CHAPTER 15 Low-Income Countries and the International Financial System
- Harold James
- Published Date:
- June 1996
In the course of the 1980s two related but separate debt crises exploded. Each raised major issues concerned with the operation and justice of the international financial system. For some time after the eruption of August 1982, most international attention was focused on the problems of private sector foreign lending, mostly to middle-income countries (see Chapter 12). But before 1982, as well as in the subsequent years, another and more long-term problem emerged concerning mostly official credits, and mostly to lower-income countries. The commercial debt crisis threatened the solvency of major international banks and thus the working of the global financial system. The official debt crisis posed a different menace, less a risk to world financial markets than a danger that a large number of countries would be practically excluded from the world economic order. In this sense, it constituted if anything an even more profound challenge to the idea of a world economy in which prosperity was “indivisible,” and to institutions committed to facilitating its operation. This chapter is concerned with that challenge, with the way in which changes in the design of international support programs have responded to a need, and also the extent to which they can help to achieve changes in policy in countries devastated by the consequences of bad policy.
The major task of international financial institutions involves policing the international financial system. This includes ensuring that the system is open, and that countries can use that openness in a way beneficial both to them and to others, that they can trade, and that they can borrow for development. The movement of goods and capital benefits in most cases both parties in the exchange. The effect of the official debt crisis was to destroy linkages with the international financial system.
The most obvious and depressing feature of most low-income countries is the extent to which they have become isolated in an economic trap that is in part structural and in part intellectual or psychological. Links with the rest of the world through capital and goods markets are curtailed. Countries in the trap attract only minor capital inflows. In most cases, the flows fell away almost completely in the course of the 1980s. When foreign direct investment in developing countries began to expand again in 1989—at the end of the intensive phase of the commercial bank debt crisis—it went to a relatively small number of countries in Asia and Latin America, while poorer economies in Africa were largely ignored. Neglect by credit markets often reflected a poor trade performance. The exports of poor countries were often limited to one or a few commodities; and their share in world trade also fell characteristically during the past two decades. The crisis of low-income countries has involved a long and agonizing process of marginalization.
Domestically, greatly reduced per capita incomes followed from the decreased contact with the benefits of trade and capital flows. A major requirement of equity involves improving conditions in these countries. In the longer run this can only be accomplished by the promotion of openness, and the creation of appropriate incentive structures to reduce the crushing extent of poverty. Poverty cannot be treated simply either as a natural and inevitable phenomenon, or as a blight that will simply disappear with the wave of a wand called “good policy.” Both these extreme positions are poor guides to effective action: the former engenders hopelessness, the latter complacency. In many cases, bad policy—inappropriate interventions in trade, pricing, and monetary policies and inadequate resources dedicated to infrastructure and education—have intensified pre-existing difficulties and have been partly responsible for an increased gloom, and a sense of hopelessness. The reaction of the international financial system—whether the private sector or governmental organizations or international institutions—in the face of such despondency has regrettably frequently been withdrawal. In many countries, international neglect intensified the urge to “go it alone” and magnified the scope for wrong policy, and in this way contributed to the vicious spiral of isolation and marginalization.
There emerged in the 1970s and 1980s two interconnected problems, whose solution would depend on a treatment in parallel, and not as logically different tasks. One involved the establishment of an appropriate framework in terms of national policymaking, the other the openness, flexibility, and adaptability of the international order. Problems in the international system threw many countries back onto inappropriate policy courses. In this way, the dilemmas and difficulties were quite analogous to those that characterized the “classical” debt crisis discussed earlier, but the degree of market failure was greater.
A Crisis of Growth
In the 20 years after the first oil shock, growth faltered and was reversed in a significant number of developing countries. Many of the countries that exhibited the extreme version of marginalization and disconnection from the international system were geographically situated in sub-Saharan Africa. (However, it would be misleading to treat the problem of endemic poverty as region-specific. There are obviously very poor countries outside sub-Saharan Africa; and equally, some African countries have exhibited very high rates of growth. For a long time, the fastest growing economy in the world has been Botswana, with an average annual GDP growth rate of 8.3 percent between 1961 and 1987.)1 A large number of countries in sub-Saharan Africa, however, have become poorer over the past 20 years in relative terms and some have even experienced declining incomes. As an indicator, in the course of the 1980s, the World Development Report changed the classification of six African states (Equatorial Guinea, Ghana, Liberia, Nigeria, Sao Tome and Principe, and Zambia) from the middle to the low-income group. The evidence suggests that problems endemic to low-income countries are peculiarly intractable in the case of many African states.
There are a number of structural and policy problems common to the region; and the region has also suffered from particular disadvantages. Both civil disorder and poor economic performance in any one state impose costs on the surrounding area. Political emergencies and civil wars in some African states have frustrated economic progress in a wider area. The Zambian economy, for instance, was badly affected by the unilateral declaration of independence in white Rhodesia (now Zimbabwe), by the embargo on Rhodesia, and by the breaking of Zambia’s most important route to the ocean. Wars in Angola and Mozambique later also affected the economies of their neighbors. Between 1960 and 1987 an estimated 4.5 million people died in wars in sub-Saharan Africa.2 Other areas of poverty in the world have been devastated by the direct and indirect effects of conflict: Bangladesh, Viet Nam, and Cambodia.
The specifically domestic economic roots of the African malaise are the following:
(1) African countries are characterized by a high rate of demographic growth, with as yet little sign of the decline in fertility rates associated across the world with higher living standards. Between 1965 and 1980, the annual growth rate of populations in low and medium-income countries was 2.3 percent; for the period 1980–89 the figure fell to 2.1 percent. Comparing these two periods, for Latin America and the Caribbean, the rates fell slightly from 2.5 percent to 2.1 percent, while for sub-Saharan Africa the growth rate increased from 2.7 percent to 3.2 percent. Projections indicate a continuation in the near future of African population growth at approximately similar rates. As a consequence, the region as a whole has one of the highest dependency rates in the world, with 47 percent of the population under 14 in 1989. In many areas, demographic growth is threatening to bring ecological catastrophe to a continent many had long assumed was naturally underpopulated. In arid zones, the movement of large numbers of people and cattle onto marginal grasslands has produced overgrazing and a depletion of resources.
(2) Historically, demographic pressure and the pressure on marginal areas of production have usually led to a reduction of savings and investment rates. African development also followed this pattern, with gross domestic savings falling in the continent. Some benchmark figures are 17.8 percent in 1972 and 12.6 percent in 1987. But the major cause of this decline has not been a fall in private savings levels, which in fact showed only a very slight drop. Increasing uncertainty and gloomy economic prospects may indeed have encouraged people to save, despite often very high levels of inflation, which eroded the value of their savings. Relatively low personal savings levels are also a reflection of low growth (by contrast, the successful East Asian economies developed a virtuous cycle in which higher growth produced higher domestic savings).3 The fundamental reason for the fall in savings rates lay, however, in the behavior of the public sector. At the end of the 1970s, in many countries, following the inflationary jolt given by the rise in oil prices, and an adverse turn in the terms of trade for petroleum importers, the tax collection mechanism broke down. Government spending failed to adjust, and the result was a large increase in public sector dissaving: between the two benchmark dates, savings rose from 3.3 percent to 7.2 percent. Almost the entire drop in the African savings level is in this way attributable to the behavior of states, and not of individual savers.
Investment also declined. As with savings, initially it stood at a quite high level. The shares of investment in GDP for sub-Saharan Africa and for South Asia were almost identical for many years: around 16 percent in the 1960s, and 20 percent in the 1970s. Then in sub-Saharan Africa the ratio declined again to 16 percent in the 1980s. In order to increase growth rates, a significant rise in investment is required.
(3) What investment took place was frequently poorly directed. Returns on investment were very low, suggesting the widespread presence of substantial misallocations, and also of an inadequate infrastructure. There is plenty of corroborating anecdotal evidence of the short life of plant and equipment as a result of a poor operating environment (the private vehicles that last only three years on the roads of Zaïre) and of the expenses involved in constructing substitutes for inadequate infrastructure. Many major industrial corporations, for instance, have to construct and maintain their own power supplies.4 Shortage of foreign exchange means that expensive equipment is often left idle because of a shortage of parts. An improvement in incentives for maintenance might in many cases reduce the extent of the destruction of capital. The absence of such inducements implies that an artificial incentive structure has been created, which gives preference to new capital investment (often through publicly owned enterprises) over servicing and maintenance payments and which frequently neglects basic infrastructural investments.
(4) Misallocation may be due in part to the neglect of infrastructure, but it is also the consequence of the adoption of a deliberate state strategy. In the years immediately following independence, governments assumed that only a strong industrial performance could create an escape from poverty, dependence, and underdevelopment. At least two sets of prices were manipulated and thus distorted: the rate of interest and prices of agricultural goods. The distortions created a deliberate bias toward import-competing activities and the capital goods sector.
