Stabilization Policies: Experience of Some European Countries in the 1950’s

This paper is based on a lecture delivered at a seminar of Brazilian professors organized by the International Bank for Reconstruction and Development and the International Monetary Fund in Rio de Janeiro, Brazil, on September 19, 1967.


This paper is based on a lecture delivered at a seminar of Brazilian professors organized by the International Bank for Reconstruction and Development and the International Monetary Fund in Rio de Janeiro, Brazil, on September 19, 1967.

This paper is based on a lecture delivered at a seminar of Brazilian professors organized by the International Bank for Reconstruction and Development and the International Monetary Fund in Rio de Janeiro, Brazil, on September 19, 1967.

Since it began activities in the late spring of 1946, the International Monetary Fund has been engaged in assisting members in evolving economic, financial, and foreign exchange programs necessary to attain or to maintain satisfactory economic growth and beneficial participation in the international division of labor, thereby contributing to the balanced growth of the world economy. In addition to providing technical advice, the Fund has often committed its resources in support of such programs. Frequently, the Fund’s technical and financial support has been accompanied by funds from other sources, e.g., governments, long-term lending institutions, and, in Europe, from the European Fund. The implementation of these programs in many cases could not be successfully completed without massive transfers of resources.1 This paper discusses how three countries in Europe—Austria, Turkey, and Finland—emerged from a prolonged inflation, restored viable economies, and resumed economic growth in the 1950’s. It also attempts to draw some conclusions based on their experience as well as the experience of some other countries.

The Experience of Austria

In Austria, the conclusion of hostilities after World War II led to the division of the nation into four zones of occupation. Although the nation was restored to statehood, confidence that it would indeed enjoy independent national life was not firm, and there was uncertainty as to the social and economic system which would prevail. One occupying power, moreover, both demanded and received as reparations a substantial volume of capital equipment dismantled from various enterprises, and placed some production (for example, oil wells) under its own management. In these circumstances, the ability of the nation to restore its productive equipment was greatly circumscribed. There was no willingness to save in the national currency. Such savings as existed were used for capital flight which, by weakening the balance of payments, further reduced the nation’s ability to restore internal balance. In view of the low confidence in the viability of the state and the frequent, sometimes arbitrary, interference of some occupying powers in the governmental affairs, it was difficult for the administrative organs to carry out their assigned functions. Thus, while the tasks of the Government multiplied, its resources—administrative, economic, and financial—to undertake them were severely impaired. The bureaucracy was demoralized and, in order to maintain an acceptable living standard, had to seek income from additional occupations to the unavoidable neglect of their official duties.

In these conditions the finances of the state resulted in large deficits, as taxes were evaded, though even if taxes had been fully collected they would have been inadequate to finance all the functions the state had to perform. In such a situation the major source of financing was the printing press with the consequent steady acceleration in the price-wage spiral—especially as workers, organized in powerful trade unions, resisted bearing the brunt of the economic difficulties. The Government’s efforts to prevent the spiral from developing by the imposition of comprehensive price controls broke down early in the postwar period (except on basic food items, housing, and public utilities). The stabilizing impact of external assistance—the proceeds of which were used to finance budgetary expenditures—was severely handicapped by a greatly overvalued currency. The overvalued currency was maintained with the stated objective of keeping the cost of living from rising and thus restraining inflation. Actually, except in a few instances, prices reflected the internal market forces. On the other hand, because of the overvaluation of the national currency, the counterpart of the foreign assistance was substantially below what the market would yield. Hence, despite large external assistance—in 1951 alone it exceeded $200 million —the budget consistently showed substantial deficits which, under the prevailing circumstances, had to be covered by central bank funds.

The balance of payments remained very weak, as exports, except for the basic exploitative industries, remained stagnant, while the import of most goods promised substantial gains. Industries producing for export had no incentives to expand; because of the inappropriate exchange rate, their profits were low or nonexistent. The Government was committed to maintaining reasonably full employment, and it absorbed a large part of the growing labor force, including labor released by the farms, in public infrastructural projects.

