Introduction and Overview
  • 1 0000000404811396 Monetary Fund


The decision of the International Monetary Fund to hold seminars on a periodic basis in various countries gave rise, in the Buenos Aires seminar, to an event whose importance was particularly evident. During the two and a half days of exposition and debate, economists from the Fund, the World Bank, the Massachusetts Institute of Technology, and various Latin American countries (Argentina, Brazil, Colombia, Ecuador, Mexico, and Venezuela—from universities, banks, private Financial organizations, central banks, ministries of Finance, research institutes, planning institutes, etc.) met to share opinions and ideas put forward by colleagues representing diverse approaches to desirable economic policies. Nonetheless—and this is what makes these seminars attractive, in my view—the majority of the participants, in the final analysis, always revealed a significant degree of modesty, in that they did not claim to have the perfect answer of how to adjust without internal and external costs and in such a way as to bring about sustained growth without distortions.

The decision of the International Monetary Fund to hold seminars on a periodic basis in various countries gave rise, in the Buenos Aires seminar, to an event whose importance was particularly evident. During the two and a half days of exposition and debate, economists from the Fund, the World Bank, the Massachusetts Institute of Technology, and various Latin American countries (Argentina, Brazil, Colombia, Ecuador, Mexico, and Venezuela—from universities, banks, private Financial organizations, central banks, ministries of Finance, research institutes, planning institutes, etc.) met to share opinions and ideas put forward by colleagues representing diverse approaches to desirable economic policies. Nonetheless—and this is what makes these seminars attractive, in my view—the majority of the participants, in the final analysis, always revealed a significant degree of modesty, in that they did not claim to have the perfect answer of how to adjust without internal and external costs and in such a way as to bring about sustained growth without distortions.

Following is a summary of the main arguments advanced by each speaker, immediately followed by a synthesis of the comments of the discussants, and of the discussion that spontaneously occurred throughout the sessions. The section concludes with some final observations.

World Economic Outlook and Prospects for Latin America

The principal message contained in Anthony Lanyi’s substantial paper is that in the past five years there has been a kind of awareness among specialized public opinion—perhaps to a greater extent than in government departments—of a basic fact; the interdependence of the world economy. The developed countries and the developing countries are interdependent; the debt crisis among the latter endangers the financial stability of the former, while any growth crisis in the capital importing developing countries significantly affects employment in the developed countries. This is a reality, despite our “small country” assumptions so prevalent in the economic analysis of open economies, which can nonetheless be reinterpreted, as does the author, by assuming that the impact on the developing countries of events in developed countries is stronger than the opposite phenomenon.

The author distinguishes two major crises in the post-1982 period. The first of these, the growth crisis, began in the 1970s as a result of the slowing down of growth in the more developed countries; the second, the debt crisis, began at the end of the 1970s with the increase in the debt of countries that were seeking to increase their growth rate within the context of a slow-developing world economy.

The author devotes a good part of his paper to a factual analysis of both crises. He explains the slackening of growth in the developed economies (a) by using recent statistical data, (b) by quantifying a range of hypotheses that emphasize medium-term (1988–91) trends, which he calls “the IMF hypotheses,” and (c) by discussing various aspects of the economic policies of these economies.

He next explains the causes of the debt crisis in the developing countries, dividing the latter into three main groups—those with and without recent debt problems and those of Latin America. For the developing economies, the author also explores (a) the origins of the debt crisis and recent data, (b) medium-term prospects (1987–91), and (c) some aspects of their economic policy.

Within this analytical framework the author asks a vital question, while at the same time establishing the limits of a possible answer: What can be done about the growth crisis without making the debt crisis worse?

The paper notes the lack of consensus in the developed countries regarding the underlying reasons for the slowdown of growth. However, various policy measures could help to rectify the situation, such as greater financial stability, a reduction in the proportion of resources absorbed by the public sector (despite the considerable ignorance that still exists concerning the long-term effects of this reduction), an attack on market rigidities, on which he observes correctly that market imperfections should not be regarded as unalterable facts of life; they can be impacted through specific programs, several of which are still at the experimental stage.

Regarding the developing countries, the author displays a notable intellectual balance in stressing that the debt crisis is the result not only of inappropriate policies in the developing countries (of which we are all aware) but also of exogenous factors in the international economy that hurt the developing countries, such as the increase in nominal interest rates in the major countries (1979–80), which affected the servicing of debt through variable interest rates; the increase in real interest rates as the world prices of primary products declined; the appreciation of the U.S. dollar (1981–84), reflected in the falling international prices of tradable goods; the increase in the price of oil for oil importing countries and for the non-oil exporting countries; and the reduction in external demand as a result of the recession in the major developed countries. The author also mentions the probable dangers for the developing countries of having to plan their economic policy in the context of the heavy burden of external indebtedness which include the assumption that there may be good prospects for a major increase in their foreign trade on the one hand and/or of obtaining significant official assistance for their development on the other.

This brings us to the central question of this paper; What can be done to solve the growth crisis without worsening the debt crisis? In the first place, Lanyi considers that there is wide scope for debt renegotiation, and, in the second place, he clearly and decisively rejects (a) any repudiation by the debtor countries of their debts and (b) the refusal of the developed countries to alleviate the debt situation.

The first commentary on Lanyi’s work dealt with the diagnosis and the prognosis that clearly emerged from his analysis. Regarding the diagnosis, the commentator “saw” a prescription in the paper: the indebted countries have behaved badly and so must mend their ways and do things properly. In part, the commentator agreed; what they were seeing was the end of the import substitution model and of the idea of bringing about growth through rapid indebtedness. This was recognized and accepted in principle as a change in the right direction, but it had to be asked whether this change would actually occur. For it to happen some things had to alter, and the commentator asked why Latin America had adopted import substitution policies that were then backed up by borrowing. Certainly, mistakes had been made, including analytical errors, but in many developing countries social forces constrained policymakers, and there were social limits. It was not only productive resources and geography that mattered; one also had to consider the social characteristics of some of these economies, which identified them as naturally more dirigiste, a fact which could not be cured by economic policies alone. Raymond Aran said: “These are countries where the State builds the Nation and not the Nation the State.” Since these structures could not easily be dismantled, it was not possible to apply general recipes; on the other hand, it was not possible to do nothing and just leave things as they were.