A critical price that determines savings and investment behavior is the interest rate. Holding interest at low levels was widely thought to promote higher levels of investment. The inflationary consequences of uncontrolled monetary policy, however, meant that real rates were often highly negative, and also very volatile. This price distortion produced a misallocation of resources as (approved) investment projects were too cheap. It also dissuaded investors from holding financial assets. For sub-Saharan Africa, the average real interest rate as calculated by the World Bank in the 1980s was −11 percent, with much higher negative levels in a few countries (Ghana and Zambia).5 Subsidized credit brought credit rationing, directed toward the creation of a heavy industrial sector in accordance with the theories held by policymakers. Negative interest rates also turn the control of credit into a major source of economic and political power, since allocating loans in effect means distributing subsidies. The emergence of corruption and the disintegration of public morality are a rational, and perhaps an inevitable, consequence of this sort of distortion.
Industrialization programs were further almost always supported by a deliberate manipulation of the domestic price structure. Internally, the terms of trade were to be turned against agriculture, in order to assist industrial accumulation, whatever might be the level of prevailing world prices. This in turn required controls to separate domestic prices from those on world markets. Marketing boards often functioned to buy up agricultural products at low prices.6
Conceptually, these attempts did not differ from the strategies adopted simultaneously in many Latin American and some Asian countries. In the African case, they had a generally more destructive influence simply because the size of the agricultural sector at the outset was much larger and also because the policies were more extreme. Unfortunately, from the point of view of the planners, and regrettably for the course of development, most of the population worked in agriculture. As most of the very poor lived in rural areas, anti-agriculture policies accentuated income inequality and social injustice.
As the industrialization strategy gained pace, it created its own political momentum. It produced a powerful intellectual and political elite that supported it, and that drew benefits from it. The strategy also produced another beneficiary: a small and usually relatively well-paid working class. Both these groups, based as they were in cities, had a strong grip on the political process. One recent survey concluded that “even in the poorer countries, however, urban popular classes are likely to be more active politically than both the rural poor and the poorest fringes of urban society.”7 The industrial groups were determined to preserve their positions and believed that alternative policies, with a more balanced development would mean a return to colonial-style subordination. This view was articulated particularly forcefully by academics and also by those in government bureaucracies who found in the spending associated with industrialization plans “the golden gateway to fortune.”8 By the end of the 1970s, this mechanism had produced widespread fiscal crisis. On the one hand was the inability of the state in most poor countries to raise additional revenues, while on the other the expanding government patronage systems expanded with a dynamic and logic of their own. This development was the fundamental cause of the decline in savings discussed earlier. High levels of inflation that resulted from fiscal problems also made it politically more difficult to abandon subsidies and price distortions. Attempts to move in such a direction frequently provoked mass discontent.
At the end of the 1970s, as a result of the obvious failures of industry-focused development, the old view came under a sustained intellectual and practical challenge. Academic studies pointed out the high costs of protection.9 In 1979, a World Conference on Agrarian Reform and Rural Development adopted a “Program of Action” under which targets for agricultural reform were to be integrated in an overall development strategy. Also in 1979, the Brandt Commission Report recognized that “food must be a priority.”10 But, in practice, the industrial emphasis had long since acquired its own momentum and, in the interstices of decision making, found convinced and unshakable advocates in many countries.
Though in every case, the industrial policy collapsed in the course of the 1970s at the latest, its intellectual underpinning still remains attractive at least to some commentators, and those who challenge it are frequently assumed to have sinister motives. It is still possible to observe among some commentators the fear that the IMF is “a recolonizing instrument which would not allow the indigenous entrepreneurs to make the critical choices that would propell the economy to selfsustained growth.”11 Some African academics argue that “both the World Bank and the IMF implicitly or explicitly endorse the colonially imposed role of primary production by Third World countries on the bogus basis of comparative advantage.… Africa has, with the massive collapse of commodity markets, reached the limits of export-oriented primary production.”12 Such erroneous assertions were, and unfortunately still are, used to support the continuation of industrialization based on a protected economy.
In many poor countries, external economic policy had in fact been subordinated to the distorted logic of induced industrialization. The exchange rate played a crucial part in the development of the industrial strategy. Here was yet another manipulated price. The combination of a high exchange rate with import licensing and restriction allowed an easy way of setting the domestic terms of trade. It could be justified as a policy by the need to import basic products needed for industrialization, and sometimes also foodstuffs, at reduced prices. By determining who could obtain foreign exchange to import (at cheap prices) and what they could import, the direction of development could be programmed. Such control also gave the controllers an obvious but critical political instrument. One commentator has described foreign exchange as the “lifeblood of the new political class”;13 but it would be a mistake to assume that the groups interested in an overvalued exchange rate were just domestic elites. In many cases, major foreign investors also defended the practice because it lowered the apparent cost of their investments.
The political importance of the preferential allocation of exchange to favored projects naturally altered the economics of development. Provided with cheaper inputs, projects that would not otherwise have made economic sense appeared attractive. They began to seem economically as well as politically rational and rewarding. The more politically prestigious a project became, the more it was allowed to cost; and, at the same time, the less it appeared to cost because of the distortions created by artificially high exchange rates. As a result, it would be less likely to be allowed to fail; and the industrial sectors accumulated examples of factories that were actually adding negative value (where, at international prices, the factors of production are worth more than the product).
The industrialization strategy had often evolved as a response to the failure of an external trade regime dependent on a limited number of products and extremely vulnerable to external shocks. Shocks were often treated not as an opportunity to re-examine policy but rather as an unanticipated setback, which called for further isolation from the international economy. This attitude shaped the approach to debt management. Countries believed that they should borrow after a commodity price collapse in order to avoid adjustment; while, on the other hand, commodity price booms were rarely used as an opportunity for consolidation and reduction of external debt. (There are countries that managed to escape this “commodity cycle trap”: Cameroon, for instance, between 1979 and 1981 provided a model of how oil revenues might be used to pay back external debt.) Commodity price changes thus had an asymmetric effect, in which price falls meant a greater need to borrow, but price rises also provided a justification for continued borrowing. Each price change, either way, required more financing. Movements of commodity prices in this way encouraged the incurring of higher levels of debt. A world economy in which fluctuations became more pronounced as a result helped to destabilize many commodity producers and drove them to adopt increasingly unsustainable policies.
In the 1960s it was impossible to detect any signs of the relatively poor performance of sub-Saharan Africa compared with a “developing country average.” But in the period after the collapse of the classical Bretton Woods system, each of the major shocks to the world economy caused a further divergence (Figure 15-1). The oil price rise of the 1970s, the second oil shock and the world depression at the beginning of the 1980s, and then the debt crisis: in each case, most sub-Saharan African countries found adjustment hard and painful. The debt crisis and the need to service debt helped to produce a further obstacle in the mid-1980s. In order to service debt, countries needed to increase exports; but the increased supply on inelastic markets produced a dramatic and very damaging price decline of major commodities: cocoa, coffee, copper. The belief that economic problems were related to the flawed development of the international system increased the propensity to turn inward, and to look for autonomous sources of development.
Figure 15-1.Gross Domestic Product Per Capita in Sub-Saharan Africa and Other Developing Countries
Source: World Bank, Adjustment in Africa: Reforms, Results and the Road Ahead (New York: Oxford University Press, 1994).
A Systemic Problem of Development
The crises were not just related to problems of domestic economic management. Critics in Africa who viewed the difficulties of their societies as systemic had a powerful case. Countries attempted to make up for inadequate domestic savings, which are likely to be a characteristic of very poor societies, by drawing on flows from the outside.
How could developing countries attract resources? The poorest countries have always had the weakest access to flows of foreign direct investment. In addition, flows to developing countries as a whole were reduced in the course of the 1980s, and only revived toward the end of the decade.14 In consequence, the low-income countries were particularly dependent on borrowing. Conditions for the supply of outside funds varied. There are three tiered but interdependent levels of availability:
(1) Private sector credit does not depend on any political process of negotiation, but requires an assessment of risk by the lender. The size of the pool of funds theoretically available is vast.
(2) Official (governmental) loans could be sought if private credits were unavailable, but might be linked with a complicated set of political negotiations. The size of the pool is limited by the budget constraints of creditor countries, and many industrial countries were increasingly unwilling to pay the notional targets of development assistance to which they had committed themselves. Obvious distress on the part of the debtor might increase the availability of these funds, but it also has the effect of cutting off any chance of commercial credit.
(3) International financial institutions had only limited facilities. The conditionality attached to their lending had a triple purpose. It served in practice as a rationing device in allocating their own scarce funds, as a linkage for creditor governments to assure that their own concessional lending was being used appropriately, and finally as an instrument to bring about a renewed availability of commercial flows.
In the course of the 1970s, with the increased size of international capital markets, private sector lending to developing countries increased. The share of private long-term debt rose from 54 percent in 1973 to 62 percent in 1983;15 as it rose, the assumption that the private sector could handle any financing problem became increasingly prevalent. Some African countries—especially producers of mineral resources—became significant borrowers on commercial markets. This lending was highly vulnerable to commodity shocks.