In mid-1949 the Austrian Government requested assistance from the Fund in the formulation of measures that could lead the economy out of the accelerating price-wage spiral. The key issue was to find a policy mix which would lessen the burden on the budget but would help to maintain full employment. The measures which were recommended by a Fund mission and gradually accepted by the Government as its own were threefold: (1) To review the next budget and to explore what consumption subsidies or subsidies which did not encourage production could be eliminated or reduced. (2) To restrain credit expansion selectively and thereby to force industries to repatriate their funds from abroad and to reduce hoarding of raw materials and finished goods. (3) To bring about a gradual adjustment of the exchange rate. Here the objectives were the following: to stimulate the expansion of production for export and investment in export industry and thereby gradually to replace the expenditures of the Government in employment-creating projects; to help to direct foreign exchange proceeds into official channels; and to restrain the demand for imports. Insofar as imports were financed with foreign aid, this measure—by raising the amount of counterpart funds—was to contribute substantially to balancing the budget. It was expected that within 12 to 18 months the rate structure could be unified and a new par value established at a level which should assist Austria to restore internal and external balance and to achieve a rate of growth higher than that expected by the countries of Western Europe, thus gradually bringing the standard of living in Austria closer to that enjoyed in those countries. In fact, however, the full implementation of the program outlined was not achieved until the end of 1953. The question arises why so much time was needed to attain the desired goal.

At the outset of the stabilization effort the proponents of stability were few—some government leaders, the main provider of external assistance (i.e., the U.S. authorities), the pensioners, and the civil servants. Certainly all sections of the political structure were sympathetic to the goal of stabilizing the value of the national currency, but they were not willing to pay the price necessary for its attainment. They feared that the group they represented would lose an economic advantage which could not be later recouped. Thus it was essential that the major political forces (in this case, the leaders of industry and commerce, the farmers, and the leaders of the trade unions) be persuaded that all their constituents would benefit from the restoration of stability. The electorate had a healthy aversion to runaway inflation; memories of such developments in the period after World War I were vivid. Hence, the political leaders had the psychological means to induce public acceptance of a changed pace of economic life and of the reallocation of resources that development with stability would entail; what was needed was that they be convinced that stability would indeed benefit the groups they represented, especially as they were not afraid that inflation of, say, a 10 per cent rise in prices in a single year would deteriorate into a runaway inflation because large-scale U.S. aid exerted substantial braking power. The task of the Government was made somewhat easier by the fact that the groups which had benefited most from inflation found that these benefits were gradually diminishing. As the scarcity conditions of the early postwar years largely subsided, demand in many areas of consumption began to slacken. Many industries found that their capacity had been overexpanded and that adaptation to new uses was increasingly costly.

These considerations pointed to the need for the adoption of remedial action. However, the Government was watching developments in nearby countries, in particular, the stabilization program of Italy in 1947 and the monetary reform of Germany in the spring of 1948, and was alarmed by the large unemployment figures which these countries continued to report month after month. Being politically exposed, it felt that it could not take big risks. In the autumn of 1949 it therefore decided to take cautious steps toward the desired goal. It strengthened the budget through tax measures and replaced the existing rate of S 10=US$1 with a system of three explicit exchange rates: a rate for basic imports, mainly food and some raw materials, of S 14=$1; a rate of S 20=$1 for most trade transactions; and a rate of S 26=$1 (which was some S 6 below the black market rate) applicable to invisibles and marginal exports. Encouraged by the response to these moves, the Government in the late spring of 1950 dropped the rate of S 14 per U.S. dollar. It absorbed part of the increase in prices resulting from the move by providing subsidies from the budget for those items which had an exceptionally heavy impact on the cost of living.

The outbreak of the Korean conflict slowed down the implementation of the stabilization program. It revived the economic uncertainties which existed immediately after the end of World War II. The black market quotations again hovered around S 32 per U.S. dollar, and capital flight increased sharply. The revival of exports as a result of the new rates introduced late in 1949 and early in 1950, as mentioned above, stepped-up demand from abroad, and renewed buying for hoarding purposes at home brought back pressures on resources. All this substantially weakened resistance to trade union demands for a new round of wage increases. In the late spring of 1951, the trade unions demanded not only compensation for the rise in prices that had occurred since the last round of wage adjustments in the spring of 1950 but also compensation for the anticipated rise in prices by the end of the wage contract a year hence. A sharper spin in the price-wage spiral was thus threatened. After prolonged negotiations a compromise agreement was reached with which neither unions nor industry was fully satisfied. The workers found that in the prevailing conditions their gain was being quickly dissipated in higher prices, while industry found that, with costs rising sharply, it was losing markets recently gained abroad. Furthermore, by the end of 1951 industry’s profits were falling, especially as, with the danger of a renewed European war receding, the European public found that hoarding was unnecessary.

