbalance. To each his own. Mr. Michalopoulos’s plea for a balanced approach to the use of available policy instruments is apposite in this regard. But let me not dwell on these familiar disputes.

Fund missions also express views on all manner of pricing and other issues. So indeed does Mr. Guitián, while trying to remain as technocratic as possible, on such matters as the role of government and the desirability of overall openness.

If the Fund were to be as restrained as Mr. Guitián says it should be and, in particular, were to use balance of payments indicators for performance targeting, there would be grounds for urging parallel respect for sovereignty on the part of a currently more aggressive World Bank. In the real world, however, one must instead lament the fact that his paper addresses so few of the issues of growth-oriented stabilization and adjustment, thus leaving them, willy nilly, entirely to the Bank. As far as adjustment and growth policies are concerned, Mr. Guitián appears to opt out of all the interesting debates.

Beyond the search for stability and efficiency there are real policy choices relating to the structure and pace of change, and distributional and humanitarian objectives. Mr. Michalopoulos’s paper is properly humble about our knowledge of the dynamics of adjustment processes. Mr. Guitián seems to imply that these are matters of domestic sovereignty and therefore beyond debate. The Fund circumspection Mr. Guitián describes and praises leaves the Fund apparently uninterested in growth, poverty, unemployment, development strategies, or political sustainability. This is both unfortunate and unrealistic. The appropriate degree of Fund intrusion into domestic policy matters remains a separate—and major—issue.

Adjustment and Growth Through External Liberalization

The Guitián approach to efficiency and thus structural adjustment relies upon establishing the correct “relative prices and costs.” He ignores the problems of differing short- and long-run supply elasticities in different sectors, of financing the investments that would make for larger supply responses, and of transitional costs.

Mr. Guitián’s enthusiasm for “opening up of the economy”—apparently for both capital and goods flows—is especially strong. (The capital proposition is particularly dubious.) The “liberalization of trade and exchange restrictions . . . constitutes a necessary (my italics) complement to policy measures in the macroeconomic and pricing spheres for the attainment of sustained growth and balance of payments viability.” This will come as a surprise to Japan, Korea, Brazil, India, and many other countries. In his conclusion he suggests “strengthened efforts to speed up liberalization and economic openness (to) . . . contribute significantly to both the adjustment and growth processes.” He has nothing to say about any “transitional costs” it might entail, about the recent record of countries that attempted to do this, whether the “success” cases really did, about its political feasiblity, or indeed any of the likely detailed effects discussed in an extensive and somewhat inconclusive literature.

More directed interventions have often been and may well in future be more efficient than the blunt instruments of restrained aggregative demand and simple reliance upon the market. Restructuring production towards tradables and protecting the welfare of the poorest (or of powerful political groups) may be better obtained by targeted incentives, credit allocation, subsidies, and investment. If effectively targeted on fast-responding sectors, especially exportables, the need for demand restraint may be eased.

Nor is his report to the Fund mandate on these matters convincing. It is true that the Fund promotes a “code” of liberal international economic conduct. But Mr. Guitián protests rather too much about the Fund’s inability to deviate from it. Clearly, deviations have been made in the case of centrally planned and innumerable hard-pressed developing countries. More fundamentally, there is nothing in the Fund’s Article I that requires or implicitly recommends that when imports must be restrained for balance of payments reasons this should be achieved via domestic deflation rather than import barriers. Policy ought to be based upon the economic and political costs of the alternatives.

The Fund has always made a point of saying that it is not an aid agency. If this paper represents current thinking in the Fund it is unlikely to be a growth agency either. Mr. Guitián’s prime approach is the traditional one of demand management over the short term with main reliance on domestic credit control. His assessment of other issues is too cautious and too simple to be very helpful. If the Fund chooses to play a purely monetary role, it can assuredly do so. This role can be important. But current efforts to design growth-oriented adjustment programs for Africa and Latin America demand more. One must hope that the Fund will join the effort.

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