Regarding the prognosis, the commentator noted that Mr. Lanyi’s paper said nothing about the probable evolution of the financial system, from which it could be inferred that everything would stay the same. If this happened, not everyone would be happy, and probably not the Fund either. It would be better for the creditors to recognize explicitly that they had lost part of their capital, because, even if they wished to do so, many debtor countries could not continue along the present path without a strong probability of facing bankruptcy and/or deep recession.

The commentator summed up with a plea for common sense, namely that more time should be given to the debtor countries, capital losses should be absorbed, and a new start should be made by making room for the necessary structural changes that respected the social constraints already mentioned.

Another commentator referred to the need to take capital losses into account in the projections in Lanyi’s work. The explicit absence somewhat undermined the projections, in that it reduced the probability of their being fulfilled. Also, since these projections related to a scenario already so intrinsically uncertain, the question arose as to what contingency measures were envisaged and what was the role to be played by the international lending organizations in helping to promote the acceptance of these losses.

In some of the comments on this paper, the author was regarded as very concerned to point out the “faults” of the most indebted developing countries and the “virtues” of other, less-indebted developing countries. These speakers did not regard this as a very felicitous classification in view of the great structural diversity of the countries within each group, which contained countries as structurally different as the Republic of Korea, Bolivia, and Mexico. One commentator touched on a recurring theme of this seminar, namely that of defining the notion of structure in a developing country, along with the degree of its immutability or flexibility. In this sense, virtue or blame became functions of the structural characteristics of each economy, although it was clear that on occasions the policies of some developing countries left a great deal to be desired. However, it was noted that the structure of an economy, with which virtuous characteristics were frequently associated, is the direct result of the economic policies carried out by the authorities.

The structuralist theme closed with an important observation regarding general equilibrium, which identifies the initial structure of an economy as the sum of previous policies at t = 0, but also as a function of the institutional characteristics that clearly are independent of these policies. But if they are independent, there may be an initial sequence of mistaken policies, and the process of correcting these (the prerequisite of any structural reform) will necessarily take time, basically owing to our lack of knowledge concerning the complexity of this process of indebtedness, which is frequently at odds with stabilization policies, thereby making comparisons unilluminating.

The discussion on this paper ended with a reference to the need for a sensitivity analysis that quantified the influence of the economic policies of the countries of the Northern Hemisphere on the various debtor countries, broken down according to their structural characteristics. It would be desirable that a work of this nature should explore the prospects for greater coordination of macroeconomic policies by these countries and the role of the Fund in this context (a recurring theme throughout this seminar, which is taken up in the concluding observations).

Impact on Debtor Countries of World Economic Conditions

To investigate the impact that macroeconomic events in the developed countries have on the debtor countries, Rudiger Dornbusch presented two models, one real and one financial. The real model is a simple one of the Mundell-Fleming type, though expanded. It corresponds to a small country participating in the international capital and primary goods markets, though not in the nontraditional exports market. Three kinds of internationally tradable goods are distinguished: traditional exports, nontraditional manufactured exports (imperfect substitutes for similar goods of foreign origin), and competitive importable goods.

The real model can be reduced to a system of two independent equations that determine endogenous variables, real absorption capacity, and the terms of trade between nontraditional exports and competitive importable goods. The international interest rate, external indebtedness, and the international price of oil are taken as exogenous.

With this model the author undertakes various exercises. First, comparative static analysis is used to illustrate the effects of external shocks such as a rise in oil prices, an increase in the external interest rate (interpreted in the model as the intertemporal terms of the trade), and a reduction in the conventional exogenous terms of trade for traditional exports.

Second, the author examines social well-being by analyzing the process of adjustment to these external shocks, First by considering a distortion-free economy that maximizes the utility of households and firms, and is subjected to constraints between two periods. The author finds that even under these ideal conditions the external shocks that cause the terms of trade to deteriorate also affect levels of well-being adversely, since to go into debt to finance disequilibrium, rather than adjusting it, is a suboptimal option, except when the shocks are purely temporary. When capital market distortions or credit rationing are introduced, the endogenous terms of trade deteriorate (real depreciation of the exchange rate) because it becomes necessary to adjust to temporary shocks also, all of which intensify the effects of the initial shock on levels of well-being.

Other “special effects” analyzed by the author that increase the cost of adjustment and the impact on well-being of external shocks include, for example, simultaneous adjustment by various debtor countries seeking to expand their exports at the same time (which causes a deterioration in the terms of trade or real depreciation, both regarding manufactured exports and traditional exports), and ends in a worldwide glut of developing country exports.

The financial model contained in the second part of the work is used to discuss the relationship between the rate of inflation and the real exchange rate. It uses the so-called Oliveira-Tanzi effect, along the lines of the macroeconomic models with multiple equilibria recently developed by various Argentine economists studying hyper-inflation (G. Escude, A. Canavese and A. Petrecolla, R. Fernandez, and R. Mantel) and also by M. Bruno and S. Fischer.

One crucial conclusion that emerges from this analysis is that debt service ends up being extremely inflationary in the countries that can least afford to allow this to happen (cf. the plus sign of the partial derivative of the fiscal deficit coefficient in relation to the real exchange rate). In other words, as the real exchange rate is depreciated in order to raise external competitiveness, negative financial effects appear in the form of an increase in the real value of payments to service a debt contracted in dollars, and hence in the coefficient of the fiscal deficit.