In this situation the Fund mission urged the continuation of the 1949 program with action on two fronts to be appropriately timed to obtain the desired results:

1. It was felt that it was even more essential than in 1949 that saving be increased and that domestic savings and foreign aid be channeled into productive investment. This objective was realizable because, by that time, the prewar standard of living and a reasonable level of employment had been reached. Accordingly, the Government was urged to adopt a balanced budget, divert the counterpart of U.S. aid into a special fund for the financing of industrial investment at concessionary terms (to be administered by the central bank and supervised by a special committee on which labor and industry as well as the Government were represented), and thereby strengthen the efficiency of existing industries and create new efficient industrial units. Temporarily, until the economy cooled off somewhat from the Korean boom, tighter credit restrictions were thought desirable.2 Beyond that, labor and management were urged to depart from the practice of annual price-wage agreements which had an upsetting effect on the economy. This practice made it difficult to reduce consumption subsidies paid from the budget, as it often happened that labor was willing to reduce wage claims, if certain consumer items, e.g., bread, remained subsidized. Also some industries (railways, coal mining, electric power companies) willingly paid high wages, and immediately requested an increase in prices or subsidies from the budget. This had to be checked if the desired mobility of resources and labor was to be achieved. Instead of an annual price-wage agreement, a resumption of collective wage negotiations on the basis of increases in productivity was advocated.

2. To accompany this domestic program of consolidation, the Fund argued for the unification of the exchange rate structure at the most depreciated level. It was felt that this would restore to the export industry the profitability it lost following the price-wage agreement of 1951 and would enable it to spearhead an expansion of the economy after the slowdown of 1952, brought about partly by a fall in external demand for Austrian products and partly by the above-mentioned measures of the Government which aimed at a reduced budget deficit and a slower monetary expansion. The unification of the exchange rate structure at a realistic level, together with a balanced budget and a further reduction of quantitative restrictions, was to signify that the process of stabilization had been completed and the domestic price structure had been integrated into the world economy. It would make it evident to the public that the national currency was once again being made a dependable store of value.

The representatives of labor agreed to the stabilization program of 1952–53 with the proviso that the temporary squeeze on employment would not exceed a tolerable percentage of the labor force at the height of the employment season (i.e., July and August) and that the promised impetus to economic activity from the devaluation would be visible by the autumn of 1953, so that labor would have to go through only one uncertain winter.

Representatives of industry agreed to the stabilization program only after they were persuaded that it was only through the program that industries could hope to maintain the prosperity that they had enjoyed in the early postwar years. They also realized that it was only thus that they could be freed of detailed government regulations which had become onerous. They noted the stringent measures which neighboring Germany had to take in 1951–52 in order to correct a balance of payments deficit. There was no guarantee that external resources would continue to be available on a scale adequate to spare the Austrian economy the painful measures that Germany had to undertake.

The program as just outlined was completed by May 1953 when the present par value of S 26 per U.S. dollar was declared. Between the end of 1953 and that of 1966 real gross national product (GNP) rose by about 100 per cent, wages in real terms by 130 per cent, the volume of exports by 250 per cent, and that of imports by 350 per cent. Monetary reserves rose from $325 million to $1,333 million during this period.

This, in capsule, is the history of the Austrian stabilization. The main factors responsible for its success could be summarized thus:

1. The key factor which made stabilization succeed was the realization by the political parties concerned that national as well as sectional interest would be best served through stability. The successive price-wage agreements had demonstrated to labor that wage concessions which must provoke a new inflationary increase in prices do not help workers to obtain a bigger share of the national income and that, insofar as they lead to a redistribution of real income and wealth, they benefit the stronger. Above all, labor—from its own experience—realized that, in order to obtain a higher income, workers have to be shifted from less to more productive occupation, and that inflation tends to hinder such shifts. It needed, however, an assurance that stabilization would not lead to stagnation and a revival of the unemployment situation of the 1930’s. Equally, industry needed an assurance that the credit squeeze would be temporary and that stabilization would not lead to deflation which, in view of its heavy indebtedness, it could not survive.

2. The second factor which accounted for the success of the stabilization program was the revival of economic activity some six to nine months after the inauguration of the program of 1952 and 1953, stimulated in the first instance through a sharp rise in export demand. This was brought about by the ability of Austrian industry to compete on foreign markets as a result of the devaluation. The effectiveness of the devaluation was strengthened by the fact that in 1953 raw material prices were falling in the world market after substantial rises in 1950 and 1951 and were thus slowing down the rise in the domestic cost of production. The rise in export demand was also aided by an upsurge in activity in Western Europe, but especially in Germany and Italy—major trading partners of Austria.

