Surveillance, the concept at the heart of the Second Amendment of the Articles of Agreement, offered a universal way of approaching world monetary management. This approach was not altogether new (it had been implicit in the mechanism created at Bretton Woods), but its importance had increased after the breakdown of the par value system. During the 1970s, it experienced two rather different types of challenge. First, there was a political reaction against what was fundamentally an institutional or technocratic approach to policy and to international cooperation. Second, the development of capital markets made increased resources available so that it appeared to some participants that the processes associated with surveillance (in particular adjustment) might be avoided. At the outset, no one could be quite certain if and how the recycling of oil surpluses could be managed, and what would be the implications for surveillance.
Surveillance, the concept at the heart of the Second Amendment of the Articles of Agreement, offered a universal way of approaching world monetary management. This approach was not altogether new (it had been implicit in the mechanism created at Bretton Woods), but its importance had increased after the breakdown of the par value system. During the 1970s, it experienced two rather different types of challenge. First, there was a political reaction against what was fundamentally an institutional or technocratic approach to policy and to international cooperation. Second, the development of capital markets made increased resources available so that it appeared to some participants that the processes associated with surveillance (in particular adjustment) might be avoided. At the outset, no one could be quite certain if and how the recycling of oil surpluses could be managed, and what would be the implications for surveillance.
This chapter tells the story of the uneven race between the market and the international institutions to expand their resources in order to recycle. It was a race won by the market, but in the context of such discoordinated economic policies between the major economies, and such a variety of inappropriate policy choices, that the result was an apparent chaos rather than the smooth operation of a system. Expectations changed too rapidly for markets to be able to take long-term views. The experience of this chaos, and its effect in the form of the 1980s debt crisis (see next chapter), set off a learning process about national policy and its relation to the international order that forms the theme of the rest of the book.
It was surprising how few problems had been solved by the transition to floating. Money as a store of value had been undermined, and so had the legitimacy of the institutions that managed money internationally. Monetary disorder at the beginning of the 1970s had shaken the foundations of the international system. The weakness of the dollar, the unwillingness of the U.S. government to attempt to stabilize it, and the response of central banks outside the United States led to an increase in the world money supply much faster than that of the period of the dollar-induced inflation criticized so heavily by General de Gaulle in the 1960s. The monetary response to disorder produced a world business cycle much more synchronized and in consequence more violent and disruptive than in the 1960s, with an inflationary boom in 1972–73 and then a bust.1 Large inconsistencies between fiscal policies in major countries produced exchange rate volatility; and the response to that volatility often involved an attempt to shelter from the international system through some form of trade protection.
The monetary chaos prompted very far-reaching demands for a complete restructuring of the system, and, correspondingly, the rejection of the notion that piecemeal tinkering might be of any value in generating effective reform. The world seemed further than ever from a consensus about the international condition of national economic policies. Then came an additional attack. Bretton Woods, the critics maintained, had been based on the needs and concerns primarily of the rich industrial countries, which managed the supply of monetary reserves, and the system created had as a result led to the economic and political marginalization of the majority of the world’s population and a profound imbalance in the growth process.
Two parallel debates occurred, involving many overlapping issues, but quite different agendas. On the one hand, a coalition of discontent proclaimed the desirability of a New International Economic Order. The fact that increased international money made the delaying of adjustment easier to finance seemed to lend a new attraction to the older populist argument about the excessively high costs of adjustment. On the other hand, partly as a response to the major clashes occurring over the shape of that order, the Bretton Woods system itself adapted and developed to cope with new circumstances. At some times the proposed “New International Economic Order” and the “reform of the international monetary system” appeared as stark alternatives, and not as complementary ways of thinking about institutional change that would help to restore international harmony and prosperity.
The sharp politicization of debate about the international order followed the shock resulting from the inflationary process that had accompanied and precipitated the breakdown of the classic Bretton Woods system. The oil price increase had itself been to a substantial extent a consequence of the monetary and currency disorder. This chapter follows the course of the rising political tensions—between North and South, as well as among industrial countries and among developing countries, and between plan and market “solutions” to economic difficulties and hardships. In the absence of a stable system, was the market and the private financial sector sufficiently large and flexible to meet the gigantic new financing needs? Or did the “system” need to be reconstructed to fill the gaps left by the inadequacies of private financial institutions? The outcome of the discussions of the mid-1970s on reform of the international economic system was as unfortunate as could be imagined. It produced in many industrial countries the feeling that debate about the international system had become too politicized, that perhaps no real need existed for a “system,” and that things could look after themselves. In developing countries, this sentiment was interpreted as evidence of the unfairness of the “system” and of the need for a fundamental overhaul. Faced with these two extreme reactions, reordering the system in a way that would take account of all the demands, frequently contradictory, on how the reform should be managed, became a daunting, herculean task.
The two extreme responses made the work of actually dealing with the consequences of monetary dislocation and oil price increases much harder. When international institutions tried to tackle the payments imbalances that arose as a consequence of the big price changes, they faced a politically charged atmosphere: on the one hand, the claim that the private financial sector might itself finance the process of adjustment; and, on the other hand, the assertion that the whole world economic order was fundamentally unjust. It is not surprising that such a climate made every detail of the negotiation of Fund programs seem like part of a gigantic economic obstacle course. This chapter examines not only the debates of the 1970s about an appropriate world economic system, but also the attempts of multilateral institutions to come to terms with the financial shocks created by the oil price rises by offering more long-term programs, and modifications of conditionality. One of the consequences of the acute political debates that surrounded them was that these programs, while helping to deal with the immediate aftereffects of the shock, too rarely were associated with the long-term stabilization for which their proponents had hoped.
Distributing the Burden of Adjustment
The question of adjustment that was necessarily raised in the surveillance process involved fundamental issues concerning the distribution of obligations within the international system. Since the late 1960s, disputes about who should do the adjusting had led to increased tensions between the industrial states and had been one of the causes of the breakdown of the par value system. It was easy to conclude that the imposition of a new oil-induced transfer problem of tens of billions of dollars would make relations even worse. For multilateral institutions committed to preserving open and liberal economic relations this consideration alone constituted a powerful case for the postponement of adjustment and the financing of imbalances.
The United States, which in addition also had a strong interest in the maintenance of the Western security framework, might well have been expected to adopt the same pattern of reasoning. But some American policymakers, notably Secretary of State Henry Kissinger, and William Simon, first Head of the Federal Energy Office and then after 1974 Treasury Secretary, believed that the price increase by the Organization of Petroleum Exporting Countries (OPEC) had been an act of political defiance. Measures that helped in financing adjustment, or recycled the oil surpluses, or made the shock easier to bear, would therefore simply make permanent a profoundly illegitimate price increase. For Simon, “the question is not whether oil prices will fall, but when they will fall.”2 On this assumption, the oil deficits were regarded only as a passing phenomenon, which the world should not help to sustain by any institutionalized mechanism for assistance.
Many commodity producers, however, saw in the OPEC action a model of how to use producer power to alter the pattern of world prices, trade relations, and distribution of income. In May 1974, a special session of the United Nations General Assembly approved without a vote a “Declaration and Program of Action on the Establishment of a New International Economic Order.” The Declaration stated that: “It has proved impossible to achieve an even and balanced development of the international community under the existing international economic order. The gap between the developed and the developing countries continues to widen in a system which was established at a time when most of the developing countries did not even exist as independent States and which perpetuates inequality.” The proposed corrective action included facilitating the role of producer organizations in accelerating development, “securing favorable conditions for the transfer of financial resources to developing countties,” and a reform of the international monetary system with the aim of “the promotion of the development of developing countries and the adequate flow of real resources to them.”3 In December 1974, a further special session of the General Assembly drew up a Charter of Economic Rights and Duties of States, specifying 15 fundamental principles that should in the future govern international economic relations.
The most ambitious and far-reaching of the “reform” proposals involved a global planning of the development process through multilateral institutions under the general supervision of the United Nations. A report prepared by a group of experts under the chairmanship of the economist Jan Tinbergen for the Club of Rome spoke of a “humanistic socialism,” “equalizing opportunities within and among nations.” Growth alone was not desirable, since it might be inequitable and destabilizing. “It is not always true that because high growth rates enlarge society’s options they are invariably preferable to low growth rates…. The poor countries should reject the aim of imitating Western patterns of life…. Many aspects of Western life have become wasteful and senseless and do not contribute to peoples’ real happiness.” One possible model of development lay in Tinbergen’s interpretation of the experience of the Soviet and East European economies organized in the Council for Mutual Economic Assistance (CMEA). The CMEA had redistributed growth through transfer funds and collective supranational decisions on the siting of industries, with the consequence that its members should all reach the same stage of development by the early 1990s. According to Tinbergen, “the projections anticipate that if present rates of development funds are maintained and an optimization of interaction within CMEA is achieved, the levels of development will be largely equalized by 1990.”4 In the course of time, of course, it became clear that such a large-scale international planning exercise contained numerous inefficiencies and became eventually counterproductive.