Professor Dornbusch’s paper gave rise to a very lively discussion that focused both on the models and the conclusions. Regarding the former, one commentator referred to the disaggregation of the real sector of the economy with the two terms of trade, one endogenous and the other exogenous; this entails accepting the hypothesis of imperfect substitution between (nontraditional) manufactured exports and their substitutes of foreign origin for developing countries, which results in the real depreciation being identified with the decline in the terms of trade. Although this is a logical conclusion from the model, it is not a very useful result from the point of view of the actual experience of various small developing countries (such as the Republic of Korea or Turkey), where clearly this decline in relative prices was not necessary to enable them to penetrate the international markets for manufactured goods. Even if this deterioration in the relative price of nontraditional exports is accepted, it is followed by a possibly efficient expansion of the industries producing import substitutes, in view of the induced substitution effect.

Another conclusion that follows from the logic of the financial model, but whose significance in the real world was of some concern, was that relating to the increase in inflation brought about by any attempt to deregulate the financial markets as a result of the increase in the velocity of circulation and the decline in the demand for money.

A serious concern was also reflected in another commentary on Professor Dornbusch’s work, involving the message received by the developing countries over time from the developed countries. In the 1970s, predictions were being made about movements in certain prices which did not in fact subsequently occur, such as an increase in commodity prices, a reduction in international exchange rates, and growth in the industrial countries. The message being received today is that of adjustment with growth, or, in blunter terms, pay your debt and open your economies. The speaker asked whether, leaving aside the internal policies of the developing countries themselves that may promote this growth, the international conditions existed for this out-come. In practice, the debt constituted a serious problem that was still not fully understood. It was serious because it was probable that the trade surpluses that were being achieved, very large in some cases, could not be sustained in the medium term. In other words, there was an incentive not to make the transfer implicit in these trade surpluses, which implied that current account surpluses and deficits should not be seen merely in terms of exports or imports but in terms of savings and investment. It was just as bad to achieve a trade surplus through a fall in investment as to increase the deficit through a fall in savings, since both undermined the long-term equilibrium of the economy. More specifically, the speaker identified a basic dilemma in querying the medium-term feasibility of the flow of domestic savings required to make the transfers entailed by adjustment, since very probably the public would reduce savings rather than consumption expenditure, which left very little room for growth.

Nonetheless, one now hears calls for structural changes in trade, fiscal policies, and exchange rate policies in the Latin American countries to help solve the debt problem. If Professor Dornbusch’s financial model were accepted, the feasibility of this objective becomes doubtful, since there is a clear conflict from the financial point of view; trade liberalization requires depreciation of the real exchange rate, which increases the deficit! In turn, a higher real exchange rate may mean lower real wages in terms of exportable goods, as has frequently been the experience in some Latin American countries. Finally, the commentator pointed to the need, in a “perfect world,” for certain contingency arrangements to be incorporated in the monitoring of the debt situation in order to offset shocks and facilitate adjustment. In other words, as various seminar participants had noted, contingency arrangements should be agreed between the parties involved in fixing targets (international institutions and the member countries) to take into account unforeseeable events that might make these targets impossible to maintain in absolute terms; there could be more general use, for example, of the contingency clauses in the recent agreement with Mexico, which linked debt service payments to oil prices.

Another aspect of Professor Dornbusch’s paper that aroused comment was the negative impact of real depreciation on the deficit emerging from the model. Bearing in mind that export taxes are an important source of receipts in Latin America, it was necessary to take account of the possible positive net effect of an increase in exports as part of the adjustment process, an issue which should be examined in the light of the deterioration in the international prices of certain export items in Latin American countries.

Another comment saw the solution proposed by Dornbusch to the debt problem as being nothing more than palliatives. It was pointed out that we needed to know more about the contribution that each of the various proposals put forward, for example, “debt-equity swaps,” Baker Plan, Bradley Proposal, and “debt-relief,” could make to solving the problem.

Choice of Growth Strategy

Julio Berlinski began by recalculating for 98 countries the hypothesis put forward by Simon Kuznets in 1964 regarding the inverse relationship between the share of foreign trade in the gross national product (GNP) and the size of a country and the positive correlation between this ratio and the GNP per capita, taking the size factor into consideration. Taking this hypothesis as a starting point, the author presented an exhaustive survey of the principal tools used in Latin America to control imports and to promote exports, emphasizing their considerable variety, the lack of coordination between them, the major role played by tariff exemptions in Argentina and Brazil, and the role of nontariff restrictions (quantitative restrictions and surcharges on imports). One important aspect of this research is the theoretical and empirical analysis of the anti-export bias and its makeup, which could lead to the improvement and refinement of export promotion tools.

The paper discussed two principal kinds of anti-export bias. On the one hand, there is the absolute bias, measured by the negative effective rate of protection due to the high cost of tradable and nontradable inputs, which renders the export sector noncompetitive. On the other hand, there is the relative bias, which results from the fact that the nominal protection rewards sales of the same good differently, depending on whether these occur in the domestic or the international market. Hence the traditional attempts, for example, to offset the anti-export bias through subsidies basically involve an attack on the absolute rather than the relative bias.

To calculate these biases, the author divides tradable goods into three groups: agriculture or primary commodities, the agro-industries, and Other industries. He finds that the last-named sector suffers the highest absolute bias as measured by the negative rate of effective protection, and that the agro-industries internalize the external competitiveness of primary product activities by receiving high positive rates of effective protection for their sales in the domestic market.