3. The third factor was a marked improvement in noninflationary sources of investment finance. This came partly from increased external aid, partly from a reduction in the rate of growth in consumption, and partly from a return of capital from abroad. The resulting public investment in infrastructure, and private investment in industry and agriculture, quickly absorbed manpower released by enterprises, which were forced to economize as a result of the stabilization exercise, and by agriculture, where labor had been underemployed.

The Experience of Turkey

The inflation in Austria had its origin in World War II and the dislocation, administrative and economic, which it brought about in the immediate postwar period. Turkey entered the war early in 1945 when the fighting had neared its end. The origin of its inflation in the second half of the 1950’s was thus attributable mainly to the economic policies of the Government.

The competition of the warring coalitions for Turkey’s adherence to their side, or at least for its continuing neutrality, provided this nation with eager customers for whatever it had to sell. This enabled Turkey to greatly strengthen its balance of payments position and to improve its net foreign exchange reserves (which were $16 million at the end of 1938 and $300 million at the end of 1946). The improvement in reserves was also attributable to Turkey’s inability to obtain the development machinery it wanted to buy. The reserve position continued to be reasonably strong after the war. The Truman Doctrine, implemented in 1947, provided U.S. military and economic assistance to Turkey. Moreover, as the markets of Western Europe began to recover, Turkey could sell again at remunerative prices some of its main exports, such as tobacco, hazelnuts, and raisins,3 which under the postwar exchange control were called consumer nonessentials. Participation in the European Recovery Program assured Turkey of additional assistance, and with this assurance the Government stepped up its development effort. For several years, but especially in 1948–52, it obtained spectacular results to which the Korean boom to some degree contributed. The results, however, camouflaged the fact that the development effort was excessively concentrated in infrastructure and import substitution.

Exports rose sharply because of the high prices paid for ores, cotton, and wheat. By 1953, however, it was already noticeable that restraint in consumption was essential if the development momentum was to be maintained. The Government, having been very successful in stimulating agricultural output by raising and fixing prices of agricultural products, felt that a further rise in prices would yield positive results and was perhaps influenced also by the election which was expected to be held in the spring of 1954. It did not give adequate regard to the fact that the increases in agricultural production achieved in 1951 and 1952 were the result of increased area under cultivation and good weather, and that no more untilled land was available. The resulting sharp rise in demand, as a result of considerably higher incomes of farmers as well as miners in addition to the continuing high demand from the construction sector and infrastructure projects, could not be met from increased imports, as the Government had reached the limits of its borrowing ability under the EPU. Turkey’s monetary reserves were drawn down, and direct U.S. aid was not increased further. Nevertheless, the Government did not change its policy. Its representatives contended that all Turkey needed to rectify the situation was the provision of more foreign exchange in order to widen some of the bottlenecks and thereby to tide over the temporary sharp drop in primary producers’ prices.

In the meantime, to deal with rising prices, the Government decided to pursue the following course of action:

1. To continue on a wide front with the development effort.

2. To restrain price rises by decreeing that cost and sales prices must be indicated on each product sold and each contract made. (The Government maintained that prices rose only as a result of the speculative activities of a small group of businessmen which had to be controlled.) Moreover, it decided to instruct state-owned enterprises to sell textiles, shoes, and sugar at prices well below their costs of production. The resultant losses of the state-owned enterprises were financed by credit from the central bank as were the government budget deficits. The financing needs of the public sector thus became the funnel through which inflation was injected into the economy. Some attempts were made to slow down inflation by restraining credit to the private sector.

3. To suspend the application of the OEEC Code of Liberalization and to introduce detailed licensing procedures. The Government entered into a series of bilateral trade and payments agreements with Eastern European and other countries. By this means, and by the accumulation of large payments arrears for deliveries made under the previous free payments regime and the utilization of fresh credits under the bilateral payments agreements and of export proceeds (which, thanks to a record harvest, were still high in 1953), the Government managed to maintain the volume of imports required to sustain the development effort for another year. At the same time, the Government requested the use of the Fund’s resources. Prior to this request, the Fund had entered into a dialogue with the Turkish Government which increasingly centered on the need to re-examine the whole range of financial and economic policies in order to foster a sound rate of growth in conditions of reasonable internal and external balance. The discussions yielded fruit in the stabilization program of 1958 (i.e., 5 years after they first began) and the adoption of a development program which, in subsequent years, has provided Turkey with an average annual real rate of economic growth of about 6 per cent. However, during the intervening 5 years, the economy was steadily deteriorating as a result of an inflation which caused annual price rises of some 10–20 per cent in the early period, leading to a near runaway inflation just before the stabilization program was adopted. The inflation first caused a slowdown in the rate of real growth and then, just before stabilization, a standstill; if one takes into account the misallocation of resources, retrogression might more aptly describe the result.