Zaïre, for instance, between 1972 and 1974 borrowed $450 million on the Eurocurrency markets. After a combination of a radical nationalization program and a sharp fall in 1975 of copper prices, lending halted abruptly, and in 1976 banks began what was to be an extremely protracted process of rescheduling. Over the course of the rest of the decade, governmental credits were substituted for private loans. In 1974, 77 percent of debt had been owed to private creditors; in 1981 this was true for only 33 percent.16
Many African countries followed a similar trajectory, although often without the initial intense phase of private market borrowing. At the end of the 1970s, when private flows of capital helped many middle-income countries accommodate to the second oil shock, sub-Saharan Africa became dependent largely on governmental credits. Perceptions of levels of development on international markets are sometimes very crude. Capital markets often engage in characterizing or caricaturing whole regions. At the end of the 1970s Latin America and East Asia could successfully cultivate a positive image (even in the case of states that exhibited almost exactly the same sorts of problems in domestic policies as in sub-Saharan Africa). Africa, in the aftermath of the violent fluctuations of commodity prices, appeared to promise much less. As a result, the buildup of African debt at the beginning of the 1980s largely involved official creditors. They then began to find themselves in the same position as the bank creditors in the case of the middle-income countries: in order to keep development on course, as well as in order to preserve the value of their holdings, they came under pressure to supply new funds.
Commercial banks were not centrally involved in this process. After 1982, transfers with regard to private creditors were negative, while the major transfers occurred rather from official creditors (see Table 15-1). At first, donor countries responded to the failure of the private market by providing increased flows of development aid. Net disbursements by members of the Development Assistance Committee of the Organization for Economic Cooperation and Development are estimated to have grown in real terms at 10 percent a year between 1983 and 1985, but after this, in the second half of the decade, the growth was much slower (1 percent a year).17. The effects of the flow of purely governmental and concessional support may not have been entirely beneficial. In many cases, substantial inflows of official aid, which were not dependent on policy performance, reduced the incentives to undertake fundamental reforms that might have made the recipient countries less dependent on aid.
The resources of official creditors began to be stretched. As it became difficult for the recipients to obtain additional financing, balance of payments problems appeared, and required the intervention of international financial institutions. Between 1974 and 1979, there had been only 8 IMF stand-by and extended arrangements with African countries; between 1980 and 1984, 27 were concluded.18 As a consequence of the emergence of large financing gaps that could not be overcome easily in any other way, by the beginning of the 1980s the IMF’s resources were acknowledged as “being used primarily for assistance to developing countries.”19 The Fund, in practice became a lender of last resort for poor economies. As a result, an extended debate about Fund conditionality occurred. The new IMF guidelines produced in 1979 (see Chapter 11) envisaged stand-by arrangements associated with an adjustment that would “pay due regard to the domestic social and political objectives, the economic priorities, and the circumstances of members, including the causes of their balance of payments problems.”20 In order to meet the demands, the Fund’s quotas were enlarged; and in addition the Fund borrowed resources. At the same time, the World Bank moved away from project and into more general program lending, providing structural adjustment loans (SALs). The extent of the new dependence of many countries on international institutions inevitably strained the relationship between the Fund and its members, especially when it appeared that the Fund had an additional importance as the only gateway to other sources of external support. In 1985, the Governor of the central bank of Tanzania, for instance, stated; “I believe that the excellent relationship between the Fund and its African members in the early years of their membership in that organization unfortunately no longer exists. There is a feeling that neither side understands the difficulties of the other.”21
Debt ratios grew throughout the 1980s, and as these figures became larger (mainly as a result of reschedulings and the financing of service payments through an involuntary extension of new credit), prospects for a relaunching of substantial inflows of either private or official credit waned. For all severely indebted low-income countries (SILICs), the value of external debt as a share of GNP rose from 35.1 percent in 1980 to 91.6 percent in 1986, and reached a peak in 1989 at 120.9 percent. The dollar appreciation of the first half of the 1980s contributed to the rise of the external debt burden. The peak year for the ratio of debt service to exports was reached in 1986: in 1980 it had been 10.5 percent, and it climbed to 31.2 percent in 1986. For sub-Saharan African countries, external debt as a share of GNP rose continually from 29.2 percent in 1980 to 109.6 percent in 1991; debt service, which was 10.9 percent of exports in 1980, rose to 28.2 percent in 1986, and then fell. A greater proportion of this debt was on concessional terms, with the result that the terms of borrowing were rather easier than in Latin America (for instance, the average rate of interest on official lending was 5.1 percent in 1986, while in Latin America and the Caribbean it was 7.8 percent).22 Even a brief overview of the statistics of the African debt crisis indicates how debt outstanding continued to rise long after debt-service payments were reduced through rescheduling arrangements, because servicing simply entered into the capital sum.
One consequence of the largely official character of debt was that the penalties for default were much less obvious than on private markets. Debt negotiation became a long-playing saga rather than a series of short and dramatic incidents.
A government in danger of imminent default on its debt needed to deal primarily with three institutional mechanisms: the so-called Paris and London Clubs and the IMF. Rescheduling of government credits took place through the Paris Club (for the origins of the Paris Club, see page 1.39); the London Club dealt with the claims of private creditors. Paris Club reschedulings and IMF programs were almost always mutually dependent. The Paris Club relied on the IMF program to produce policy adjustment that would typically in time allow the service of debt to be resumed. The arithmetic of the IMF program depended on the Paris Club arrangements to fill proposed financing gaps. But unlike the banks in their negotiations with middle-income debtors, on whom a substantial amount of pressure was applied both by international institutions and by national authorities, the Paris Club creditors did not necessarily put up new money (although such resources might be channeled in other ways). The rescheduling generally only covered one year of debt service.
Paris Club reschedulings represented a complex and almost continuous bureaucratic process, which itself became the subject of many complaints. It sometimes seemed to the participant countries like a deliberately complex obstacle course, full of chicanery. Debtor states found preparing for the meetings difficult, negotiating with individual creditor governments to find support for their position in the Paris Club demanding, and the result confusing and to some extent arbitrary. “The ‘transactions costs’ of endless dealings with individual bilateral donors, the World Bank, the IMF, and, in the case of the debt-distressed countries, the Paris Club, are enormous when expressed in terms of their domestic opportunity costs.”23 A senior staff economist for the U.S. Treasury responsible for Paris Club negotiations later wrote: “Rescheduling … is an unpleasant affair, and the official creditors must keep it unpleasant as an incentive to debtors to honor their debt-service obligations.”24 The difficulty of the process came to act as a substitute for the judgment of markets on economic prospects. Any governmental or bureaucratic intervention of this type will appear as arbitrary and was resisted as an imposition on the populations of debtor countries. The fact that it needed to be repeated annually made the routine seem worse. (One of the advantages and attractions of market operations is that they are quick, continuous, and impersonal. If they can be made—if the market functions—they are much less likely to trigger resentments.)
The first multiyear rescheduling agreements (MYRAs) for private sector debt were concluded in 1984; and in 1985 a MYRA on official debt was agreed in association with a provision for a Fund extended arrangement with Côte d’Ivoire. Most reschedulings, however, were still conducted on an annual basis. Official reschedulings were generally followed by private sector action at the London Club; but only in the case of Côte d’Ivoire did banks agree to provide new money in association with a Fund adjustment program.25 One other African state, Nigeria, was included in the new money provisions of the Baker Plan. A substantial number of countries tanked as middle-income under the World Bank classification and burdened significantly with debt were not covered by the Baker strategy: among these were Cameroon, Congo, Gabon, and Zimbabwe. These debtor countries, despite the classification, had significantly lower per capita incomes than the countries that were regarded as the classic victims of the 1980s debt crisis, and often more rigid export structures, and as a consequence found it more difficult to adjust to the debt crisis.
Because of the drying up of private flows and the unavailability of greater official credits, the financing available was often barely adequate to meet balance of payments needs. It was tempting to blame those institutions that continued to be involved in discussions and whose terms appeared linked with those of the nonavailable private or governmental funds. However, it was also clear to most that the international institutions were not themselves responsible for the failure of private markets of the inadequacies of other forms of official aid. President Julius Nyerere of Tanzania, a very sharp critic of Fund policies in Africa, acknowledged that “the IMF is among those who recognize that the money it can make available in return for these conditions bears no relation to the need.”26 The system appeared fundamentally political because it involved international institutions and creditor governments in constant and explicit judgments about the nature of policy in debtor countries.