A first step envisaged by many reformers would be the regulation of commodity trade and the establishment of mechanisms for reshaping the international monetary system. At the end of 1974, an intergovernmental group of developing countries formulated a common program for “integrated global action on raw materials,” which involved a stockpiling and intervention mechanism to be financed by the IMF, and the indexation of raw material prices to the prices of imported manufactured goods. A highly limited version of such a proposal was actually agreed in February 1975 under the terms of the Lomé convention signed by the European Community (EC) and 46 African, Caribbean, and Pacific countries. Twelve staple goods would be managed under a compensatory facility for the stabilization of export earnings (Stabex): bananas, cocoa, coconut products, coffee, cotton, groundnut products, palm products, hides and skins, sisal, tea, timber, and iron ore. All industrial products and 96 percent of agricultural products were to be given duty-free access to EC markets. Increased development aid would be channeled through a European Development Fund.
In the minds of the critics, mostly from developing countries, reform of the international monetary system should accompany the transformation of trade relations. The programmatic point was made at the opening of the meeting of nonaligned developing countries in Dakar in February 1975 by President Senghor of Senegal: “The Third World must take part in the conduct of the world’s monetary affairs…. If the additional resources flowing from petroleum were to swell the wave of capital floating about in search of speculative investment, or were to be placed largely on the traditional markets, our problems would obviously only be shifted and not be on the road to being solved.”5 The Tinbergen-Club of Rome group thought that the prerequisite lay in the “democratic redistribution of voting power among all IMF members,” on the lines of majority voting in the United Nations General Assembly.6
Since the early discussions in the 1960s of the shape of the SDR, there had been proposals that allocations should be linked to development assistance. The “link” might be “organic” in that allocations could be based on development needs; or, in a more restricted and practical version of the scheme, “inorganic,” in that the distribution would be made in accordance with quota calculations, but that the richer industrial countries would contribute their allocations, via an institution such as the International Development Association (IDA), for development assistance.7
The link provided the most concrete instance of a measure that might push the international monetary system in the direction of the New International Economic Order. To its advocates, it appeared as a means of bypassing the uncertainty and instability of private capital markets and also the conditionality of traditional IMF assistance. Did not one of the functions of the IMF lie in the provision of a mechanism to guarantee additional reserves in the case of need? It was clearly those countries that failed to obtain access to the newly dynamic capital markets that now experienced a reserve problem. In fact, the amounts that would have been involved in a scheme to allocate SDRs to developing countries were relatively small, as some critics pointed out. Based on the size of SDR issues between 1970 and 1972, the link might have generated an additional $1 billion of assistance (compared with a total of official development assistance in 1972 of $8.7 billion).8 Similar proposals were made regularly in the course of the 1970s and 1980s, perhaps most strikingly by the Brandt Commission in 1980,9 but also by the Group of Twenty-Four (developing countries) in their report of 1985.10
The result was a high degree of politicization of the SDR, which had the unintended consequence of making the intended role of the new primary reserve asset, as discussed in the C-20, less realizable. The C-20 reached no decision and made no recommendation on the link. After 1976, the SDR repeatedly divided the IMF’s Interim Committee. The United States and Germany, in particular, argued against a new SDR creation as being inflationary in the circumstances of the highly liquid mid-1970s. In consequence, no new allocation of SDRs took place until 1978. Even after the major new allocation between 1978 and 1981, the proportion of SDRs in the world’s reserves was lower than it had been in 1972 after the first series of allocations.11 The role of the SDR as a reserve asset was as a result substantially limited.
Accepting Oil Deficits
The economic future looked uncertain and hazardous in the early 1970s. The desire to preserve a harmonious international economic system, which represented the most fundamental concern of the C-20, led it to formulate in the Rome meeting the view that the oil-induced deficits should be “accepted.” As a result they would have to be financed. Otherwise, as IMF Managing Director Johannes Witteveen explained, there existed the risk of “the sort of ‘beggar my neighbor’ policies that had been adopted prior to the Second World War and which had created manifold conflicts and great disorder.”12 But when Japan and Germany offset their oil-induced deficits through corrective measures relatively quickly, and in 1975 developed surplus positions, the lopsided adjustment pattern that had been so feared in the Rome meetings actually came about, and imposed major strains on international relations.
The IMF developed, at the personal initiative of Witteveen, a mechanism for financing of oil-related problems through the use of resources borrowed from the oil producers. He intended the new oil facility to reduce economic strains and in this way to preserve the open international system that had been the legacy of Bretton Woods. This measure was strongly opposed at the outset by the United States and Germany, on a rather varied range of grounds: that it would make it easier for the OPEC prices to be maintained at their high levels, that new ways of producing and saving energy would “come out of the woodwork,” that it was misguided to distinguish in importing countries between oil-related difficulties and general balance of payments problems, that the oil price increases were so large that they could not be financed, and that some of the borrowing countries might prove unable or unwilling to repay.13 Instead, the oil producers themselves should take the responsibility of providing a “substantial amount of grant assistance” to prevent a collapse of living standards in poor countries. The German Finance Minister (and later Chancellor) Helmut Schmidt pleaded very vigorously for a discussion of a common energy policy rather than of ways of financing future deficits and debts.14 The United States, on the other hand, was happy to see some mechanism to facilitate adjustment in the industrial countries, and indeed vigorously supported the idea of creating an oil facility through the Organization for Economic Cooperation and Development (OECD); but it hoped that pressure from developing countries would embarrass OPEC into rescinding the rises.
The IMF’s oil facility (established on June 13, 1974) aimed at preserving the stability of and confidence in the international system. Together with the rival OECD proposal, the new facility was dismissed as a mere “palliative” by radical critics who wanted the new monetary order.15 But it quite dramatically altered the character of the IMF. The use of quotas as a basis for financing the needs of members had given the Fund an international character analogous to a cooperative credit union in national economic life.16 The oil facility moved the Fund closer toward functioning as a bank, as it established in the Fund a practice of borrowing and lending on terms that were almost but not quite commercial. Almost, because the rates (7.7 percent) were much higher than the Fund’s traditional charges, in order to reflect the cost of borrowing. Almost, because the Fund broke the link that had existed since the 1950s between credit and policy changes, and there was “virtually no conditionality,”17 apart from a requirement to hold consultations about adjustment. But not quite, because access to the oil facility was determined not by determination of credit standing and risk in the manner of a commercial bank, but rather through the application of a formula based on oil imports and balance of payments position in the legal tradition of the Fund, which required the application of abstract and universal rules. And not quite, because the attraction of the Fund to the oil producing lenders was that it would guarantee their investments in a way that recycling through the private sector might not. In addition, the IMF offered an exchange rate guarantee on the loan.
The IMF was an especially attractive borrower due to its stature as an international institution, privileged by international law. The funds, amounting to a total of SDR 3.0 billion ($3.6 billion), came from Iran, Kuwait, Oman, Saudi Arabia, the United Arab Emirates, Venezuela, and later Nigeria. Germany, in line with its initial hesitance about the proposal, refused to participate, and the only industrial creditors as a result were Canada and the Netherlands. Thirty-three developing countries, as well as six developed primary producing countries, borrowed under the oil facility, as well as Italy, the only developed industrial country that required this assistance. India was included in the oil facility, even though no balance of payments deficit existed, as a way of encouraging India to liberalize imports and stimulate economic growth.
In September 1974, Witteveen proposed the establishment of a second IMF oil facility, which would include more lending to the industrial countries. Here the conditionality was slightly stricter, although the terms were not as far-reaching as the Fund staff would have preferred. Of the total of SDR 3,856 million ($4,650 million) borrowed, SDR 1,000 million ($1,200 million) was taken by the United Kingdom, and SDR 780 million by Italy.
The oil facilities, with their high interest rates, did not deal with the difficulties facing the poorest developing countries. At the end of 1974, Henry Kissinger suggested a three-tiered approach to the oil crisis: the OECD would establish a fund to give stand-by credits to the developed countries; the United States would create its own “common loan and guarantee fund”; and the IMF would manage a Trust Fund to subsidize the cost of adjustment in very poor countries. The latter proposal was developed by the IMF into a proposal for a Subsidy Account. The United Nations drew up a list of the 41 countries (39 of which were members of the Fund) “most seriously affected by the current situation,” on the basis of low per capita income (below $400 in 1971) and balance of payments deficits (of over 5 percent of imports). The Subsidy Account, financed through the contributions from 25 rich countries, allowed the reduction of interest payments on the oil facilities by 5 percent. In 1976, in addition, a Trust Fund administered by the IMF began operations, supplying concessional balance of payments support to low-income countries at 0.5 percent interest, with a repayment schedule beginning after five years. It was financed through the sale of part of the IMF’s gold holdings. (In November 1973, the major central banks had ended the gold agreement of March 1968 and became free to sell gold on the private market. As a consequence, a dispute about the ownership of the Fund’s gold took place, involving the interpretation of what had been meant by the original “subscription.” In a compromise, two thirds of the gold remained with the Fund, one sixth was returned to central banks at the official price for gold, and one sixth was sold through the Trust Fund.)