Berlinski’s work ends with a proposal designed to improve this state of affairs as a response to the question as to how both kinds of bias can be reduced. To lessen the relative bias, he proposes, on the one hand, that account should be taken, at t = 0, of the institutional framework or initial conditions for the reform, and, on the other hand, that a compromise should be sought between the best policy from the point of view of the trained economist and a policy that is a function of the credibility that it possesses, and which can be embodied in stable, lasting rules by economic policymakers. To achieve an increase in exports he proposes a phased reform, designed to achieve a major initial expansion of exports (capable of “purchasing” credibility) by reducing the absolute bias through reimbursements and drawbacks, culminating in the full liberalization of imports which would eliminate the relative bias by introducing rationality into the incentives to domestic sales. The basic justification presented by the author for this first stage is that export promotion is a historical fact that already exists at the start of the process. Therefore, the aim must be to improve its application by reducing the relevant bias. For the author, credibility is a function of the sequential approach, which shortens the time required to achieve the long-term benefits brought about by the elimination of the above-mentioned double bias.

Many of the comments stimulated by this work focused on the sequential nature of the process of opening the economy, which the author proposes should be preceded by an expansion of exports. It is not clear why credibility requires this expansion in exports, when in reality it should be a function of the degree of compatibility of the various policies among themselves. It might happen that export subsidies would not produce the required structural change in production, such that resources are transferred From nonmarketable and import-substituting sectors to the sectors producing exportable goods. Furthermore, if these subsidies are high enough, the need to transfer resources could be avoided and goods could be exported that previously were import substitutes. Thus, a sequential process such as that proposed by the author might end up merely prolonging existing distortions, even leaving aside the problem that any export promotion policy entails for public finances, a problem which in fact requires that explicit attention be given to the linkages between commercial policy and financial policy.

Another commentator discussed the experience of twenty countries in a World Bank project that was capable of throwing some light on the optimum sequence for opening the economy on the terms suggested by the author. Reference was made to the Republic of Korea, where in the 1960s a very complex system of export subsidies was devised which in later studies by Larry Westphal was shown to be neutral at the margin. This neutrality indicated a lack of relative bias in the so-called Korean miracle. However, this aggressive subsidy policy would not be feasible today because of regulations of the General Agreement on Tariffs and Trade, which leaves us with the real exchange rate as the crucial variable in implementing the process of opening the economy.

There was an interesting discussion on this point, during which it was pointed out that in practice Japan, the United States, Brazil, and even the Republic of Korea had industrialized with protectionist policies, but that it was impossible to draw any conclusions from these experiences regarding the notion of “intelligent protection” that could lead to it being possible to “pick the winner.” Economists are very ignorant in this area, which frequently produces a situation in which political systems, which are responsible for the design of tariff regimes, end up by protecting every product at any price (as in Argentina). Therefore, it is not clear how providing export subsidies can put an end to internal distortions since, when these exist, the conditions of Lerner’s theorem are not completely satisfied. The solution has to be simple: tackle the import substitution sector as soon as possible, reduce tariffs, and simultaneously allow the real exchange rate to rise to achieve external equilibrium. If this solution is not adopted, it is because the consequent dismantling of the tariffs around highly protected sectors undermines some very long-standing privileges.

Finally, it was noted that the financial cost of promoting exports through subsidies increases in line with the success of the policy, while the financial cost of tariff reductions declines with the success of the process of opening the economy. Therefore, in terms of the financial effects of the two policies for opening the economy, the tariff reduction strategy would be more credible because the treasury would not press for it to be abandoned.

Fiscal Policy, Growth, and Design of Stabilization Progams

The general objective of Vito Tanzi’s paper was to respond to a common complaint by critics of the Fund that the countries faced with a situation such as the oil or debt crisis are obliged to follow stabilization policies that are incompatible with economic growth.

The author strongly challenged this criticism, setting out the general guidelines of what he called the “financial approach to the balance of payments” or the “financial approach to stabilization programs,” while at the same time raising a series of questions for discussion. In general terms, these focused on the link between the short term and the long term in the approach taken by the Fund, which involved the recognition that growth without stability was not technically feasible in the long term and that stability without growth was not politically feasible except in the short term. The financial approach to the balance of payments had several simultaneous implications.

  • In the first place, it involved the recognition that there is a macro-economic approach and a microeconomic approach to stabilization policies. The former, which is that traditionally followed by the Fund, is based exclusively on demand-management policies that consist of setting financial targets or limits based on an implicit model (Polak and Robichek) linking the budget deficit and the balance of payments outturn. Then each country decides on the specific way in which it will meet the financial target; in other words, it decides which tax rates it will raise or which expenditures it will reduce, with the advice of the Fund. Under this approach it makes little difference whether the financial target is achieved by reducing productive expenditure or by raising taxes that generate major disincentives. The second, or micro-economic approach, involves the recognition that financial policy affects both aggregate demand and aggregate supply; in other words, it entails an examination of the specific financial measures adopted, since in the medium term these do make a difference in relation to the target of reducing a given financial deficit.

  • The recognition of the crucial difference between these two approaches leads naturally to both a theorem and a corollary. The former tells us that the macroeconomic approach is a necessary but not sufficient condition for growth, which requires effective structural policies that attack the microeconomic distortions in the economy. The corollary points out that the greater the reaction of supply to the structural changes (microeconomic approach), the less the amount of demand regulation required; in other words, it will be that much less necessary to use the macroeconomic approach, with its concentration on variables such as the levels of saving and investment or the amounts of tax receipts. However, this does not necessarily mean accepting the existence of tradeoffs between greater microconditionality and greater flexibility in the macrotargets.

  • In the author’s view, the transition from the macroeconomic approach to the microeconomic approach, not yet complete, gives rise to several vital questions for the International Monetary Fund and for its member countries, questions that contain a double danger. Concerning the macro approach, the danger lies in attention being diverted from the basic objective of economic policy (lasting gains in the balance of payments, growth, and price stability) to the fulfillment of the targets for their own sake to establish the success of the program.

Concerning the micro approach, the danger lies in the increased conditionality (defined as the range of policies that the Fund expects member countries to follow to obtain access to the general resources of the Fund) that may be entailed if it is necessary to identify a core of structural policies on the supply side.