The nature of an appropriate policy response by debtor governments was highly controversial at the beginning of the sustained low-income country debt crisis. The World Bank Report of 1981, sometimes known as the “Berg Report,” on Accelerated Development in Sub-Saharan Africa, set out a series of criticisms of African government policies and insisted on the need to regain market shares for exports, on the centrality of appropriate exchange rate and trade policies, and on the need to “adjust.” It was often believed to be the conceptual blueprint for the World Bank’s structural adjustment lending programs.27 The system seemed to be blaming the states; and the states responded with a completely antagonistic approach and tried to limit and reduce their links and contacts with the world economy. The Organization of African Unity (OAU) had produced one year earlier, in 1980, the “Lagos Plan of Action for the Economic Development of Africa,” heralded by Nigeria’s President Shagari as “the commencement of Africa’s struggle for economic independence.” The program envisaged increased regional and subregional cooperation, leading to an elimination of tariff barriers throughout the continent, and a major increase in industrial output as well as the attainment of food self-sufficiency by 1990.28
In the course of rethinking the debt crisis over the next five years, a compromise position between the two extremes emerged. International financial institutions recognized that part of the debt problem had come from the unexpectedly sharp deterioration of the terms of trade (by 50 percent in the 1980s, according to one IMF official),29 and from the global rise in real interest rates, The 1982 IMF World Economic Outlook explained that; “The weak demand in industrial countries for primary commodities induced shortfalls in African export volumes that were largely unexpected, but have turned out to be substantial.” 30 At the same time, the severity of the fall in output and the extent of impoverishment brought almost every country to recognize the contribution that could be made to a solution to the crisis by the adoption of appropriate policy. The OAU’s 1985 “Priority Program for Economic Recovery” quite candidly acknowledged the contribution of domestic policy failures and argued for reform with an emphasis on growth.
Part of the new general consensus that gradually emerged during the late 1980s between international institutions and poor countries supposed that structural adjustment would be impossibly harsh without the provision of some measure of concessional support to cover the period of transition (since the other parts of the international financial system, private and official transfers, were not flowing easily). The new mood developed in part out of the general criticism of IMF conditionality in the early 1980s, which had produced a widespread belief that the term was too charged with unpleasant political connotations to be any longer useful. As a consequence, bilateral aid was rarely linked with IMF programs. The European Community, whose development division described IMF policies in Africa as simply “too brutal,” made its credits to African, Caribbean, and Pacific countries under the Lomé convention subject to a vague “policy dialogue.”31
In March 1986, the IMF created a structural adjustment facility (SAF), with resources of SDR 2.7 billion ($3.2 billion), which could be used by the 61 countries eligible for loans from the International Development Association (IDA), in the case of balance of payments difficulties. The SAF was financed through repayments on previous loans to the IMF’s Trust Fund (which had already been established in the 1970s to provide similar concessional support, and financed through the sale of part of the IMF’s gold stock). At first the amount available was set at 47 percent of the member’s IMF quota, though later the amount was raised to 70 percent, at a low rate of interest (0.5 percent), with repayment over five and a half to ten years with a five-year grace period. It was to be accompanied by the formulation of a policy framework paper (PFP), prepared by national authorities together with the staff of the Fund and the World Bank, setting out macroeconomic and structural policy objectives, but also the external financing requirements (which were to be circulated among potential donors). The lending programs of the Fund and the Bank were to be mutually coordinated. Usually, the policy papers included a proposal for the strengthening of the fiscal position. An elimination of parallel or gray markets would widen the tax net, and in association with reforms of the tax administration, increase revenues. Foreign exchange flows were to be attracted into official channels from parallel markets through more realistic rates.32
The new programs reflected the conviction that if adjustment were to succeed, it would require a medium-term orientation toward resumption of growth. This would he more feasible if a macroeconomic stabilization plan were associated with microeconomic reforms to stimulate enterprise and initiative on the local level. An important element of reform included a reduction in the scope of marketing boards, with the goal of allowing producer prices to be freely determined, and eliminating highly inefficient and costly marketing mechanisms. Such an approach would also be more compatible with poverty alleviation, since it was frequently the very poor in the countryside who had been victims of the pricing policies of the marketing boards. In mid-1987, the Managing Director of the IMF, Michel Camdessus, who had devoted himself to the realization of the SAF and its extension in 1987 with a missionary zeal, emphasized that “adjustment does not have to lower basic human standards.”33
At the end of 1987, a new IMF facility with larger funding and a longer support framework was introduced: the enhanced structural adjustment facility (ESAF). It provided financing of up to 250 percent of the member’s IMF quota (with a limit of 350 percent in exceptional circumstances) for a three-year program period. Of the 19 countries that had begun ESAF arrangements by mid-1992, 15 were in sub-Saharan Africa. At a donors’ conference in December 1987, the World Bank launched the Special Program of Assistance for low-income and severely indebted countries in sub-Saharan Africa, which included additional debt relief, increased adjustment lending through IDA, cofinancing with other multilateral and bilateral donors, and coordination with the IMF’s ESAF. By the end of the 1992/93 financial year, a total of SDR 5,035.56 million ($7 billion) had been committed through SAF and ESAF, and SDR 3,741.0 million ($5.3 billion) had been disbursed. The ESAF formed a part of a more general strategy, and the most successful ESAF schemes were also those where an improvement in the debt situation brought a return to some form of access to external financing (The Gambia, Ghana, and Malawi in Africa, as well as Bangladesh and Sri Lanka).34 After the introduction of the SAF and ESAF, most official bilateral aid to poor countries was [inked to the acceptance of IMF conditionality. In this way the SAF and ESAF strengthened both the concept of conditionality and the leverage involved in IMF programs.
Did this provision of subsidized facilities mean that the IMF had “lost its virginity” or “turned into an aid agency, at least in part”?35 Or that some malign external force would not let “the IMF be the IMF”?36 In fact, the international financial institutions were stepping in because of the failures and inadequacies of other parts of the international financial system. Holding them responsible for a crisis that had originated elsewhere is rather like blaming seat belts for the severity of accidents sustained in automobile accidents. It is true that in some cases the existence of the security produced by a safety mechanism makes drivers more inclined to take risks (and as a result end up in crashes); but equally, there is no doubt that in most cases, the seat belt helps to reduce the extent of injury. The analogy can be taken further. Complaining that the institutions are damaged by the crisis is rather like claiming that car crashes have a bad effect on seat belts, and place a strain on them: this is a true, but not enormously helpful, observation. Seat belts are there to protect.
The establishment of the SAF and the ESAF brought the Fund much closer to what had traditionally been World Bank operations. With the World Bank engaging in structural adjustment lending, and the Fund active in longer-term and concessional lending, the distinction between the two institutions would inevitably blur. The overlap in functions was not new—there had already in the 1960s been tensions as a consequence—but it grew substantially larger in the mid-1980s. The Fund and the Bank had developed rather different institutional cultures.37 The Fund was much smaller (with less than a third of the staff of the Bank) and had come to pride itself on its high-level contacts with governments and central banks in an atmosphere of trust and confidentiality. Critics correspondingly accused it of being a highly and unnecessarily secretive organization. The Bank stressed openness and semipublic persuasion much more (and its critics then said that it was too prone to flavor-of-the-month faddishness in terms of the criteria it applied in lending).
In 1989, a series of initially rather tense discussions at a senior level in the aftermath of a clash over assistance to Argentina (see page 379) eventually resulted in a new concordat between the Bretton Woods twins, a more detailed revision of the 1967 agreement. The Fund’s management began by complaining that the Bank saw the two institutions having parallel responsibilities for a wide range of economic policies and wanted to achieve a consensus with the Fund about these policy issues; while the Fund believed that it had “unique responsibilities” in macroeconomic management.38 The Bank eventually agreed that it would in general limit adjustment lending to countries having concurrent stabilization programs with the Fund; and the managements agreed that there should be regular meetings of senior staff (in particular between Fund area department directors and Bank regional vice presidents).
The most difficult aspect of the negotiations had always focused on the delineation of respective responsibilities. The section of the concordat that dealt with the respective responsibilities of the Fund and Bank was not in the event entirely clear. The IMF has, the agreement stated, “among its purposes the promotion of economic conditions conducive to growth, price stability, and balance of payments sustainability and is required to exercise surveillance … over the performance of its members as defined by Article IV.… The Fund has focused on the aggregate aspects of macroeconomic policies and their related instruments,” On the other hand, the World Bank “has the objective of promoting economic growth and conditions conducive to efficient resource allocation, which it pursues through investment lending, sectoral and structural adjustment loans.… In these areas, except for the aggregate aspects of the economic policies mentioned in the previous paragraph, the Bank has a mandate, primary responsibility, and a record of expertise and experience.”39 The distinction between the aggregate aspects of policies and all other aspects was not a neat one, and could not be so, especially at a time when more and more experts and practitioners were insisting that it was essential to pay attention to the micro aspects of macro policies. The uncomfortable proximity of the Fund and the Bank had arisen not just out of the ambiguity of the original Bretton Woods agreements. It had been clear since the 1960s that short-term balance of payments problems could not be treated in isolation. It was the failure of other parts of the international financial order in the 1980s, in particular with respect to poorer countries, as well as the weakness of policy in many poor countries, that required either the formulation of a common approach and a basis for understanding, or the entire surrender by one of the two institutions of its responsibilities for dealing with the poorest countries.