Within a few years, the apparently enormous problems created by the oil price increases of 1973–74 began to appear surmountable. Slower growth rates combined with fuel economy measures held down the demand for oil. Oil exporters increased their imports, both of consumer goods and of capital equipment, as they tried to move further along the petroleum production process into refining and processing. The OPEC surpluses were recycled, mostly through credit markets rather than through multilateral institutions (despite the IMF oil facilities). Although drawings on the IMF increased (see Figure 5-2), the rise of private international debt was much more dramatic (see Figure 11-1). Correspondingly, the debts of developing countries rose. Most of the medium-income developing countries found it easier and more attractive to borrow from banks than from international institutions. Many international civil servants remember being kept waiting outside finance ministries and central banks, while the (mostly American) investment bankers cut their own deals.
The Euromarkets proved to be an easy institutional mechanism for recycling the petroleum revenues, mostly to governments, and mostly on a short-term basis. In 1974–75, loans to governments and public financial institutions accounted for over half of total Eurocredits. The maturity of the loans fell. While in 1974, two thirds of the loans still had a maturity of between seven and ten years and one tenth had a maturity of more than ten years, in 1975 two thirds were dated between one and six years, and only 1 percent had a maturity of more than ten years. The behavior of the markets indicated that they expected the recycling phenomenon to be short-lived; and at first, banks found the exercise rather unfamiliar. In the summer of 1974, some of New York’s leading bankers told the IMF’s Managing Director of their worries over instability on the Euromarkets. David Rockefeller, chairman of Chase Manhattan Bank, believed that the banks could only continue to recycle oil money for another six months at the maximum. “Both the capital of the banks and the increasing lending risks are becoming serious constraints.… Recently some of the incoming Arab money has already been moving to the Federal Reserve instead of to private banks. This may sharpen the scarcity of funds in the marker.”18
The explosion of short-term lending also alarmed the IMF. Initially, in 1974, the Fund’s Annual Report had asked whether private banks would be able to finance the recycling process.19 By 1976, the Report noted the “sudden escalation” of borrowing after 1973, and warned that: “Many borrowing countries, however, have become potentially vulnerable to any significant change in their access to external credit, or to any seriously adverse shift in their export earnings. This vulnerability is heightened by the eroding effects of inflation on the real value of external reserves, which are now quite low in relation to current and prospective imports.”20 Witteveen delivered his warnings both in public and in private. In spring 1976, he told a conference that: “Competitive enlargement of this role of private banks might well foster a climate of all-too-easy borrowing by deficit countries, thus facilitating inflationary financing and delaying the adoption of needed adjustment policies.… In general, therefore, a very careful and balanced policy by the international banks is needed.”21 Later in the year he told the Interim Committee at the Fund meeting in Manila that “commercial bank lending should not be so easily available that it made the need for adjustment less clear, and hence caused the authorities to accumulate larger debts than were desirable.”22 In 1977 U.S. officials continued to note Witteveen’s concern about international bank lending. “He is worried that incentives favoring bank lending abroad may be too attractive, that such lending is essentially uncontrolled, that it leads to international liquidity creation (as countries borrow foreign currency to add to their reserves), and that its continuation may permanently prevent another SDR allocation.”23 The same theme appeared in statements in the Annual Meeting. Since there was a danger of resurgence of inflation, the world required “more stress on the adjustment of external positions and less emphasis on the mere financing of deficits.”24
Some of this concern was shared by central banks and banking regulatory authorities. The Chairman of the Federal Reserve Board, Arthur Bums, in 1977 proposed compiling a list of questions on the current indebtedness of borrowing countries, and on the content of bank lending. When the Bank for International Settlements (BIS) discussed the Burns suggestion with individual banks, the response was largely hostile. Almost all the bigger banks opposed such intervention, and declared themselves fully “satisfied with their present information on, and methods of assessing, country risk situations.” “The recommendation of a checklist of questions would appear to reflect on their past lending policies and would therefore be resented by them.” Other banks believed simply that they should not provide information to regulators, but that the “official” institutions such as the World Bank, the IMF, or the BIS should have the “job” of putting together information (although it was not clear from which sources such data could be compiled). As a result, the Bums and BIS discussions for the moment led nowhere.25
Such advice from national and international regulators was very unpopular with the intended subjects of regulation. Bankers did not see why they should not lend across frontiers, and some came to believe that the Fund’s advice was obsolete, outmoded, and suitable for a past era when capital markets had not reached their current levels of sophistication and integration. In this view, the market, rather than multilateral institutions, held out the best way of solving the world’s problems.
Finance ministers in deficit countries felt equally strongly that warnings about financing and invocations to adjust were quite inappropriate. One of the attractions of the Euromarkets was that it allowed them to ignore the warnings of the IMF. Vast resources opened up that involved virtually no foreign control. As one astute comment noted, “probably no international capital market in history has had a lower degree of political interference, to the dismay of ‘strategic minds’ like that of Dr. Henry Kissinger.”26 In the interim Committee, Mario Enrique Simonsen, the Finance Minister of Brazil, in 1976 said that “he was rather disturbed by Mr. Witteveen’s reference to commercial banking: banks should naturally be cautious in lending, but not only to foreign countries.”27 In the following year, he was even more explicit in his insistence that the Fund should not give advice or attempt to influence the private sector. “While they [the developing countries] would … certainly welcome the technical assistance of the Fund and other institutions, in helping them improve their own statistical and informational systems, the developing countries continued to feel that the Fund could play no useful role as a purveyor to the private sector of judgments, analyses and forecasts.”28 In fact, judged in relative terms, the Fund’s activity indeed diminished. In the course of the 1970s, the proportion of developing countries’ current account deficits financed by the IMF was lower than it had been in the 1960s (5.1 percent rather than 7.5 percent).29 On the other hand, it was hard to argue that Fund support should simply ignore the extent of commercial lending. Debt incurred through commercial banks clearly affected the outcome of Fund programs, and the Fund needed to take private liabilities into account in judging the viability of member countries’ external position. In 1979, the Fund decided that if the size or growth rate of external indebtedness might affect the design of a Fund-supported adjustment program, performance criteria for the program should include foreign loans with a maturity over one year (and in exceptional circumstances, non-trade-related loans under one year might be included).30
For finance ministers in deficit countries, the Fund’s involvement in recycling brought difficulties because of its conditionality—or as they and other critics came to call it, during the 1976 Annual Meeting and afterward, its “strict conditionality.” It was conditionality that distinguished the lending of multilateral institutions from that of the private sector. Apart from the oil facilities, Witteveen emphasized, “the dominant feature of all other Fund lending is the degree of conditionality that is attached to it.”31 Or, as one of the Executive Directors put it in the course of one of the many long debates in the Fund Board about the working and principles of conditionality, without conditionally “there need be no Fund.”32
The absence of the concept of “conditionality” in private lending might at first appear puzzling. Do private lenders not also expect their debtors to follow policies that will ensure that it is possible to make repayment? The security on any loan is a kind of conditionality, limiting further borrowing. Formal or informal credit ratings give information about policies being pursued by corporations or governments that is used in assessing risk prospects, and thus the terms of a loan. There is then in fact a conditionality, but it can vary dramatically over the course of time—even, as credit conditions and the psychology of the market change, in a very short period. Bank conditionality in short exists, bur is less predictable than that of international institutions.
In the middle of the 1970s, in practice private markets applied very low degrees of conditionality because of their high liquidity. This was the consequence of the OPEC surpluses, although there were other influences. Domestic borrowers in some of the major countries and particularly in the United States avoided bank credit and moved into securitized borrowing; and in consequence banks sought new debit customers. Increased bank liquidity implied that new financing would always be available, and that there would be no problems with the repayment of individual loans. Retrospectively, such a deduction appeared rather irresponsible. It put not only the banks themselves at risk: more seriously, it created a “debt trap” from which those countries that had been ensnared found escape hard and very painful. Both lenders and borrowers worked with an excessively short mental time horizon. If the horizon is sufficiently limited, adjustment can always appear to be just on the other side; and the illusions that sustained the flow of credit could continue. The lending phenomenon also owed much to a calculation about the likely stance of policymakers in the major industrial countries: that, despite all the rhetoric of summit communiqués, inflation would continue to run at high levels, with consequently low or even negative real interest rates.
Fund conditionality had been developed as an operating principle in the course of the 1950s (see Chapter 3). In the early stages, it involved tests on fiscal conditions and credit expansion as well as on the balance of payments (because of linkages between internal credit conditions and the external balance). Budgetary and domestic credit restraint would be an indicator that a country was in a position to balance its external account. In the course of the late 1960s and the 1970s, the specification of conditions and the discussion of policy issues became much more detailed. More attention was paid to trade liberalization. The pricing of public utilities, public sector pay policy, measures that might affect or control private sector pay such as guidelines or indexation, all entered into the texts of the letters of intent produced and signed by finance ministers in the course of negotiating Fund arrangements. Without such details in the arrangements, it was feared that policy would be pushed in an undesirable direction. Underpriced utilities, for instance, would result in pressure on the budget; or a limited budget would be used to pay civil servants at the expense of capital projects; or private pay settlements would produce inflationary effects.