As was to be expected, this paper gave rise to a lengthy and animated exchange of views involving sixteen contributions, which are grouped under various headings and summarized below.

It was stated that the paper did not set out a theory of growth nor a specific model of growth, but that it nevertheless assumed that growth would be positive if distortions were eliminated through the microeconomic approach, that is, distortions that prevented relative prices from assigning productive resources efficiently. In the absence of a theory of growth, and since at present the sources of economic growth were not precisely known, it was difficult to define these new conditions objectively. The World Bank, for example, had an objective and practical standard of conditionality, namely, the rate of return; what was needed was a more practical criterion than that of “growth,” which was perhaps too abstract. Although it was true that there was no theory of growth generally accepted among economists, it could nonetheless be agreed, without any need to adopt any of the many existing theories, that the paper pointed out the destimulating effects of many distortions whose removal would have positive effects on growth.

Another group of comments stressed the merit of the paper in spelling out some of the basic problems, both methodological and operational, revealed in Fund programs. It was because of these problems, which the author grouped under the name of the macro-economic approach, that the paper essentially sought to extend conditionality to the allocation of resources, given the inability of aggregate financial targets to achieve the objectives of adjustment in a context of permanent growth. Therefore, the crucial issue in Mr. Tanzi’s work was that of extended conditionality, since there was no need to prove that distortions existed in Latin America, whatever economic approach or economic model was used and accepted. These distortions are a reality in both the public and private sectors, and to remove them would unquestionably mean a movement toward the real limits of productive potential, a prerequisite for any lasting growth. However, it was also noted that extending conditionality was not a simple matter, in that, although there might be a consensus regarding the existence of distortions at the microeconomic level in many markets, there was no comparable consensus as to what was the best way of eliminating them; nor was there sufficient theoretical or empirical knowledge on which to base, with the appropriate precision, the proposed extension of conditionality, or double conditionality as it was termed by some participants, who expressed great concern on this issue. In their view, the elimination of these distortions should be a long-term task supported financially by the Fund in the meantime, since knowledge was still lacking regarding the function providing the precise link between the inputs of a policy decided by the authorities and the result of that policy (a problem common to both microeconomic and macroeconomic policies, although many people claim to see a one-to-one relationship between inputs and results).

In other words, several participants expressed their doubts as to the degree of objectivity attainable in the actual process of monitoring by the Fund of an extended conditionality oriented to growth and economic development policies. It was also made clear that the excessive emphasis placed by Fund programs on the macroeconomic aspects of stabilization totally ignored microeconomic structural aspects. If the former, although a necessary condition of adjustment, were conceived of as being independent of the latter, market distortions were left intact to act as permanent sources of many aggregate problems. It frequently happened that, because of the total absence of micro-economic conditionality, governments ended up taking decisions on political grounds at the expense of criteria of economic efficiency. For example, infrastructure was ignored and roads and highways left unrepaired, while unproductive expenditure that had direct political consequences was left untouched. Obviously this was a problem affecting any representative democracy, but it was also true that the effects increased exponentially with the degree of structural maladjustment in the economy. It was for precisely this reason that the extension of conditionality sought to influence in some way (although just how was not yet very clear) the microeconomic aspect of adjustment, through a close scrutiny of the kinds of investment to be reduced in countries that were called upon to place natural, endogenous limits on their financial deficit as a proportion of GNP. There was no doubt that these natural limits existed, since they were the result of the level of development of the domestic capital market, the size of the tax burden that the country could support, and/or the inflation tax, which was always neutralized by the consequent loss of receipts, given the current constraint on external borrowing in the light of the existing stocks of external debt. In scrutinizing the kind of expenditure to be reduced or the type of tax to be increased or introduced, or the structure of public service tariffs, et cetera, one would be helping to ensure that the latent problems did not remain untouched because only the symptoms of the disease had been attacked.

Some participants expressed concern that this issue could vitally affect the relations between the different international financial institutions, such as the International Monetary Fund and the World Bank, since the Bretton Woods Agreements created a clear division of labor between them. From the beginning it had been the World Bank’s role to be concerned with the supply side in its impact on the growth of member countries, although recently the Bank had been moving toward structural adjustment loans. Nevertheless, it was regarded as a very positive sign that attention was no longer exclusively focused on the size of the financial deficit, in the light of the international reality of the 1970s and 1980s, which had produced so many exogenous supply-side shocks; these, when added to the internal problems of many economies, made it difficult to distinguish between short-term adjustment and medium- and long-term structural changes. Therefore the initial division of functions between the two international organizations ought to be regarded more as a matter of institutional history, now superseded by a new reality that required growing institutional cooperation to facilitate adjustment with structural change. In other words, for several participants, the real problem was not who would design the new conditionality, but how the specific conditionalities of the Bank and the Fund were to be reconciled when they made an agreement with a member country, in order to avoid differences of opinion in their respective recommendations.

Adjustment, Indebtedness, and Economic Growth

Guillermo Ortiz put forward his own views on some issues closely related to those discussed by Vito Tanzi. In broad outline, he dealt with the need to link adjustment to growth and consequently to the necessity for structural changes, a subject which, as the speaker acknowledged, has become rather fashionable.

He discussed these issues not only from the standpoint of what was necessary or desirable but also, and more fundamentally, from the standpoint of the practical problems actually created by the implementation of adjustment programs, in terms of their effects on growth. Hence the importance of the basic question put forward by the author as the title of the last section of the paper—“Adjustment and Growth?” This contained some valuable thoughts deriving from deep study of the experiences of the Fund in designing stabilization programs over a period of time.

In the author’s opinion, it was necessary to make a crucial distinction between moderately indebted countries and highly indebted countries, which came down to differentiating, at t = 0, between countries with moderately unbalanced flows of funds and countries with enormous imbalances of all kinds, including large stocks of debt, resulting both from their economic structure and from inappropriate domestic policies.