The IMF and the World Bank were limited in their room for maneuver by their practical inability in low-income countries to act as a catalyst. Ideally, private flows would follow after an official program had demonstrated the resolve of a government to create stable conditions. Unlike in more prosperous cases, however, flows of additional resources rarely resumed with the conclusion of a package; it was consequently harder to pay off debt to the IMF and the World Bank. As a result, a more radical approach to Low-income indebtedness was required. The fundamental issue of debt outstanding to official creditors was only tackled in 1988 at the Toronto G-7 summit; but the discussion excluded debts owed to the Bank and the Fund. At Toronto, after a Franco-British initiative, the major industrial countries adopted what was termed a “menu” approach in which the creditor governments could choose between three options in the case of SILICs: first, a partial write-off (of one third of the outstanding debt) and a rescheduling of the rest; second, longer repayment terms (25-year maturity, with a grace period of 14 years); and third, a reduction of interest rates (to the lowest of 3.5 percent below the commercial rate or half the commercial rate) with repayment over 14 years with an 8-year grace period. The grace periods amounted, of course, to an additional reduction in the discounted value of the debt. These plans were then adopted at the Annual Meetings of the Bank and the Fund in Berlin, and applied in five sub-Saharan African countries by the end of 1988, and in another ten in 1989.
These terms proved insufficient to remove the burden of the debt overhang (the impediment and disincentive to reform posed by the fact that increased production and exports would work primarily to the benefit of the creditor, and less to that of the reforming country). Debt owed to the Paris Club creditors in fact only amounted to about a third of the total debt-service costs of the first group of countries given relief under the Toronto terms.40 More radical schemes were developed in the subsequent period. In September 1990, John Major, then the U.K. Chancellor of the Exchequer, proposed a two thirds reduction, with a rescheduling of remaining debt over 25 years with a 5-year grace period, and debt service made conditional on the debtor’s export capacity (again, this leaves to some extent the problem of debt creating a disincentive to export and reform). The most extensive proposal, put forward by the Netherlands Minister for Development Cooperation, Jan Pronk, envisaged the complete cancellation of all official bilateral claims for debt-distressed low-income African countries. All of these suggestions, however, left unaffected the debt owed to the Fund and the World Bank.
The obstacles to a wider application of debt relief lay partly with the worsening fiscal situations of major industrial countries, which made debt cancellation politically more controversial, and in the linkage of Paris Club (official) and London Club (bank) relief. If Paris Club debts were to be radically reduced, should the same principles not apply in the case of commercial bank loans? Otherwise, the operation would appear to be a bailout of bank losses with the taxpayers’ money in the industrial countries. But if such a loss were imposed on banks, would it not obstruct the recommencing of the desperately needed credit flows?
The case for some general settlement became at the same time more pressing: not least because, under the uncertainly about low-income debt, bilateral official credit flows had been following the path already taken by commercial bank credit and gradually drying up. In every year since 1986, the net flow of bilateral debt to low-income countries has been lower than in the previous year (see Table 15-1). As commercial and bilateral Transfers fell, countries became more dependent on multilateral institutions. This increased dependence naturally raised the issue that had been fiercely debated since the early 1980s about the appropriate form of conditionality.
A vast literature has been produced on the effect of IMF programs. Disappointing results have often been taken as evidence of program misdesign. But it is important to remember that programs are only launched in already difficult circumstances, and that the only appropriate way of judging the effects of a program is to make a comparison between the actual outcome and the likely outcome (“what would have been”) in the absence of a program.41 In practice, this is a very difficult exercise, which inevitably gives room for a considerable amount of subjectivity in constructing the counterfactual.
Many programs ran into difficulties because they were based on inadequate original estimates and assessments of the financial extent of the problem. In the early 1980s, in the almost inevitable absence of accurate data on the extent of the debt burden,42 and because of the need to work with very limited financing, there was a constant temptation to include rather optimistic assessments of likely commodity price developments simply in order to be able to construct any kind of program. The result was that performance in the case of program countries, particularly where the emphasis had been on demand constraint, appeared very disappointing in terms of growth compared to the original estimates.43
Judging the success of programs is additionally complicated because the elements of program design were by no means standard. In the course of the 1980s, an increasing number of criteria were set (prompting a criticism that programs had become too complicated and involved excessive intrusions on national sovereignty). One set of measures often requires the taking of additional steps in order to prevent unwanted consequences. Characteristically, programs involve a commitment to a realistic exchange rate. Devaluations often produce short-term expansionary effects.44 In order to prevent subsequent inflationary developments creating renewed overvaluation and new distortions, devaluations are accompanied with a requirement to pursue a restrictive monetary, fiscal, and wage policy. Supply-side stabilization measures attempt to remove price distortions.
The most serious contemporary criticisms focused on two features. Probably the strongest case made by critics of the Fund in the early 1980s suggested that the time horizon provided in stand-by arrangements was too short, given the long-term nature of the Fund’s involvement in policymaking in many countries.45 In fact, the Fund did not expect balance of payments to be turned around necessarily within the course of the year or 18-month duration of a stand-by arrangement. But a longer program did not, it seemed, necessarily guarantee satisfactory adjustment. The lengthened time frame of the extended Fund facility had proved unsatisfactory in many of the earlier cases (see pages 328–35).
A second criticism came from commentators who believed that priorities attached by Fund officials to the removal of controls were misplaced.46 These critics, however, never succeeded in showing how a retention of controls could have prompted a more satisfactory path of economic development.
As the Fund became more and more central to the affairs of low-income countries (Julius Nyerere of Tanzania referred to it as “the International Ministry of Financiers”),47 a new set of problems emerged. Pressure to negotiate a program increased: because the alternative would have been a complete disaster in the country concerned, and because of the dependence of other credit on the Fund’s agreement. Countries that went to the Fund almost by definition found themselves already in very precarious circumstances. The precondition of the intervention was almost inevitably a balance of payments crisis. But the intense pressure applied to both sides in the negotiation. On the one hand, it made some elites in some countries feel that the extent of the concessions they made had been too great. The international financial institutions also experienced the compulsion to reach agreement. Looking at the catastrophic alternative obliged Fund officials to put together what were sometimes unrealistic packages, either from the point of view of financing or because of insufficient allowance made for negative developments in the world economy. Debtor governments frequently had their own reasons for being excessively optimistic and negotiating on the basis of shaky forecasts of future prospects and developments.
Sometimes geopolitical considerations also intervened, with creditor governments taking a strong Line about the urgency of a particular rescue (former colonial powers sometimes treated their old colonies as protégés; the United States had a particular concern for the position of Egypt in the delicate politics of the Middle East). In the case of two of the most publicized negotiations of 1987, with Egypt and Zaïre, the feeling that the Fund had been compromised by a fundamentally political logic led to the resignation of the head of the IMF’s Exchange and Trade Relations Department, David Finch.48
The accusation became endlessly repeated. At the end of the 1980s, a periodical reported that “there is a widespread feeling amongst academics, bankers and even some within the IMF that the agency has blundered badly in Africa.… In order not to pull the plug on these countries, making it inevitable that it would lose the money it had lent to them, the IMF has been softening its attitude towards countries’ compliance with its policy conditions.”49 (How appropriate was it to be so skeptical? At least in the case of Egypt, the Paris Club rescheduling consequential on the Fund agreement proved to be the beginning of a quite effective liberalization process.) The collapse of the other components of the international financial system, banks and official bilateral sources of credit, with regard to poor countries left multilateral agencies.—and, in particular, the Fund and the Bank—with an expanded task in which they needed to be active in other areas than simply a narrow balance of payments correction or the design of more projects. Circumstances obliged them to take a larger and much riskier role: in practice, this was simply the logical outcome of a development evident since at least the early 1980s.
Arrears and the Fund
The same process through which other parts of the international financial system abandoned low-income countries also led to the building up, for the first time in the IMF’s history, of substantial arrears by some member countries (see Table 15-2). (That this might happen had of course been one of the unrealized fears of the early critics of Bretton Woods in 1944–45). The arrears cases provide the most striking, and depressing, examples of the consequences of economic isolation for a country, combined with an initial overoptimism in the design of external assistance programs. It was suggested above that a vicious cycle starts operating: as the situation becomes more desperate, pressure to agree grows, and programs are concluded on the basis of inadequate figures or inadequate finance. The countries with arrears to the Fund represent one outcome of that cycle.
|Number of members||Amount|
(In millions of SDRs)
Defenders of the Fund often pointed out that obligations to the Fund could not be treated as credits subject to a process of renegotiation or partial cancellation. The Articles of Agreement had laid down that the Fund’s resources were intended to be used only in “exceptional circumstances” and to revolve among members. They did not legally constitute loans, but rather purchases of foreign currency for domestic currency with an obligation to repurchase. There was a moral point as well as a legal one: the Fund was the agency that would help recover standing in the international order, and in order to be effective, its rules required compliance. (Although it could be argued that even the acceptance of this principle might not preclude reductions of interest payments.)