The 1979 IMF Guidelines on Conditionality, which provided the most systematic codification of the Fund’s objectives, contained a very wide-ranging list of considerations. Section 4 states: “In helping members to devise adjustment programs, the Fund will 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.” The performance criteria specified in Fund programs should, however, be as few as practically possible. Section 9 stated that they would “normally be confined to (i) macroeconomic variables, and (ii) those necessary to implement specific provisions of the Articles or policies adopted under them.” They would relate to other variables “only in exceptional cases when they are essential for the effectiveness of the member’s program because of their macroeconomic impact.”33 In light of concern about the increasing activity of private capital markets, and their effect on the practice of Fund conditionality, these Guidelines were later supplemented with an additional code on performance criteria with respect to foreign borrowing (August 3, 1979).
Inevitably it was the elaboration of additional (“exceptional”) details intended to ensure that the macroeconomic criteria would be observed that drew the Fund into domestic political debates about microeconomic management. The shape of the Fund program emerged in the course of discussions between Fund officials and national civil servants and politicians. Without the latter’s cooperation and involvement it stood no chance of being realized, bur the policymakers often found it hard to convince their compatriots. On occasion, therefore, they used the argument about external pressure as a way of sheltering from criticism or domestic political debate.
The extent to which such an exercise in the shifting of political responsibility increases or decreases domestic political stability is contentious. Examples can be accumulated for both sides of the case, to show that dependence on external discipline strengthens state authority, and, on the other hand, to demonstrate how it may erode politically responsible behavior. In the postwar reconstruction of Japan and Germany, which had been a conceptual model for Fund activities in the Per Jacobsson era, there is no doubt that blaming the Allied policy and the military authorities for the initial economic difficulties that accompanied liberalization took a substantial strain off initially weak and vulnerable political structures and greatly facilitated economic revival. Both the German currency reform of 1948 and the Japanese financial reform of 1949 (the “Dodge Plan”) were initially unpopular, and their substantial benefits became apparent only after a substantial delay. In the meantime, it was helpful for economic reformers to have the occupation authorities impose political stability.
Weak governments like to be able to reduce the domestic political pressure applied by interest groups and parties by pointing to the need to respond to an alternative pressure coming from the outside. The IMF in the course of the 1960s had become accustomed to being used in this way as an external whipping boy or scapegoat. In the 1970s, even quite large and powerful industrial countries, such as the United Kingdom, saw the uses of the Fund in this regard. In the longer run, however, it is impossible for any political structure to operate just by saying that it is merely doing what the outside world, or external informed opinion, is telling it to do. The sustainability of the package often became endangered by the perception that sound policy was something imposed by a malign outside influence. It was too easy to conclude that the program was not in the best interests of the country concerned. Over longer time periods, a process of shifting from the use of an external scapegoat to a domestic debate about appropriate policy choices could be the only way of sustaining political legitimacy. The case of Jamaica at the end of the 1970s (see below, pages 330–33), would show how using the Fund to impose bad news on a vulnerable population in the longer run made it harder to sustain Fund programs and led to an intensification of economic difficulties.
The implementation of conditionality became even harder because of two developments that arose as responses to the unprecedented international strains of the 1970s: first, the proliferation of multilateral institutions offering their own forms of conditionality as ways of helping to promote the process of adjustment; and second, the multiplicity of different forms of lending by the same institution but with differing goals and varied conditionality.
The World Bank and the IMF now experienced similar problems. The increasingly encompassing character of their activities brought about a convergence in operational activity that produced increased practical cooperation between the two institutions, but also tensions when—as inevitably occurred from time to time—each institution advocated a different approach to the same problem. The overlap and the occasional variance in emphasis led to widespread reflection, at least by some bolder spirits, on whether a radical administrative simplification might not require the eventual merging of the Bretton Woods twins. In 1982, a U.S. Treasury document referred to the Bank’s “moving away from its project lending emphasis into an area of balance of payments support more appropriate to the IMF.”34 Classically the World Bank had dealt with microeconomic adjustment and a supply-centered reorientation of policy in reforming countries, while the Fund had focused on macroeconomic adjustment and issues arising out of the balance of payments. Even in the 1960s, the Bank in some instances had moved into the “territory” of the Fund, notably in the large-scale assistance to India in 1966, which in practice amounted to a balance of payments program (see page 143). By the late 1970s, however, it had become clear that many national economic problems were fundamentally connected, and that they could not be treated step-by-step or in isolation from each other. Macroeconomic adjustment could not hope to succeed if it were not linked with supply-side measures, requiring microeconomic policy choices about investment in infrastructure, training, and education. It was equally apparent that the chances for success of such policies depended critically on global economic variables. In this way, the domains of the Fund and the World Bank coincided. In addition, traditionally the Fund had been concerned with all countries, and not simply poor of “developing” countries, but after 1977 no major industrial country would conclude a Fund program, and the constituencies of Fund and Bank operations in consequence appeared to become closer if not identical.
Three major answers could have been given to the question posed by the increasing overlap of Bank and Fund activities. One rationale for the continuing existence of separate institutions was precisely that they might offer, on occasion, a diversity of views on a series of highly complex subjects, where debate might be desirable and productive. Both the Fund and the Bank engaged (and engage) in internal self-criticism, but external help is also needed. When it comes to giving advice, it is good to draw on a variety of institutions, including regional development banks, as well as such nonfinancial institutions as think tanks and universities; and in this regard, it was beneficial that the Bretton Woods twins were not identical. Discussion and debate is essential if advice is to be persuasive. Second, the major impact of the two institutions came at different stages of the process of economic policy reform. The IMF dealt with acute balance of payments crises, that might well have been an indicator of a deep underlying problem, and tried to find answers that would fit into a longer-term perspective. The World Bank was concerned with a sustained process of economic growth. A third, and perhaps even more convincing answer, is that indeed the spheres of activity of Fund and Bank were logically distinct.
The Fund was fundamentally a monetary institution, whose responsibility encompasses monetary issues (including of course those affecting poor countries) on a global level, and not simply through specific programs. Two examples, which will be dealt with in later chapters of how development issues are affected by the general world economic environment, concern interest rates (Chapter 12) and the effects of regional institutions (Chapter 14). International interest rate behavior has been determined largely by the actions of central banks of a few large industrial countries; in order to protect developing countries from abrupt changes in interest rates, a greater degree of global coordination around better policies is needed. Regional institutions can also produce monetary effects that have a global impact: for instance, in the late 1980s the exchange rate mechanism of the European Community profoundly affected the behavior of the francophone West African countries.
The World Bank’s concern, however, was primarily with development. In 1979, it began to move into a wider field of operations with structural adjustment loans (SALs). Before that date, most of its activity had been confined to project lending. Though there had been some program lending, it involved only a relatively small share (around 6 percent) of total lending. Most of this had been in the form of import credits as a response to the sharp deterioration after 1973 of the terms of trade of the oil importing developing countries, offered in parallel with the IMF’s oil facilities. SAL was intended to support policy reforms that would achieve “sustainable growth.” This involved the alleviation of poverty, the mobilization of domestic resources (increasing savings rates), appropriate price policy to create incentives, “wage flexibility” (that is, the avoidance of indexation to prevent the impact of external shocks being taken mainly in the form of increased unemployment), and greater flexibility of trade and exchange policy.35 Although almost all of these objectives could be described simply under the general label of “liberalization,” setting out the details of what liberalization involved, in the context of often highly controlled, administered, and regulated economies, demanded complex regulatory guidelines on methods and the appropriate sequence for carrying out a viable reform strategy.
The practical problem for both the Fund and the Bank in setting out such a range of objectives—or with increasing the detailed content of conditionality—lay in the fact that the outcome was only knowable after the passing of a substantial time period. Programs had to become longer as conditionality became more complex, because the simple guidelines provided by fiscal, credit, and balance of payments indicators alone could not be sufficient as the basis for assessment. The development can be formulated in terms of the old discussion (which went back to the Bretton Woods era and the immediate postwar period) of the balance in the international system between rules and discretion. Increasing the number of rules and making them more complex also would give to rules an ad hoc appearance, so that the system began to appear as much more discretionary. As the element of discretion increased, so too did the opportunities for claiming that the system was arbitrary, or politicized, or unequal, or insufficiently market-based. As international institutions evolved to respond to the problems of the 1970s, they were inevitably challenged by both the political left and the political right. The left thought it detected a political interference that resulted in subordination to the market and the subversion of democratically expressed wishes. The right complained that there was not enough market in the intervention of the international institutions.
The Fund as well as the Bank extended its range of facilities and programs. The extended Fund facility (EFF), launched in 1975, was designed to create a longer-time framework for the adjustment process. It had become clear that a one-year stand-by arrangement could not be adequate as an accompanying measure for a serious structural transformation. A typical EFF program would involve drawings over three years and repayment (repurchases in the Fund terminology) over four to eight years. An eleven-year horizon would create the appropriate incentive structure for more effective institutional change: liberalization of external trade following the establishment of a realistic exchange rate (through devaluation), ending import quotas and simplifying the tariff structure, streamlining fiscal systems, and encouraging domestic savings. Some of the Fund programs were successful in opening up trade through exchange rate adjustment; but in many of the largest arrangements, the programs were thrown off course through the unexpected behavior of commodity prices of unanticipated surges or government revenue.