What differences could be observed between these countries, as subsequently revealed in terms of the degree of success achieved by the stabilization programs agreed with the Fund? In practice, despite the tremendous efforts by the countries with enormous initial imbalances to solve their external problems, the Fund programs had not been successful either in reducing the rate of inflation or in reestablishing sustained growth. It seemed as if the countries that desired and attempted macroeconomic adjustment, with the concomitant real reduction in public and private sector debt, saw in the process of seeking this adjustment a new inherent dynamic that worked against the stabilization process itself. This phenomenon was not yet completely understood, but was reflected in practice in stabilization costs that were higher than the accepted doctrine on these matters suggested, since this doctrine had been developed exclusively from the Fund’s experience with countries with moderate imbalances of flows, because prior to the 1980s external debt problems had not reached such proportions. The author suggested that the problem of the stock of debt was capable by itself of complicating the relationship between growth and inflation with a different dynamic from that incorporated in the current macroeconomic approach of the Fund’s stabilization programs.

No doubt this line of argument went some way toward explaining the grave problems of countries like Mexico, Argentina, and Brazil. It could also, in the manner of a laboratory experiment, implicitly endorse the introduction of “shock” stabilization programs in Argentina (Plan Austral), Brazil (Plan Cruzado), and Israel, which included price controls; in other words, a laboratory experiment implicitly reflecting a basically different endogenous dynamic.

Those who commented on this paper, both the invited speakers and the other participants, were in general agreement on the analysis and description of current external indebtedness. The notion that Fund programs are successful in dealing with moderate inflation but not with higher levels of inflation was illustrated by Mexico’s various stabilization programs, of which only that of 1954 was successful, with inflation then at some 15 to 20 percent. It was suggested that when inflation reaches 50 or 60 percent the programs fail, possibly because the Fund model does not include the concept of inertial inflation, independent of demand factors or expectations. Other participants noted that the existence of inertial inflation required greater automatic flexibility in interpreting the results of the macroeconomic targets in stabilization programs, going beyond the current waivers (used for minor, localized, and correctible deviations from stabilization program targets); that is, moving on from the current acceptance of major, general, and irreversible deviations (such as those produced by changes in exogenous variables, e.g., changes in the international prices of basic exportable commodities, which seriously affect the performance of the program) to accepting the possibility of changing the program in the light of uncertainties about the country’s financial capabilities. There had been a number of changes in attitudes recently and these should be extended.

Various commentators pointed out the need for greater analytical precision in the kind of dynamic complication caused by the stocks of debt per se, and to illustrate this with further examples of actual adjustment experiences.

This paper gave rise to the most intensive discussion of the entire seminar regarding concrete solutions to the debt problem, with interventions not only from those who deplored the absence of this kind of debate, especially concerning politically viable solutions, but also by those who pointed to ways in which some of the Fund’s action programs devised to deal with specific cases could be improved. The starting point for this discussion on concrete solutions was a kind of “devil’s advocate” contribution, in the form of a very clear and candid triptych of diagnosis, objective, and tactics of the creditor banks and the international organizations regarding the external indebtedness of developing countries from 1982 onward.

In summary form, the diagnosis pointed to the origins of the debt in the problem of illiquidity, leading to a domino effect in Latin America initiated from outside by increases in international interest rates which aggravated a pervasive existing problem. The objective consisted in re-establishing normal financial flows to these countries. Finally, the tactics were based on two rules of the game that could not be broken and so far had not been broken: the “case-by-case” approach which did not create precedents (the system could not support massive bankruptcies) and the principle that concerted action must always prevail over any potential unilateral action. This logical scheme was disrupted only temporarily by the accident of the drastic fall in the prices of oil and other basic commodities, which hit most severely the “model” (in terms of the triptych) countries—Mexico, Venezuela, and Ecuador.

From this standpoint, it was, in the opinion of several participants, extremely unlikely that the seven or eight hundred private banks, governed by twenty or thirty different banking and financial systems, reflecting a wide range of attitudes, could in the aggregate be regarded as willing to “negotiate and compromise,” as it was put during the seminar, and that all that was lacking were serious proposals by the debtor countries. More specifically, if the only realistic solution to the debt problem was a reduction in interest rates on the debt so as to make debt service payments possible, then the Fund and the World Bank should promote simulation studies that could identify, under various alternative economic growth scenarios for certain countries, feasible payments hypotheses in terms of the generation of trade surpluses.

Other commentators noted that sensible concrete proposals had indeed been made to the creditor banks. Mexico, for example, had proposed an automatic capitalization of interest on the debt, taking into account changes in oil prices and interest rates and involving constant amounts of repayment in real terms; this proposal had been rejected. In response to the observation that such proposals were rejected because they ran contrary to the philosophy of the bankers, since this implied converting the banks into forced partners of the country in question, the seminar was referred back to an important point raised during the debate on Professor Dornbusch’s paper: the absence in the international legal system of the kind of machinery that governs firms in every country in any capitalist system; in other words, the possibility of calling a meeting of creditors. The absence of a higher international tribunal made it necessary to have recourse to a system of unilateral proposals, for example for converting debt into long-term, low-interest bonds, as an alternative to possible capitalization solutions, which would require a certain amount of across-the-board negotiations. However, the current bankers’ cartel, in the form of advisory committees, and the case-by-case approach that entailed the prior approval of the Fund, penalized banks such as those in Europe, for example, that would be willing to negotiate on an individual basis but in the final analysis could not leave the cartel.