Two of the four countries with the largest arrears were African (Sudan and Zambia); the other two were Peru and Panama. These cases were preceded by years of increasing and apparently semipermanent Fund involvement. In many other arrears cases the original circumstances were rather different, and the problem reflected less specifically economic circumstances and difficulties than extreme political instability and domestic and foreign war: this was the case in Cambodia, Liberia, and after 1990 in Haiti, Iraq, and Zaïre.
After the oil price rise of 1973–74, Sudan hoped to use some of the new income of its neighbors and develop, by means of large-scale agricultural projects, into the “breadbasket of the Middle East,” as well as emerging as a major cotton producer. As early as 1978, it became clear that most of the new investments had failed. Development had been financed by heavy borrowing on commercial markets, but the returns were insufficient to meet the cost of the credit. Exports dropped from 16 percent of GDP at the beginning of the decade to 8 percent. Instead of an expansion of cotton growing, the amount produced declined, and in 1981 reached the lowest level for 25 years.
In 1978, Sudan concluded a stand-by arrangement with the IMF, and in 1979 an SDR 200 million ($258 million) extended Fund facility was approved. The major elements of the program included reform and liberalization of exchange and trade, the reduction of price distortions, a restraint of domestic consumption, and the revitalization of agriculture and promotion of agricultural exports. According to the plan, cotton production would be revived, and the development of a major oil field in the south was expected to cut dependence on imported fuel. This plan was fundamentally overoptimistic. It depended on the absence of adverse external shocks: but with higher petroleum prices, the interest rate surge, and an increase in food prices, these came thick and fast. Under the impact of these shocks, the government would have had to tighten policy in order to keep on track with the program. Such a tightening, however, produced increased capital flight and made the external position even more fragile. But attempts to manage the crisis domestically, by increasing food subsidies, had exactly the same destabilizing outcome.
During the negotiations on the 1979 extended Fund facility, as the extent of the Sudanese crisis increased, the amount was increased to SDR 427 million ($552 million), but the program still broke down because of the increased fiscal deficit. The collapse of the program, and the intensification of capital flight, ruled out any chance of additional borrowing. By 1981 debt service amounted to more than 100 percent of export earnings, and a series of stand-by arrangements (three between 1982 and 1984) and four rounds of Paris Club reschedulings were needed. Because the Paris Club mechanism offered no debt relief, each round needed to include previously rescheduled debt, and the total outstanding simply snowballed. In 1983, interest due in that year had to be capitalized into the debt to be rescheduled.50 The debt situation was additionally complicated by the existence of a large Iranian claim that was not negotiated within the setting of the Paris Club. At the end of all the reschedulings, debt service due was still larger than export earnings. By 1984, the government could not meet its obligations to the IMF. Six devaluations had brought no lasting improvement in the balance of payments. Inflation and budget deficits remained largely out of control. In the light of successive failures to meet program specifications, “IMF conditionality became something of a sham.”51
Political stability disintegrated almost as quickly as economic stability. In September 1983, President Nimeiry introduced Islamic law (the sharia), with a prohibition of interest on all domestic borrowing and lending. It had an immediate impact on economic life, since banks and other creditors found inventing substitutes for interest (such as “mark up”) politically difficult. Most significantly, it reflected a shift in the regional balance of political power against the south. In May 1984, Nimeiry imposed martial law, and the country slid into civil war. In June 1984, the United States gave emergency funds to allow the settlement of arrears to the IMF, and a new and rather smaller (SDR 90 million or $92 million) program was launched, involving radical cuts in price subsidies. In 1985, the U.S. Agency for International Development made assistance available, but on severe terms, and the assistance did not prevent food riots and popular disturbances from finally toppling the Nimeiry regime. Attempts of the transitional regime to negotiate an IMF credit failed: the government agreed to a free determination of the commercial bank exchange rate, but then did not allow the market to operate. In February 1986, outstanding arrears led to a declaration of ineligibility for further IMF assistance. Throughout this period of great human agony—as civil war and famine spread—projects continued to be approved by bilateral and multilateral aid agencies, in the belief that specific schemes could be justified, while general payments that might be used to repay IMF arrears could not. As a result, contact with international institutions did not altogether cease. In 1987, a Program of Action was negotiated with the IMF (although without the provision of any funding).52 It included such telatively standard features as a devaluation coupled with an announcement of price increases for agriculture and consumer price rises. Arrears of official debt continued to accumulate, although a combination of the presence of severe humanitarian problems and political considerations meant that a net positive inflow of capital continued. After 1989, under the auspices of the United Nations Children’s Fund (Unicef), several debt-for-development swaps were carried out, with the aim of promoting water, sanitation, and health care improvements in rural areas. Debt cancellation in these cases was agreed in return for spending by the national government on mutually agreed development projects.53 At the same time, the breakdown of order led to continued outflows from the informal sector that in the past had been sustained by large-scale remittances from Sudanese working abroad. They reflected a loss of confidence as much by Sudanese themselves as by foreigners or the international system.
Was such a development inevitable? It is not necessary to assume that failed programs are an indication of an initial utter hopelessness. Some of the most successful cases of policy reorientation were preceded by a history of failed attempts at reform (Turkey at the end of the 1970s is a case in point). Two or three aborted initiatives do not necessarily mean that the infernal cycle of increased expectations of programs with decreased ability in practice to fulfill those programs will keep the country in its grip. The disaster begins when economic crisis is allowed to destroy the fabric of coherent decision making.
Arrears to the Fund were a product of a nearly complete political and economic collapse, and a demonstration of how difficult it was for countries in extreme circumstances to rejoin the international financial system. They were frequently associated with an instability in policymaking that made reform much harder. But it was not altogether impossible to escape from the trap. Zambia, which had great difficulty in formulating a consistent policy in the 1980s, provides an example.
The economy had already been badly hit in the 1970s first by production problems at the largest (state-owned and highly inefficient) copper mine at Mufulira, and then by the collapse of commodity prices (in particular zinc, copper, and cobalt). (At the end of the 1980s, copper still amounted to some 85 percent of total exports). Between 1974 and 1984, per capita income dropped by 44 percent. The disastrous decade following the first oil price shock marked the end of a particular vision of Zambian development. Under President Kenneth Kaunda, the country had followed one of the most intensive industrialization strategies in Africa. It generated exceptionally high levels of urbanization (by the 1980s some 60 percent of Zambians lived in cities), but also high levels of income inequality and social instability.
An IMF stand-by arrangement had already been negotiated in 1973 to tackle the shortfalls in foreign exchange caused partly by the drop in copper output, but above all as a result of the closing of the Rhodesian border. In 1978 a new stand-by arrangement was linked with devaluation, and a planned reduction in domestic demand, but also with meetings of a consultative group of creditor governments to bring in additional resources. An extended Fund facility was agreed in 1981, but was thrown off course by a new decline of copper output, as well as of copper prices, and was canceled in July 1982. In 1983, a stand-by arrangement associated with a government “financial recovery plan” took the place of the extended Fund facility.54 In 1984, Zambia made only a fraction of the payments due under the terms of an agreement with the Paris Club, and then it failed to repay privately held debt rescheduled through the London Club. By 1985, as a result, banks were refusing to finance oil imports. Arrears to the IMF also mounted quickly in 1984.
After years of experience of failure, and faced with an immediate and sharp crisis, the government embarked on a search for alternatives. In 1985, a “shadow program” (that is, a reform program but without the provision of resources) was negotiated with the IMF, and it became eventually the basis of a new stand-by arrangement concluded in February 1986. The shadow program provided for the elimination of food and fertilizer subsidies and the freeing of bank interest rates. According to its provisions, the collection of taxes and duties would be improved, and the overall fiscal deficit would be reduced to 5 percent of GDP. One of the reform measures also involved the introduction in 1985 of a foreign exchange auction as a substitute for complete liberalization.55 This liberalization program ran into trouble from two sources.
First, one of the characteristics of the Zambian political system had always been the rapid rotation of personnel. In accordance with this principle, in April 1986 the economic team that had launched the reforms was exchanged and replaced with a group of men fundamentally opposed to the IMF program. The Bank of Zambia began to undermine the auction principle (which was implemented at the same time also in Ghana and Nigeria) by increasing the amount that could be bid while not having sufficient available foreign exchange to match the bids. Second, large-scale riots broke out in December 1986 in the Copperbelt (with smaller disturbances in the capital Lusaka) in response to a proposal to withdraw subsidies and price controls for higher qualities of the staple food, maize meal (the subsidies were to be continued for poorer qualities). Eventually, the subsidies were restored, at an estimated cost of 4 percent of GDP.56
The riots provoked a fierce political debate about the future of the IMF program. After new rioting in the Copperbelt, the foreign exchange auction was canceled altogether. Kaunda announced a new development initiative based on the theme of “growth from our own resources.” In presenting the new course in a radio and television address, he argued that “the IMF conditionality has meant that the restructuring program, which was and still is imperative in order to lead the economy to recovery, could only be sustained through recourse to massive external borrowing.” Instead he proposed to “discard the ‘Dependency Syndrome’ which had over the years led us to believe that external financial institutions … can solve our problems for us.… We chose the way of IMF of our own free will. Again of our own free will we have decided to try another way. We did not, 1 believe, offend anyone when we employed IMF methods. I believe we shall offend no one now when we choose this other way.57 The program would make agriculture a priority sector, and would also create a new Export Import Bank to promote and finance a “massive export drive.” The objectives of the new course in fact looked quite similar to those of the 1985 reforms, but with the one very obvious difference of a break with the international system.