In Kenya, Mexico, and India, unexpected increases in commodity production or in export prices during the time period of the program made the task of adjustment look deceptively easy, and encouraged governments to halt or postpone reforms of fiscal or trade policy. In other cases (perhaps most spectacularly in Jamaica) the long haul of the EFF framework was simply too long, and added to the political strains inevitably associated with adjustment.
The first EFF arrangement was concluded with Kenya in 1975. Its purpose was to facilitate a period of substantial (5 percent per annum) growth, in which over a five-year period the need for balance of payments assistance would be eliminated. The budget would be reshaped so as to limit public consumption and spending on roads and buildings while increasing the flow of funds for the development of agriculture. The government prepared an ambitious paper, “On Economic Prospects and Policy,” in which the contribution of fiscal policy in the stabilization process was elaborated. But in fact relatively little was drawn under the program, because the volatility of commodity prices suddenly worked dramatically in Kenya’s favor. Tea and coffee prices rose in 1977–78 and created large unanticipated payments surpluses. This allowed the complete decontrol of the fiscal process and, in 1977, a “record amount of deficit financing.”36 High rates of growth indeed occurred (4 percent real growth in 1976, 1978, and 1979) after an initial very sharp contraction in 1975; but they were followed by the reappearance of balance of payments problems, requiring a much shorter-term IMF stand-by arrangement with a greatly simplified conditionality in 1979.
The oil price shock contributed to an inflationary crisis in Mexico in the mid-1970s, in a country that traditionally had low rates of inflation. The maintenance of a high external value of the peso led to a growing current account deficit. Public sector borrowing expanded as the government of President Luís Echevarría Alvarez built up a vast public sector. By 1975 the deficit had reached 10 percent of GDP. In the summer of 1976 a crisis of confidence broke out, as the economy contracted, as foreign lenders refused to subscribe new funds, and as domestic capital flight set in. In August, the peso was floated, and depreciated by 40 percent almost immediately as the crisis of confidence continued. As a result, the new administration of President José Lopez Portillo made the first Mexican approach to the IMF since the stand-by programs of the 1950s. The resulting EFF was intended to restore Mexican growth on the basis of the stabilization of public sector finance and a reduction of inflation. A principal goal involved reduction of the public sector deficit to 3.5 percent of GDP by 1979.
Initially, the program appeared to be successful beyond expectations. It had been based on rather conservative estimates of Mexican oil output provided by the state oil company PEMEX. But as the result of the discovery of new fields, partly under the sea, production more than doubled in four years, from 830,000 barrels in 1976 to 1.9 million barrels in 1980, and Mexico again became highly attractive to foreign lenders. The new revenue (together with the promise of ever large future income) allowed a considerable expansion of public sector investment, rather than a reduction. By 1979, the deficit had reached 7.6 percent of GDP, three times the level provided in the EFF program. As a result, though there was a considerable success in restoring growth, it owed little to the design of the program, and the nature of the growth allowed the postponement of the adjustment envisaged in 1976. Growth at very high rates (4.2 percent real GDP growth in 1976 and 3.4 percent in 1977 was followed by four years of over 8 percent) was financed primarily through borrowing on the world’s capital markets. The development plan announced in early 1980 provided for the maintenance of the 8 percent growth, as well as an average yearly rate of increase in employment by 4.2 percent. The apparently self-sustaining cycle of confidence and growth allowed a neglect of the Fund’s advice on the public deficit, and a “withdrawal” from the Fund’s “tutelage,” after the Fund’s consultation report contained references to “signs of overheating.”37 But the Fund report also concluded that “Mexico’s external debt management has improved markedly over the last three years.” Mexico moved from the terms of the EFF to the greener pastures of Euromarket borrowing.
Even without commodity booms, such as the tea and coffee price surges in Kenya, or the increase in Mexican oil output, which encouraged the postponement of adjustment, countries found it difficult to sustain the longer-term conditions involved in EFF programs. The experience of Jamaica has frequently been used, literally as a textbook case, of bad relations with the Fund—of the dire consequences of either (or both) political insensitivity on the part of the Fund, of misguided radical populism on the side of the government of a poor country.38 The Jamaican economy had grown very quickly in the 1960s, at an average real rate of GDP growth of 6 percent, developing tourism and bauxite production. But the growth was not matched by employment creation, and in 1972 unemployment stood at 23.5 percent. The new Prime Minister elected in that year, Michael Manley, promised to solve the labor surplus by implementing “democratic socialism.” Bauxite production would be expanded with the help of foreign capital as well as development assistance. OPEC’s manipulation of commodity prices was interpreted as a hopeful signal for the bauxite market. Manley in practice built up a large public sector and implemented new social programs. When the economy was hit by the oil price shock, the government attempted to minimize the effect on living standards by an expansive monetary policy designed to allow higher consumption. Investment fell abruptly, the unemployment rate returned to 24 percent (in 1976), and by 1977 real per capita GDP was 20 percent below the level of 1972.
In the December 1976 elections, the opposition attacked Manley with the allegation that he had accepted devaluation as part of an IMF program, and he responded with a campaign against “IMF impositions.” After a new victory, in 1977 his party’s National Executive Council prepared a paper recommending that Jamaica should stay as a member of the Fund, but work toward the creation of a New International Economic Order. The essence of the Jamaican position was explained by Foreign Minister Percival J. Patterson to the United Nations General Assembly: “Unfortunately, developing countries which take a really serious view of their obligation to divert resources to meet the needs of their underprivileged find little sympathy or understanding among developed countries and certain international institutions. If we devote domestic resources primarily to meeting these needs and have to seek temporary foreign-exchange assistance from the international monetary agencies, those agencies ignore of discount the social objectives and apply rigid and anachronistic yardsticks to the credit application; stigmatize our Governments as having frittered away our resources and provide limited amounts of credit only on condition that the vital social programmes are cut back. All this is done in the name of sound financial practice.”39
At the beginning of January 1977, Manley told parliament that: “This government, on behalf of our people, will not accept anybody anywhere in the world telling us what to do in our country. We are the masters in our house and in our house there shall be no other master but ourselves. Above all, we are not for sale.” The parliament began to develop a non-IMF alternative Emergency Production Plan for self-reliant development with an increased emphasis on agriculture and closer relations with socialist economies; but eventually turned to the IMF instead, while still engaging in a harsh criticism of the international economic order.40 The goal of the government was to use the international authority as the scapegoat for the imposition of an unavoidable, but unpopular, program. This was the background to an SDR 64 million ($75 million) two-year stabilization program negotiated with the IMF in August 1977. Although the program specified a flexible external rate and a real depreciation, in practice currency controls remained and the exchange rate was overvalued, especially as wages rose further. Other performance criteria were not met, and in December 1977 the Fund suspended Jamaica’s drawing rights under the program.
The suspension alarmed Jamaica’s private creditors, and the banks formed a syndicate organized by the Bank of Nova Scotia. At a meeting with the Jamaican Finance Minister (who appealed for further funds) and IMF representatives, the bankers discussed the possibilities for solving Jamaica’s debt crisis. Essentially they hoped for a bailout from the official sector. They expected official development assistance might help Jamaica, that the World Bank might participate with some program financing, and that the U.S. Exim Bank would grant some debt relief. But the fundamental strategy involved linking further private credit to the Fund’s conditionally. The banks proposed to refinance 87.5 percent of the credits maturing in 1979 and 1980, “subject to the negotiation of a suitable program under the Fund’s extended facility.”41 The EFF program was indeed negotiated during 1977–78, in a wide-ranging set of discussions designed by the IMF to involve as many Jamaicans, both officials and politicians, as possible in the formulation of an improved economic strategy, in order to avoid the Fund being used as a scapegoat. The IMF would provide SDR 200 million ($250 million) over three years. Regular devaluations (“a crawling peg”) would guarantee a realistic exchange rate. Subsidies would be cut, and prices and taxes increased.
In fact, in the first year of the program balance of payments problems persisted, and there was little substantial economic growth. In mid-1978 the crawling peg devaluations were suspended, with a Jamaican assurance that wage policy would tighten. In 1979 some indicators showed a modest recovery, but the economy was then hit by the second oil shock, and the IMF now extended additional facilities for commodity and buffer stock financing. Attempts to agree on a new refinancing with the private banks failed. The Fund staff urged a renegotiation of the EFF, with a concentration on microeconomic adjustment, with a slimmed down public sector providing only “basic services,” the identification of a number of specific production and investment bottlenecks, and the creation of task forces with business, labor, and government participation to tackle them.