Some commentators anticipated the probable argument regarding the failure of the analytical model underlying the stabilization programs for countries with major imbalances and large initial stocks of debt; in their view, the model was correct, the failure being attributable rather to the countries that could not fulfill the commitments undertaken in the agreements because they lacked the political capability to do so. This naturally gave rise to the question as to why some countries undertake to perform something that they cannot perforin, and indeed why they are asked to perform something beyond their power. The first question was answered in fairly direct terms: loans from the Fund are cheaper than loans from other sources, but it was also admitted, on the second point, that there could possibly be design problems in some stabilization programs, especially when a large number of such programs had to be concluded in a period of only three or four years.

Savings in Brazil

In this work, Carlos Longo reviewed recent developments in savings in Brazil (broken down into domestic, external, and public savings), and in the tools of financial intermediation, noting the orthodox but progressive policy of the Castelo Branco Government, which introduced structural changes through reforms in the banking system, the capital markets, and the tax system. The author was at pains to contrast this experience with the current need for in-depth institutional reforms in order to maintain the rate of growth, which had been significantly affected by problems associated with the mobilization of domestic savings.

The paper began by examining the changes in financial intermediation instruments in Brazil and went on to refer to the recent decline, as revealed in the national accounts, in domestic savings. After mentioning the main investment peaks, the author concluded by discussing the problems faced by the present government in financing its deficit (now stabilized at about 6 to 8 percent of gross domestic product) under the cruzado plan. The speaker questioned the medium-term and long-term potential of this plan, since it had to coexist with problems of maladjusted relative prices, excess demand, a growing generalization of currency margins, and shortages of goods and a deterioration in their quality in order to get round the price freeze imposed under this decidedly unorthodox plan.

The author concluded his paper by proposing a series of constructive measures to improve the currently difficult situation of Brazil’s economy. The paper, although dealing entirely with Brazil’s experience, gave rise to an animated discussion that frequently transcended the case study in order to raise general issues and experiences common to many developing countries, such as Argentina, Chile, and Venezuela, especially concerning the position of the Financial markets in conditions of high and variable inflation, on the one hand, and low inflation, on the other. It also provoked much discussion about Brazil’s economy in the recent past and the lessons to be drawn for the future; Brazilians present at the seminar expressed a range of different views about developments in their country’s economy.

It was interesting to hear about the experience of Argentina and Brazil regarding institutional changes in their central banks and investment banks, the focus being on the issue of indexation of financial assets and its influence on the generation of private saving. Several commentators raised the important question of the design of a good financial system in a context of high and variable inflation, analyzing the alternatives of a free market with a floating interest rate or an indexed financial market. If the floating rate is abandoned under these conditions the result will be that experienced in both countries, reflecting the evolution of the market toward the short term (60 days in Brazil and 30 days in Argentina). If maturities are extended with a floating rate, the result is Argentina’s terrible experience under Circular 1050, since the rates reflect inflationary expectations, so that the short-term volatility is extended into the long term, although the long-term market is intrinsically more stable. It would seem necessary, in countries with a long experience of high and unanticipated inflation, to accept the division of the capital markets into short term and long term, through some indexation of the financial system which increases long-term assets. However, this indexation requires that certain conditions be met, such as, for example, low or medium inflation rates (not exceeding 40 to 50 percent a year), otherwise the indexed financial assets will be established in current money, with the grave results experienced in Brazil and Argentina in 1975. The reason is that high inflation rates are associated with a high volatility of relative prices, and sooner or later it will be necessary to supplement the system with subsidies to the financial system, which then become extremely difficult to eliminate. Argentina’s experience with indexation, unlike that of Brazil and its indexed treasury bills (ORTNs) since 1964, has been very bad, since the system was established in 1975 at a time when the rate of inflation was accelerating from 40 percent to 300 percent a year. It is also regrettable that neither the austral plan nor the cruzado plan makes provision for indexation, when inflation is not so low as to make this superfluous; its omission undermines long-term contracts in general. On the other hand, correct indexation of the financial system also requires an appropriately consistent macroeconomic framework that avoids large government deficits and the consequent “crowding-out” that gives rise to high interest rates.

It was noted that Chile’s experience in the 1960s was interesting; an indexation system was introduced for housing loans made through private banks, which became very important in that they enabled Chile to create a capital market that lasted for fifteen years, enabling housing to be financed through the issue of obligations at real interest rates of 8 to 9 percent a year. The system collapsed in 1973, when the inflation rate reached 600 percent a year. People could not meet payments from their wages, and the government could find no better solution than to suspend indexation for a year. Another instructive experience from Chile concerned the consequences of the financial reform of 1975, when the commercial banks introduced medium-term and long-term indexed loans into the market that initially were not very popular. With the inflation rate at about 300 percent, people preferred to stay with nonindexed short-term loans, but when inflation fell to about 50 or 60 percent a year, these indexed instruments became much more widely used, although no institutional change occurred. However, when real annual interest rates climbed to 40 and 50 percent after the macroeconomic adjustment, the financial system could not withstand the consequences, and many loans became unrecoverable.

Another group of comments dealt specifically with Brazil’s economy, the speakers questioning some of the author’s hypotheses and conclusions regarding private and public investment, the generation of trade surpluses, and the evolution of the cruzado plan. These commentators were divided between optimists and pessimists. The former took heart from a recent survey which made it possible to quantify a widespread impression that private investment was increasing; breaking this down into investment for modernization and investment to increase installed capacity, it was clear that the latter was increasing much more rapidly than the former, having risen 243 percent between 1985 and 1986, much faster than demand. Furthermore, 60 percent of the firms surveyed had increased their investment since the introduction of the cruzado plan. Other speakers felt it was wrong to attribute recent investment gains to the cruzado plan, since investment had already been accelerating before the plan, which had already created a very damaging uncertainty regarding future relative prices, which could not be adjusted in the event of real shocks.