Part of the new “national” alternative involved the limitation of debt service to 10 percent of net foreign exchange earnings and the inclusion of IMF resources in the unilateral default. In practice, the new course produced higher inflation, food shortages, and a renewed fall in per capita income. Eventually, discussions began again about a rapprochement with the international system. But the policy framework remained fundamentally incoherent. Memories of the violent lurches between 1984 and 1987 away from and then toward and then away from the international system were too recent. Uncertainty and policy failure provoked an internal process of reform, which included political change and a democratization that offered a stronger basis for the conclusion of consistent policies. At the end of 1990, the government’s ban on alternative parties was lifted, and in October 1991 a multiparty election brought the previous opposition into power, which very quickly began to implement economic reform. The Zambian trajectory resembled that elsewhere—in Turkey in the 1970s and the Philippines in the early 1980s, for instance—where the mismanagement of debt provoked and also required a political transformation.
The general problem of arrears to the Fund was tackled at the international level through the adoption in May 1990 by the IMF Interim Committee of a “rights approach.” Rights could be “earned” during the period of an adjustment program monitored by the IMF, which would be used for future financing once arrears were cleared. In November 1992 the Third Amendment of the Fund Articles of Agreement came into force, allowing the Fund to suspend the voting of any member that fails to fulfill any of its obligations under the Articles, other than obligations with regard to SDRs. In other words, persistent arrears could be penalized by the suspension of voting rights.
Juridical constructions surrounding the arrears problems, however, were only partial remedies to a problem that was incapable of solution by the Fund alone. As long as there is a large debt overhang (from the official sector), it is unsurprising that some governments began to treat Fund resources as only a variant of official credit. In the worst variety of the debt trap, if Fund resources appear relatively small in comparison with other external means of assistance, they may be treated, logically enough, as a rather unimportant part of development aid. The incentives to rejoin the international system will then appear as negative. The problem of arrears requires for its satisfactory solution agreements on the proper consolidation and reduction of official debt, in association with an economic reform program. There are some useful historical precedents, which were agreed when the debt problem was less of a global concern (it is clearly easier to produce such solutions when fewer countries are involved). The best model is perhaps that adopted by Indonesia in 1970, where a 30-year debt consolidartion was accompanied by a marketization of the economy, which eventually produced an example of an “Asian miracle.” But Indonesia, like the Zambian example, shows that a solution to the debt problem can only be achieved part passu with the implementation of internal reform. It may eventually be possible to envisage circumstances in which some mechanism for reducing debt owed to the IMF and the World Bank would be appropriate.
Hopes for Successful Adjustment
Countries that adapted much more successfully to the new international environment of the 1970s and 1980s usually did so because their political structure made them less insistent on large-scale industrialization strategies. Often they had gone through the same cycle of misery and deprivation in the wake of the shocks of the mid- 1970s, and often the experience of repeated crisis had been a spur to rethink the nature of policy. Kwesi Botchwey, one of the principal architects of Ghana’s turn toward a market strategy, expressed the experience epigrammatically: “Structural adjustment is very painful, but structural maladjustment is much worse.”58
Ghana, which had become independent quite early, in 1957, had begun with considerable prosperity and great hopes. The 1960s and 1970s saw a tremendous economic and political collapse, primarily the result of a destructive policy designed to discriminate against the countryside, and which ended by producing a vast and overpaid urban bureaucracy. One example often cited is the monopoly organization for collecting and exporting cocoa, Cocobod, which over 20 years increased its number of employees from 5,000 to 100,000, even though the amount of cocoa actually marketed dropped by a half.59 At the beginning of the 1980s, drought and severe food shortages produced general demoralization. Discussions about economic reform started, at the same time as a radical populism demanded a restructuring of politics, and led to a ferocious campaign against corruption. The slogan of “self-help” brought an attack on the notion of a rural-urban divide. For instance, groups from the towns were organized to work in the cocoa fields. The shaking up of Ghanaian society in the early 1980s may have facilitated the process of economic adjustment later in the decade in that the market appeared as a valuable ally in the struggle against corruption. Officials and politicians had used controls in order to extract benefits for themselves. Academic analysts noted subsequently that in 1983, “a market-oriented system was seen … as the best way of establishing a noncorrupt economic system.”60
From 1982, talks took place with the IMF. They were filled with considerable tensions over the extent of devaluation, and the Fund’s wish to use the black market rate as a guide to the required alteration of the exchange rate.61 In April 1983, the government launched a three-year Economic Recovery Program, which was supported by three IMF stand-by arrangements. The cedi was progressively devalued from 1983 to 1988 (with an auction system introduced in 1986). The budget provided for increases in basic consumer prices, but also for a near doubling of the price paid to producers of cocoa. As a result, cocoa exports gradually rose.62 Apart from price liberalization, fiscal restraint played a major part in the program: the government proposed to reduce its overall budget deficit from 4.7 percent of GDP in 1982 to 2.5 percent in 1984.63 Government subsidies were cut back. Later in the year petroleum prices were allowed to rise. In 1984, the investment code was revised so as to make capital inflows more attractive. The April 1983 program, and the price rises, led to immediate protests, but the program was very vigorously defended in a public address by the Chairman of the Provisional National Defense Council, Jerry Rawlings.
The process of marketization and price liberalization accelerated during the second halt of the decade. A second Economic Recovery Program for 1987–89 was supported with extensive resources from the World Bank (in 1987 Ghana was the third largest recipient of IDA funds) and by an extended arrangement under ESAF with the IMF. After 1987 a privatization program began, with an initial divestment of 32 public sector enterprises. Remarkably, the program survived despite a savage setback inflicted by price developments on the commodity markets, although its implementation was rather slower than had originally been hoped. The strength of Ghana’s reform lay in significant fiscal improvement, a realistic exchange rate, and improved domestic prices for cocoa producers. Between 1984 and 1991 the international price of cocoa fell by over 50 percent; yet at the same time Ghana returned to real rates of growth of around 5 percent after 1984.
The reasons for the relative success of the Ghanaian program Lie primarily in a willingness to ignore urban insistence on cheap food and to apply market mechanisms to rural produce, thereby increasing production. The most striking feature of the political regime was the extent to which it was prepared, because of the strength of its anticorruption commitment, to ignore the often vociferously expressed demands of urban elites and as a result to reject demands for fiscal relaxation and higher spending. It built its popularity in a different fashion, supporting the adjustment process through a series of special projects providing basic services to the poor (health, nutrition, education, and shelter), and through community initiatives. (The programs were referred to collectively as Pamscad: Program of Actions to Mitigate the Social Costs of Adjustment.) In addition, the reforms were pursued consistently by a coherent reform team of well-informed technocrats. President Jerry Rawlings once made a remark, which subsequently became frequently quoted, about economics, which implied that these sorts of problems should best be left to the experts: “1 don’t understand all these theories, all this economic blah blah blah.”64 In the light of the damage done in the past by erroneous theory, such an extent of political modesty may have been very helpful.
The pattern of a successful adjustment being associated with the willingness to swing the rural-urban balance back in favor of rural producers (or at least not to distort prices grotesquely to their disadvantage) is evident in other experiences. Raising rural producer prices has been a critical element in campaigns to increase food production. Examples of such transformations can be found in Côte d’Ivoire, where rural entrepreneurs moved into a gap between the formal and the informal sector; or in Zimbabwe, where farmers benefited in the first half of the 1980s from a rise in producer prices and from improved access to credit. The application of new technologies, insecticides, hybrids, and fertilizers led to a doubling of maize production in Zimbabwe between 1979 and 1985.65 As a result, it was much easier to manage the transition from the early post independence euphoria about industrial development to a more balanced policy approach. The Transitional National Development Plan with wildly overoptimistic growth targets collapsed in 1981, In 1981 and 1982, the government tried to support the economy through heavy short-term foreign borrowing, but this became increasingly difficult. In 1983 Zimbabwe negotiated an IMF stand-by arrangement, which marked the beginning of an era of stabilization and slow Liberalization, Almost a decade later, with a new reform initiative of 1991 and supported by an ESAF program in 1992, the process of trade liberalization was accelerated despite the major problems created by a severe drought.