Macroeconomic adjustment had repeatedly failed in the case of Jamaica. As a consequence, the concept of conditionality came to include ever more details about the appropriate course of economic management. But this might appear like a new intrusion, especially when linked with the identification by the IMF team of a large J$170 million gap in the budget plan for 1980/81. The IMF was used again as the bearer of bad news. At first, Jamaica tried to obtain a “waiver,” under which the Fund would overlook the breach of performance criteria, and that would avoid the necessity of negotiating a new program. But the government found it impossible to deal with the budget gap, and the waiver negotiations broke down.
Manley, on March 2, 1980, as a response proposed new elections before the adoption of a new EFF program. Once again, as riots broke out outside food stores, Manley mounted an anti-IMF campaign, in which the EFF became the object of a political ball game. Some American congressmen joined in the criticism of the “harshness” of the IMF, and the Managing Director responded with a personal letter to Manley in which he explained that the fact that “Jamaica has received more Fund financing, relative to its quota, than any other country in the Fund’s history is evidence of our readiness to assist Jamaica.”42 At the end of March, the Prime Minister announced that he would hold no further talks with the IMF, and on March 30, 1980 delivered a speech asking whether the IMF had any “genuine value to the Third World.”43 The opposition Jamaica Labour Party campaigned on a promise of sounder economic management, smaller and more efficient government, an improved environment for private enterprise, and a resulting creation of jobs. It won a massive majority in the elections, eventually held in October 1980, and the new government of Edward Seaga began negotiations with multilateral institutions and also with U.S. aid authorities. Relations with international agencies as a result improved dramatically for a while, although the fundamental problem remained of how to accept a painful adjustment program that appeared to promise little recovery.
A staff memorandum prepared in the IMF explained the Jamaican experience in the following terms: “The Fund staff can perhaps be faulted for an overoptimistic assessment, in the earlier stages of the exercise, of the political commitment to the program; and for its overestimation of the management capabilities of the administration.”44 Longer-term adjustment created too many problems for governments concerned with short-run popularity, and obsessed with distributing elsewhere the blame for poor performance and unpopular measures.
Even the most successful (as well as the largest) EFF in the aftermath of the second oil shock—that concluded with India—left a rather ambiguous legacy. In this case, the problem lay not in the breakdown or failure of relations, which remained quite harmonious, or in the wish to use the IMF as a scapegoat, but—as in the Kenyan or Mexican cases—in external circumstances that allowed a quick apparent success but also a postponement of some of the larger structural reforms that should ideally have accompanied adjustment.
The Indian program of 1981 was the largest single transaction in the history of the Fund yet: an SDR 5 billion program ($5.75 billion), although as the balance of payments quickly improved, not all of this sum was in fact drawn. Like other EFF programs, it was intended to accompany a period of sustained growth. The Indian Sixth Five-Year Plan envisaged an average growth of 5.2 percent annually until 1984/85, an acceleration from the 4 percent averages of the late 1970s. It was also designed to deal with a potential balance of payments problem, resulting from the second oil price shock of 1979. In 1981 the current account deficit amounted to 2 percent of GDP, and shortages and bottlenecks in the supply of capital goods had caused problems in some of India’s key heavy goods industries and infrastructure: electric power, coal, cement, steel, and transportation. The Fund program evolved in parallel with specific World Bank programs.
The Indian strategy involved following the Fund’s often repeated advice to “go to the Fund early,” since last minute programs were bound to occur in an emergency climate, and since negotiation of a program itself necessarily involved some time, in addition, the Indian government was worried by the deterioration of the international economic and political situation: a growing hostility in the major industrial countries toward official development assistance, and the belief that some large Latin American countries would soon have to draw on scarce Fund resources. It did not want to build up a large amount of external bank debt.
Initially the IMF’s response was to insist that “the Fund should not appear to be engaged in development financing,” but rather only in the promotion of balance of payments adjustment.45 It argued, however, that any new program should be linked to a renewed discussion of increased trade liberalization.46 Though a very partial liberalization had been launched by the short-lived Janata Party government in 1977, the government of Indira Gandhi after 1980 had responded to balance of payments problems with a tightening of import restrictions. In addition, the Fund believed that the government should reduce domestic subsidies and maintain realistic interest rates. Petroleum prices were indeed raised in June 1980, January 1981, and again in July 1981; but in 1981, although there was an inflation rate of nearly 20 percent, the rates on fixed deposits remained restricted to between 2.5 percent and 10 percent.
The proposed drawing encountered substantial hostility from the new Republican administration of the United States, despite the extent of the proposed liberalization program. There appeared to be, so the U.S. government argued, no evidence that the Fund had had much impact on Indian policy. In general, at this point, the United States was increasingly explicit about its desire to use multilateral financial institutions primarily for the ends of U.S. policy.47 Would it not be better if India went to the commercial banks who would select their projects more carefully? (This type of argument was not heard so much after the Mexican debt crisis of August 1982, when it became clear that commercial banks were not always very judicious in their financing choices.) Agreement to the package was preceded by an extensive lobbying by Indian officials in France, Germany, and the United Kingdom, as well as by the Fund’s Managing Director, Jacques de Larasière. In the end, the U.S. Executive Director of the Fund abstained rather than blocking the program through a negative vote. But even after the Executive Board had approved the Indian drawing, American opponents attacked it in Congress and in the press.
As agreed in November 1981, the Indian EFF involved the drawing of SDR 5 billion ($5.75 billion) over the course of three years. Commercial bank financing of the government deficit was to be reduced from 4 percent to 3 percent of GNP. No conditions were made as to the level of the exchange rate, and neither did India make any explicit commitment about trade policy. In practice, as some commentators (as well as IMF reports) also pointed out, there was almost no trade liberalization.48
In India, the program was treated as a victory for “adjustment with growth,” as a demonstration that “growth need not be sacrificed at the altar of adjustment,” and as an example of a conditionality that was “self-imposed,” rather than forced from the outside. Mrs. Gandhi defended the package in parliament in these terms: “There is absolutely no question of our accepting any programme which is incompatible with our policy declared and accepted by Parliament. It is inconceivable that anybody should think that we would accept assistance from any external agency which dictates terms which are not in consonance with such policies.”49 And the outcome certainly resulted in additional growth.
The improvement of India’s current account after 1982 came about, not as a consequence of a rise in exports after an exchange rate alteration or of improved performance, but because of the accelerated development of India’s petroleum capacity. The figure for production in the final year of the Sixth Five-Year Plan had originally been 21 million tons, but the projections were raised to 26 million tons and then to 29 million tons. All of the increase came from the output of one field, Bombay High, which raised its production from 5 million tons to 21 million tons.
The concomitant of this growth was a rise in public spending and public sector deficits, which led by the second half of the 1980s to a serious financing problem. In the biggest of the EFFs, in India, as in the first (in Kenya), the adjustment framework proved to be too long term, and the conditionality too unclear, for the program to be judged a complete success as a facilitator of liberalization. Indeed, viewed with hindsight, these programs may actually have delayed the process of loosening economic controls and regulations. The programs differed in this regard very dramatically from the deregulation and liberalization pursued in Mexico after 1985 and in India after 1991. Both in Mexico and in India, the longer-term Fund facilities had helped to support the expansion of the public sector.
Some of the programs of the late 1970s however did prove to be the prelude to successful longer-term adjustment. The case of Turkey raises the important issue of whether repeated failures of a program mean that subsequent programs are necessarily doomed, and whether it is necessarily wrong to try once again to devise an alternative program. The situation in Turkey at the end of the 1970s looked extremely unpromising: an unsustainably high level of external debt, two failed IMF stand-by arrangements, rising inflation, a collapse of (officially recorded) exports, shortages of basic goods, and an upsurge of political instability with violent terrorism that successive governments failed to contain. Ten years later, the situation was almost completely transformed (though high inflation rates remained a problem); and Turkey came to represent one of the most successful and attractive cases of adjustment.
By 1977, largely as a consequence of the real overvaluation produced by inflation and its effects on trade, Turkey had fallen into arrears on debt service. Two rounds of rescheduling by creditor governments within the framework of the OECD in 1978 and 1979 were linked with the completion of a program with the IMF. In the middle of 1978, some Turkish officials were cautiously optimistic that the effects of three years of relative austerity would soon produce a recovery of confidence.50 The optimism was misplaced. In 1979, the central government deficit rose to 5.4 percent of GDP; consumer prices rose by 58.7 percent. The two-year SDR 300 million ($376 million) stand-by arrangement of 1978 was canceled in 1979 after a dramatic deterioration of the fiscal position and an acceleration of inflation; a new agreement was only reached in June 1979, after the second rescheduling of official loans from OECD countries in the Paris Club. The OECD discussions were accompanied by intense high-level diplomacy on the part of the major OECD countries, which feared the obvious security consequences of a destabilization of Turkey, and a resulting weakening of NATO’s southern flank. Elections in November 1979 were won by the conservative Justice Party of Suleiman Demirel; and the new Under-Secretary of Planning, Turgut Özal, rapidly devised a more effective program, which was implemented as a coherent package on January 26, 1980. It involved a depreciation of the main exchange rate of the Turkish lira by 33 percent at the beginning of 1980, with a further devaluation in the early summer. Bank lending and deposit rates were liberalized. Prices in state economic enterprises were raised to more realistic levels.