There was general agreement regarding the need to achieve a financial surplus to facilitate the recovery of public investment in Brazil as a means of maintaining the rate of growth from 1987 onward, given the significant effects on investment and private savings and the need to overcome bottlenecks in key sectors. Some speakers took a pessimistic view: even if the necessary adjustments were made in lagging public service tariffs, and fiscal reforms (made possible by a 5 percent reduction in the tax burden as compared to the 1970s) were carried out, this would not be enough to solve the Financial problems of the public sector. The possible crisis in the external sector would require transfers overseas to be reduced, not only through an adjustment of flows but also by attacking the problem of the stock of debt, because of the concentration of external indebtedness in the public sector. In the author’s view, on the other hand, internal adjustment had to be undertaken first, which was not necessarily very orthodox if the budget deficit was large.

Concerning the short-term consequences of the cruzado plan, the optimistic speakers sought to discount the comments of the more alarmist commentators (the majority) by pointing out that an examination of overall demand did not appear to indicate that the shortage of goods was getting worse. They pointed out in this regard that at the beginning of the cruzado plan (1) while stocks held by households and firms were very low, the process of replenishing them would tend to lose impetus as time passed, (2) people had anticipated their requirements to take advantage of the price freeze while it lasted, and (3) there had been a kind of monetary illusion that had led to the disappearance of many savings accounts. It would therefore be dangerous, against this background, to attempt drastic adjustments in demand through a restrictive monetary and fiscal policy that could cause problems for the cruzado plan, which had been implemented in the context of pre-existing imbalances among relative prices, aggravated by the rapid expansion of demand. The discussion ended in the conclusion that controls on demand should be lifted as part of a movement to a system of administered prices to enable the cruzado plan to function; some of the other Brazilian participants thought that this process would lead to the disappearance of the private sector from Brazil’s economy.


The three issues referred to in the title of this seminar—external debt, savings, and growth—have proved to be closely linked in their application to Latin America. The adjustment entailed by the existence of external indebtedness, and reflected in the need to generate current account surpluses, if considered from the standpoint that the required transfer of resources can only be sustained in a context of growth (F. Machlup in modern guise) requires the generation of an adequate level of savings. Alternatively, if these transfers are achieved at the expense of investment, growth and hence future generations will suffer. These are the core issues justifying the title and subject matter of this seminar, which were approached with total frankness and freedom by the participants, not with the objective of achieving immediate results in economic policy, but rather with the far-reaching aim of raising and reflecting productively on issues of great relevance to the countries of Latin America and the world economy in general.

One recurring theme in the discussion of the various papers presented at the seminar concerned the need to bring consistency and coordination to the macroeconomic policies pursued by the more developed countries, and the effects that their present absence is having on the world economy and especially on the less developed countries. If these policies have a decisive impact on the international economic environment, which in turn governs the possibility of correcting the external imbalances of the developing countries, with the assistance of the International Monetary Fund, the question then arises whether the international organizations can influence the policies of the largest countries with a view to their overall optimization.

The debate showed that this is an issue of profound concern, not only to the economists from the less developed countries who were present at the seminar, but also to international institutions such as the Fund and the World Bank. The Fund has recently embarked on a more intensive use of economic indicators (such as those published in the latest World Economic Outlook), which point to the need for a reduction in the U.S. budget deficit and for expansion in the Federal Republic of Germany and Japan. However, it is important to remember that, while these indicators are useful tools, they cannot automatically bring about changes in current policy, and it would be premature to express a view about their results. It was also noted that the 1986 Annual Report of the World Bank called attention to the fact that without a reduction in the U.S. budget deficit, without an expansion in Germany or Japan, without a reduction in the real rate of interest in conjunction with the reduction of taxation in the United States (to the extent that this would not occur automatically through the consequent reduction in “crowding-out”), then the future growth of the world economy would be seriously affected, particularly in the less developed countries. Nonetheless, it was also accepted that the specific problem of the debt would not be solved per se by the recovery of the industrial economies; the developing countries had a long way to go in their domestic policies for stabilization, but they also had to be given access to the international market for loan funds and the possibility of selling their exports.

The discussions on these points ranged widely, and it is possible to distinguish the following points of view: (1) those who believed that the current inconsistency in financial policy objectives in the largest countries is the principal cause of the economic crisis that exploded in August 1982, and who pointed to the need for the Fund to do something about it; and (2) those who asserted that the Fund’s surveillance power is asymmetrical, since, although it can exert influence over the policies of member countries who use its resources, it has little power over the policies of countries that do not use these resources and even less over the most important countries, despite the many initiatives put forward in the Fund’s Executive Board on this question.

Another much-discussed issue, going beyond the specific papers in which it was raised, was that of the possible extension of Fund conditionality, which might involve moving from the traditional macro-economic approach of stabilization programs (which concentrate on the size of the budget deficit) to the microeconomic approach (with its possible trade-offs with the former). The latter approach, in analyzing the quality of the specific policies adopted by the countries implementing adjustment, also attaches importance to the removal of distortions in the resource allocation process that are capable of affecting growth.

Concurring with these arguments were also (1) those who were concerned that the extension of conditionality would affect the division of labor between the Fund and the World Bank, and who referred to the need for compatible conditionality in the agreements made between the two organizations and specific member countries, and (2) those who, accepting the fact of the distortions, were concerned about the extension of conditionality in a context where there was no professional consensus about the best way of eliminating them, an issue which highlighted the current lack of knowledge about the precise functional relationship between policy inputs and obtainable results. Dispelling the ignorance about these functional relationships was a complicated matter, particularly because of the problems resulting from the fact that accumulated stocks of debt had proved capable by themselves of introducing into the relationship between growth and inflation a different dynamic from that built into the macroeconomic approach.

Both major groups of issues—among many other possible themes that will occur to the interested reader of the discussions—made it clear once again that achieving the desirable adjustment with growth will require a combination of domestic efforts by the various countries involved and an international context markedly more favorable to these efforts than that existing at the end of 1986.