The experience of successful adjustment raises the question of whether it would not be equally possible to undertake the basic features of stabilization (budgetary consolidation, elimination of price distortions, and privatization or commercialization of the public sector) without external assistance. Botswana in the early 1980s provides a striking instance. Responding to the kind of external shock that elsewhere frequently sent policies off course (in this case a sharp fall in diamond prices), imports were cut back between 1983 and 1985 and the budget was stabilized (after 1982 relatively small fiscal deficits were followed by large surpluses). After 1984 Botswana showed consistent current account surpluses.
Self-adjustment is most attractive in cases where balance of payments constraints are less pressing, often as the result of substantial natural resource endowment, and where contacts with international capital markets have not been entirely severed. In middle-income developing countries, there have been some spectacularly successful cases of countries that adjusted earlier in the 1980s, could achieve higher levels of growth, were able to attract substantial inflows of capital during the adjustment period, and did not need the (financial) support of the Bank and the Fund (although there may have been substantial informal contacts). Malaysia and Indonesia have been treated as models in this regard.66 Most countries, however, have a substantial financing gap and require a flow of resources so large as to make self-adjustment an impossibility; here external support is essential. In addition, there are dangers in the process in that the momentum of reform is easily lost in the absence of outside financing and advice.
The most powerful warning example is Nigeria, where in the second half of the 1970s, oil revenues produced a large fiscal income, but also affected the balance of payments so as to cause problems for the non-oil sector, a Nigerian version of Dutch disease. By the early 1980s, capital flight became a major problem. The government of General Babangida in 1985 began with an inherited suspicion of international financial institutions, Nigeria conducted a long public debate about the merits of the “IMF approach.” Most of the opinion expressed was highly critical: on the lines of “the IMF loan is a Trojan horse,” of rather three (devaluation, trade liberalization, and the removal of petroleum subsidies). “The first two will facilitate the admission of the Greeks into Troy and the last will ensure that Troy does not recover from the pandemonium that will come.”67 Urban workers threatened to go on strike if a Fund program were implemented. Perhaps as a response to this national debate, which culminated in a referendum overwhelmingly rejecting “Fund solutions,” the government adopted a half-solution in 1986. It negotiated a one-year SDR 650 million ($763 million) stand-by arrangement, but decided not to use the resources made available in this way.68 Adopting the stand-by arrangement made possible a rescheduling of debts with the Paris and London Clubs (the official debts were rescheduled in December 1986, the commercial bank debts in November 1987).
The government’s self-devised and self-styled Structural Adjustment Program envisaged some of the standard elements of African economic reform: the introduction of a foreign exchange auction, a cut in subsidies for petroleum and fertilizer, the abolition of agricultural commodity boards and the freeing of agricultural prices (a major step toward reform), and the commercialization or privatization of many state enterprises (including the restructuring of the Nigerian Electric Power Authority and Nigerian Telecommunications Limited). Fiscal restraint and a wage freeze would prevent the emergence of an inflationary spiral. A revealing example of how the urban-rural balance was affected is provided by the behavior of the Ondo State Public Service. When the fiscal austerity program resulted in a four- to six-month period without pay, many civil servants went to work in agriculture.69
Characteristically, the program was opposed by some foreign companies with plants in Nigeria and by the Manufacturers Association of Nigeria (which called for reflation and the reintroduction of protection). Labor unions protested against the wage freeze and against the proposed elimination of the petroleum subsidy. In 1988 strikes and violent protests demanded a change of course by the government.
The commitment of the authorities to the shadow program of their own devising was always ambiguous. In 1988, under the impact of the protests and demonstrations and the violence in the universities, the government budget deficit increased.70 Some opponents of the regime thought that the fiscal issue was at the center of the dispute with the Fund. The Finance Minister in Babangida’s first government, Kalu Idika Kalu, was quoted as saying: “One reason they rejected the IMF was that they did not want all that inspection of their finances.”71 The program proved to be unsustainable. The petroleum subsidy, politically the most sensitive issue of all, remained fundamentally untouched. The architects of the plan later regretted that it had not been conducted directly under the auspices of the IMF: it is good, they said, to take an appropriate medicine, but it is really best to do it under the supervision of an excellent physician. In some cases, the physician may be the only possible source of assistance, but even less sick patients might benefit from additional guidance, and additional support, on the way back to health.
Much of the experience of Africa over the past two decades has been profoundly dispiriting, disappointing, and disillusioning. Is there any reason to believe that the future will hold a change? One commentator came to the conclusion chat “the unfortunate reality seems to be that neither the World Bank not the IMF (not indeed the African governments concerned or the academic and UN communities) as yet have a coherent conception of an exhaustive set of interventions, policies, programs, or investments that might represent sufficiency in this context.”72 This seems a good example of how not to pose the African problem, or indeed any other question in international economics. Did Economics Minister Ludwig Erhard, or President Park, or Minister Turgut Özal, or Finance Minister Leszek Balcerowicz have an “exhaustive set of interventions and policies”?
A number of lessons can be learned from the cases of successful adjustment. They apply more to the general policy environment than specifically to the design of programs by international financial institutions. Learning these lessons may draw the institutions into ever more complicated and problematical tasks concerned with the management of micropolicy. But the risk of not using these results of experience is that the programs may replicate the hardship involved in successful adjustment without producing long-term benefits.
First, the process of adapting economic structures can never just be accomplished by the diktat of a technocratic elite. Such a top-down approach is likely to provoke widespread discontent. It courts the risk of a sudden reversal of policy. (Some countries, for instance, after liberalizing were subsequently forced to resume the administrative control of foreign exchange allocation: Kenya, Madagascar, and Nigeria.)73 Adjustment frequently increases the resources available to a large number of people; devaluations, for instance, often bring benefits to the ill-organized rural majority. In this way, the consequences of adjustment are frequently actually anti-elitist, helping majorities against powerfully organized special interests.
Greater social cohesion can help to make more bearable the strains inevitably created by the transition. Targeted interventions to reduce poverty and prevent starvation are an important part of the effort to increase the resilience and the adaptability of societies. One feature of many low-income countries that stands out in a statistical cross-country analysis (and that contrasts remarkably with the experience of many rapidly growing economies in Asia) is the prevalence of extremes of income disparity.74 Tackling this through the extension of education, by the provision of greater opportunities, and through the guarantees of a rule of law is an important social precondition for effective economic performance. And economic performance, in turn, is justified and in the longer run only sustainable if it accords with the demands of justice. The prospects of a combination of economic and political transformation are higher after a democratic transition of the kind that Africa began to experience in the early 1990s. The process of building confidence needs to take place on several planes simultaneously; and in that case, each achievement will reinforce the others. For instance, in terms of credit relations, better performance at a local level will help to keep capital in the country and reverse capital flight, and this serves as a signal of strength to the international market.
The most common form of current criticism of Fund and Bank programs is not so much any longer that they are too harsh or restrictive, but rather that programs worked out by Western-educated political elites in association with international civil servants are likely to be unfamiliar with local cultures and insensitive to the local environment. In short, desirable macro-reforms may not deal adequately with the issue of how to secure reform on the micro level, so that there is a more adequate response to an improved macroeconomic environment.75 This is both a more realistic and appropriate critique than the older one, and one much more difficult to deal with, How should programs and policy recommendations best be attuned to the circumstances of daily life?
The second major lesson of adjustment and growth policies is relevant in this regard. There is a long-standing and increasingly powerful recognition that large overstaffed state firms can stand in the way of growth. Privatization, at least of nonstrategic enterprises, found advocates in Zaïre in the late 1970s, and in Kenya since the early 1980s; but relatively little action occurred. In most cases, the largest enterprises, holding the bulk of public assets, in transport, mining, and utilities, have not been privatized. Privatization, however, has worked frequently as a way of restoring or creating incentives to employees within enterprises as part of a program of employee participation.76 It is important not merely to create incentives within firms. Rather than privatizing effective monopolies, a wide range of different enterprises at different levels, making their own independent judgments, is desirable. Privatization may also encourage the inflow of foreign capital that is not subject to the constraint of the credit flows described above: it may lead in particular to higher levels of foreign direct investment, and these may be associated with transfers of skills and technology, A favorable regulatory environment is needed, with a removal of restrictions, but the availability of the right kind of technology is also a major element in fostering the right kind of growth.
Finally, all societies can benefit from the exchange of the products of different sorts of human skill—not just within countries, but also across national barriers. But for that exchange to occur smoothly requires the operation of a sophisticated system of credit and trust that also reaches across frontiers. International institutions can and should facilitate the operation of that system: but when they are forced by circumstance to attempt to make themselves into a substitute for the system as a whole the results cannot be expected to be satisfactory. Unfortunately, this was the situation that produced the African catastrophe of the last two decades. But recognizing what went wrong is in this case at least a necessary preliminary to putting matters to right.
Often this chapter has described developments in terms of a vicious cycle. This cycle needs to be arrested and reversed. Reforming domestic economies and building a functioning international financial system are not two logically disparate tasks, but rather part of the same endeavor.