The Turkish stabilization program is frequently cited as an example of an effective reform strategy introduced by a very small technocratic elite, in this case a group of like-minded ex-civil servants who had become disillusioned with the official state-centered Turkish development strategy, and had moved into the private sector. For Özal and his associates, the liberalization of the exchange rate was the key to opening up the Turkish economy, and to the introduction of a better incentive structure. They presented their reform plans to the Demirel government in slightly different terms: this dramatic shock would be the last opportunity to reach an agreement with the IMF and the international community. The plans had, however, fundamentally been developed without the support of the Fund, although the Özal group had already been speaking in 1979 with IMF and World Bank officials as well as with private bankers.51
Once this program was in place, it was supported by a three-year IMF stand-by arrangement. Initial discussions had revolved around an SDR 500 million ($625 million) figure; but the amount involved grew substantially larger in the course of elaborating a rescue strategy for Turkey. Özal argued that SDR 500 million would not be sufficient to restore confidence and fill the immediate financing gap produced by higher energy import costs. He then negotiated on the basis of SDR 1,000 million ($1,250 million). Then the Fund supported an even larger sum, based on the judgment that the Turkish reforms were exceptionally strong.52 At the same time, the OECD creditors agreed to a consolidation and three-year rescheduling of $3,000 million debt. The program eventually involved SDR 1,250 million ($1,620 million). It appeared a bold gamble in the light of the failures of previous Fund programs, and the narrowness of the political base in Turkey on which the new reforms were conducted. There were severe debt problems, an entrenched bureaucracy apparently committed to the continuation of state-centered industrialization, and a record of overoptimism about the effects of changes. But the hopes proved fully justified. The external payments situation improved dramatically in 1981 and 1982 (surpassing the program targets significantly). Net medium- and long-term capital inflows began again; and syndicated medium-term commercial lending resumed at a time when elsewhere in the world lenders became very nervous.
One of the major problems of the late 1970s had been the very high losses of the state economic enterprises (they had amounted to some 4 percent of GDP in 1979). In 1979, an attempt was made to strengthen financial control by reorganizing these enterprises under the control of sectoral directorates. As part of the 1980 reforms, they were committed to maintain marketoriented prices. After 1984, at the same time as imports were liberalized further, a partial privatization program began.53 After 1981, the economy grew quickly (the real growth rate of GDP between 1980 and 1990 was 5.3 percent).54
The Turkish reforms occurred in the middle of the great international uncertainty produced by the second oil shock and the rise in interest rates. They succeeded because of the radical character of the 1980 program, and because of the extended and extensive nature of the support offered to the adjustment process. The result of the provision of very large external resources was a quick end to the debt crisis.55 By 1983, the IMF Annual Report cited Turkey as the most notable recent example of the redirection of output from domestic to external markets.56 Here was an indication that a number of repeated failures to achieve stabilization did not inevitably mean the impossibility of reform, if sustained with adequate policies—and also adequate resources.
Quotas and the Size of the Fund
The activity of the IMF in response to the 1970s crisis in the world economy was initially substantially handicapped by the difficulties encountered in raising quotas. As a consequence of rapid worldwide inflation, the real value of existing quotas fell; at the same time, the increasing imbalances in the world economy led to additional demand for resources. Some indication of the nature of the problem is given by the relationship between world balance of payments developments and the size of the Fund’s available resources. Between the early 1960s and the second half of the 1970s, the sum of current account imbalances for the 111 countries for which data is available rose by a factor of seven, while the Fund’s resources grew only fourfold.57
As a result of the confidence of some industrial country governments, and of many bankers, that the private sector could handle the recycling of petrodollars more efficiently than official agencies, the willingness to negotiate quota increases waned. But such increases would have been needed were the IMF to be able to play a more active and supportive role. Credit tranches appeared ever smaller in relation to the balance of payments needs of member countries; and countries became dependent on higher tranche drawings that involved greater elements of conditionality. In the middle of the 1970s, the larger part of Fund credit was under the form of special facilities (the compensatory financing facility and the oil facilities), with much reduced conditionality, but after 1976–77 the relative importance of this type of financing fell away, and countries became dependent on conditional resources. The existence of conditionality, and the contentious policy debates that inevitably surrounded it, encouraged stronger borrowers to go by preference to the private sector. This set of circumstances helped to produce the international debt crisis of the 1980s.
After the Fifth General Quota Review (that is, an increase, coupled with modifications of the distribution) in 1971, quotas stood at $28.8 billion. The Sixth General Review began in 1974, and increased quotas by a rather modest SDR 10 billion ($12 billion), but member countries were very slow in subscribing. The quota enlargement went in parallel with the protracted negotiations about the Second Amendment of the Fund’s Articles of Agreement. The debate was complicated by the demand of developing countries for a greater say in international institutions (and a preference of some of their spokesmen for a transfer of responsibilities to the United Nations General Assembly, with its voting based on a one-member one-vote principle).
As a result, quota increases for the first time were calculated on a different basis for differing groups of countries (industrial, more developed primary producers, oil producers, developing countries). Moreover, some of the richer and larger countries felt hesitant about the whole exercise of raising quotas. Even the limited increase had been controversial, because of the implications for the distribution of quotas at a time of great actual and even greater potential institutional change in the management of the world economy. The oil exporters’ enhanced importance needed to be recognized in an increased share of quotas. On the other hand, the United States did not want to allow its quota to be reduced to a figure near to the 20 percent that gave it an effective veto on all vital Fund decisions. The United States and Germany argued that large quota increases would be inflationary. The size of the increase, to SDR 39 billion ($47.4 billion), was agreed in January 1975 at the Interim Committee, but the actual distribution was only approved just before the fall Annual Meeting of that year. It was October 1978 before all members agreed to the increase, which was widely recognized as being inadequate. Although the Seventh Review began almost immediately, no one could expect that it could be finished speedily.
At the April 1978 Interim Committee meeting, most members supported a new 50 percent rise in quotas. The communiqué stated that “there was a need for an increase in total quotas under the Seventh Review that would be adequate to meet the expected need for conditional liquidity over the next five years and that would strengthen the available sources of balance of payments financing by enhancing the ability of the Fund to provide such financing without heavy recourse to borrowing and by furthering the process of international adjustment.”58 The Seventh Review became effective in November 1980, and increased total Fund quotas to SDR 60 billion ($78.1 billion). Already before this date, the Interim Committee had called for a new increase that would mean that quotas remained the primary source of financing of the Fund’s operations (rather than borrowing). The suggested increase was accompanied by a substantial controversy and hostility, especially in the United States, until the extent of the international debt crisis made apparent how badly needed were Fund resources for the stabilization of the world financial system. Under the Eighth Review, in March 1983 quotas were increased to SDR 90 billion ($95 billion). The quota basis of the Fund had tripled in the course of the five years following 1978. This review had been intended to establish the position of the Fund securely until the end of the 1980s; and indeed there was no further increase until the Fund Board of Governors authorized a Ninth Review in June 1990. The increase came into effect in November 1992, with a total quota size of SDR 144.8 billion ($204 billion).
The 1978 increase had immediately appeared as inadequate because of the ever more conspicuous need for large-scale Fund programs to support adjustment. Between 1979 and 1983, the use of Fund resources rose quite dramatically each year (see Figure 11-2). In 1978, there were three very large programs involving Turkey, Zambia, and Peru; and in subsequent years, these countries required further resources. In addition, other major programs were implemented. The need for international stabilization through IMF intervention became increasingly apparent as the cases mounted in which the market failed to supply necessary funds. In 1980, the Annual Report stated that “the Fund has been giving active consideration to means that it might use to facilitate the movement of funds to countries that may not have sufficient access to funds from private sources.”59 The inadequacy of quota increases meant that programs increasingly involved very high multiples of the quota. By the end of the 1970s, countries could draw as much as 600 percent of their quota, in addition to drawings under the compensatory financing and buffer stock facilities. As lending moved to “higher tranches” of the quota, the IMF applied higher levels of conditionality to its programs, and as a result many borrowing countries felt even more powerfully than ever that the Fund was only a lender of last resort, of that “the quota resources available in the Fund were too small to justify the considerable changes in economic plans and policies that might have to be made in order to be allowed to draw on them.”60
As a result of the slow and cumbersome quota discussions in the mid-1970s, a number of decisions regarding credit operations were taken. The Fund needed to become much more active as a financial institution. At the beginning of 1976, credit tranches were extended by half to represent 37.5 percent rather than a quarter of the quota, with the result that total drawings could now amount to 245 percent of a member’s Fund quota. But it was clear that even these amounts could not be enough, and in February 1977 the Managing Director made a new proposal for a “supplementary financing facility” (which in practice was frequently called the “Witteveen facility”).61 The new facility would link traditional lending of funds available through quotas with funds obtained through borrowing. It would allow countries to go beyond 245 percent of quota, and it would be linked to drawings in the upper credit tranches. The lenders would be governments and central banks in countries with strong external payments positions, and would work through bilateral arrangements with the Fund rather than the complicated process of reaching mutual agreement under the General Arrangements to Borrow (GAB). The potential lenders included oil producers, and formed a very different group to the ten industrial countries of the GAB, some of whom were by now in acute payments difficulties. When Witteveen invited finance ministers and central bankers from 13 member countries to a meeting in Paris in August 1977, the shape of the new grouping, and its implications for the world economic system, became clear. Power in the world economy no longer lay with the club of the G-10. The rather broader group brought together as new lenders to the Fund reflected at least a realization of the changing shape of world finance: Belgium, Canada, France, Japan, the Netherlands, and the United States were there (as was Switzerland), but not the United Kingdom or Italy; and so were seven oil producers, Iran, Kuwait, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela. These countries lent SDR 7,784 million ($9,100 million) for the supplementary financing facility. The Fund became a borrower because of the difficulties in raising quotas, and the group of lenders reflected the new structure of the world economy. The new position of Saudi Arabia was also reflected in a major revision of its quota in 1981, raising the share in total Fund quotas from 1.74 percent to 3.5 percent.62 The supplementary financing facility carried a commercial rate of interest, essentially that paid to the lenders with the addition of a small surcharge.
As the IMF’s transactions expanded in the 1980s, it continued to need to borrow. In 1983, borrowing was facilitated by an agreement of the G-10 to enlarge the GAB substantially, from SDR 6.4 billion ($6.8 billion) to SDR 17.0 billion ($18.2 billion), and to permit these resources to be used in the financing of transactions with Fund members who were not members of the GAB. In addition, special borrowing arrangements were concluded with Saudi Arabia.63 Increased current account imbalances, and the need to finance them, had led to a new activity of the Fund—but also to a closer proximity to the functions of a private banker (acting as an intermediary for borrowed funds) rather than as the form of credit cooperative implied in the original concept of the Fund’s work. In the cooperative, for the sake of solidarity, members would be prepared to make deposits at below market rates; and they would be compensated for their loss through a gain in security. If in need, they might then draw at cheap rates. Once however the Fund became involved in large-scale borrowing on markets and ceased to be simply a credit cooperative, its role became less clear, and also inevitably much more controversial.
The new approach was reflected in the Fund’s charges for the use of its resources in Fund programs, as well as in the interest rate paid on the SDR. After 1981, SDR charges were kept in line with the interest rates of the five currencies that composed the SDR basket. Charges on the ordinary borrowing of resources remained lower than this, but gradually moved nearer to commercial interest rates. The IMF was caught in a dilemma. If interest rates had been held at significantly lower than market rates, Fund program lending would have expanded even faster; in the absence of a large quota increase the Fund would then have had to borrow more and could only have done this on market terms. Some commentators advocated that the Fund should be allowed, through an alteration of the Articles of Agreement, to create more money and should then act as a genuine international central bank pursuing an anticyclical monetary policy. It would lend more, and on looser conditionality, when it judged world growth to be sluggish.64 Alternatively, if the Fund could not borrow and was not allowed to make new money, it would have been obliged to use some mechanism to ration its resources: perhaps, for instance, the imposition of more complicated variants of conditionality as a deterrent to potential borrowers, or, alternatively, the market mechanism of higher interest rates. A rise in interest rates could be reasonably expected to lead to greater difficulties for Fund borrowers, and make Fund programs less effective as a path to balance of payments recovery.
In the course of the 1980s, higher charges may have contributed to the development of an arrears problem, as some countries became unable to service their obligations to the Fund. The arrears in turn led to a need to apply higher charges on the Fund’s resources under a burden-sharing arrangement (after 1986). Critics of the Fund consequently argued that either it, or the creditor countries as a whole, should have felt a duty to act in a countercyclical way and, in particular, to reduce the adverse impact of the worldwide increase in interest rates after 1979. The volatility of rates, and the unexpected and dramatic rise, inevitably had an adverse effect on investment plans in borrowing countries, and imposed new balance of payments constraints. For practical purposes, the Fund’s policy represented a compromise between these two contrasting stances: market interest, on the one hand, and advocacy of the principle of concessionality, on the other (see Figure 11-3). At the beginning of the debt crisis, in the financial year 1982/83, the Fund’s charges were set at 6.25 percent, or less than half of the major international interest rate, the London interbank offered rate (LIBOR). (In the next year, the charges rose slightly, while LIBOR fell; but Fund lending was still financially attractive.)
In retrospect, the dilemma of the early 1980s seems almost insoluble. With the benefit of hindsight, of course, the historian can see all manner of superior solutions. For instance, a better coordination or harmonization of policy between the major industrial countries (and an encouragement of higher rates of saving) might have avoided the dramatic increase in interest rates of the early 1980s. But such an outcome required persuasion and coordination, rather than financial action, and in any case could not be expected to be effective immediately. It was the absence of this kind of action, and the prevalence of high interest rates internationally, that eventually necessitated the adoption of a second-best solution: subsidized or concessional interest charges to particular classes of poor borrowers undergoing fundamental policy reform. The need for this kind of support was only met rather late, after 1986 (see Chapter 15).
Within a few years of the Paris meeting on supplementary financing of August 1977, the balance of world economic power had shifted once again, and the nature of the global economic problem changed. In the first place, by 1978, the OPEC surpluses had almost disappeared. Only two of the large oil exporters still had a large current account surplus, Kuwait and the United Arab Emirates. The external accounts of Libya and Iran were nearly balanced, with very small surpluses; and Saudi Arabia and Nigeria both had substantial deficits. Oil producers had developed, rapidly, and shown that development could be expensive. The major surpluses in the global economy were the ones familiar from the era of the currency crises in the late 1960s and the early 1970s: Germany and Japan.
Then, second, at the end of the year, the Iranian revolution overthrew the Shah, and a new round of oil price increases began. But these increases were not well coordinated by the OPEC cartel; indeed, the largest OPEC producer, Saudi Arabia, initially held down prices and increased production in the hope of preventing price chaos and a disintegration of the world economy. The rises were the result of panic in the market, supply scares, and doomsday visions. OPEC had lost control, and could coordinate neither relief for developing countries hit by a new wave of energy price increases nor an effective presence in international economic diplomacy. As a result, the second oil crisis produced a substantial reduction in the economic power of oil producers. When it was followed by a collapse of commodity prices (Figure 12-1), the belief that the world economic order could simply be changed through the assertion of the monopoly power of commodity producers also vanished. As after the first oil price rise, the current account positions of the producers quickly changed. The major oil exporters in the Middle East had a large surplus in 1980, but already by 1983 they were running moderate deficits.65
The second oil price crisis produced a markedly different response from the first. In part the difference lay in the breakdown of the “Third World” solidarity that it seemed, at least briefly, the first had provoked. The logic of economics also played a role. As a result of the persistent upheavals, eventually the oil market became much more integrated and flexible, and a sophisticated futures market developed allowing rapid responses to changes in supply and demand. In part the new environment was also a product of the transformation of the domestic and international politics of the industrial countries (see Chapter 10). The fact that the first oil crisis had been overcome despite all the original deep fears made many political and banking figures too confident that the second oil shock could be managed equally well. Little systematic attempt was now made to coordinate the recycling of oil payments and the adjustment of balance of payments imbalances. The private capital market, which had been quite tentative in its handling of the first oil shock, became much more confident in the face of the second oil shock. Creditors and borrowers worked together through private sector intermediation, in the context of an uncoordinated system. The private market grew at the same time as cooperation between the major economies failed, and in the absence of any common outlook on economic policy.
Surveillance on an individual country basis had not worked very effectively, as debtor countries used the availability of commercial credit, of the chance circumstances or commodity booms, to withdraw from the application of external discipline as quickly as they could. On a global level, surveillance was handicapped by the absence of reliable and up-to-date information on the extent of international private market activity. The consequences of partial and inadequate data proved to be disastrous for borrowers and lenders; and only in the aftermath of the new shock produced by the debt question of the early 1980s was the need for effective surveillance of the system as a whole demonstrated more clearly. The new crisis propelled the IMF back into a more prominent role in the international monetary system.
It was not simply a single “debt crisis.” A number of different debt crises broke out, in very varied circumstances, with the consequence that the term “debt crisis” came to be used to describe almost any type of external imbalance. There was the “classical” debt crisis of middle-income countries, largely a consequence of inappropriate policies (sometimes fiscal policy, sometimes exchange rate policy) following as a response to the activity of the international capital markets. This is the theme of Chapter 12. There was also a debt crisis in low-income countries, with poorer access to capital markets (see Chapter 15); and a problem of a different nature in centrally planned economies (Chapter 16). These problems needed to be dealt with through a mixture of external support and the creation of a domestic policy framework that would restore confidence. To some extent they reflected national policy problems, to some extent a global problem of the 1980s. Other parts of the subsequent analysis deal with the attempts in industrial countries to promote smoother adjustment—either on a global level (Chapter 13) or in regional monetary of trading arrangements (Chapter 14). The debt crises came to be a symptom of the ills of the more chaotic international monetary system that had emerged since the early 1970s.
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