Why did a Government dedicated to securing the economic advancement of its people continue a course which, to outside observers, seemed like a sure road to disastrous inflation? What motivated the same Government to adopt a stabilization program in 1958, having previously resisted it for 5 years? The available evidence tends to suggest that the Government felt that its policies were—under the prevailing conditions—the best for mobilizing domestic and foreign resources and the most suitable to bring into the development process a stagnant rural society. Its electorate, i.e., the peasantry, the new entrepreneurial class, and the small artisans, supported that course. Indeed, as demonstrated by the parliamentary elections of 1954 and of the autumn of 1957, the Government was returned to power with a substantial majority. It was only late in 1957 that increasing resistance to government policy became noticeable. The Government had lost the support of some intellectuals as early as 1954, and it lost more after it had abandoned an abortive stabilization attempt in 1956. The Government believed, however, that the changed attitude of the intellectuals was caused mainly by their dislike of certain noneconomic aspects of its program and that on the issue of economic development all Turks were united as to the goal and were divided only on the method of its achievement.

All were united in maintaining a mixed economy in which the state had an important role in stimulating and guiding the development process. The opposition was willing to tolerate the private sector as a useful supplement to government effort; the ruling party, however, was ready to accept the private sector as a full partner and anticipated a gradually reduced role for the Government in agriculture, manufacture, and trade. The Government overlooked the fact that the intelligentsia, together with the army, felt that inflation was steadily reducing their standard of living, while the rate of real growth in GNP was declining. The intelligentsia came to the conclusion that the sacrifices demanded of it were not yielding the expected benefit to the nation as a whole and questioned more insistently than hitherto the economic policies of the Government.

Second, having reaped impressive results with the policy of high support prices to agriculture, easy credit to business, and large infrastructure expenditures in the first 3 years of its rule (1950–53), the Government felt that more of the same in due course would lead to the achievement of their development objectives. The slowdown in real growth in 1954 and 1955 was attributed primarily to inadequate external support, unfavorable weather for the crops, and falling world market prices for the main export products.

The Government did not heed the advice from successive IMF missions and from OEEC and the International Bank for Reconstruction and Development that, in order to attain its objectives, it must reform internal policies and adjust its trade and payments system so that exports could move again and foreign suppliers would be forced by a more liberal import licensing policy to compete for the Turkish market. Instead, as mentioned before, following the suspension of liberalization Turkey entered into a large number of bilateral trade and payments agreements and barter transactions. On this basis, and with the accumulation of large payments arrears to Western European countries, it was able to obtain resources from abroad to continue its policies for a while. The Government later found that, when the external supply of capital goods on credit also diminished, it could still proceed, albeit temporarily, with infrastructure development projects, such as village water wells, irrigation systems, roads, power dams, with the existing machinery. (It used military trucks and bulldozers when civilian equipment wore out.) Construction thus progressed: there were new roads, new dams, and new harbors, but no new vehicles on the roads. Industrial consumer goods, based on imported raw materials, also disappeared from the market, and prices began to rise sharply. It was only when this stage was reached that the Government came to accept the need for a stabilization policy.

The Fund advocated a stabilization program consisting basically of the following elements: (1) The causes for the steadily expanding injection of inflationary central bank money should be eliminated. (2) Conditions should be created for channeling noninflationary funds for financing development. (3) Conditions should be established for the unification of the price structure and for organically linking the Turkish domestic market with the rest of the world through an appropriate unitary exchange rate. (4) By appropriate negotiations with foreign creditors, the strains from the heavy external debt burden should be reduced and conditions should be created for an economically sound inflow of resources from abroad.

Faced with a runaway inflation, the Government agreed to accept these guiding principles as a basis for measures to be adopted and for negotiations with OEEC and with friendly governments for debt relief and renewed financial assistance. As to internal measures, it was decided that except for three commodities (wheat, coal, and electric power) price control would be lifted. With some exceptions, state economic enterprises were forbidden to borrow from the central bank, but, in order to facilitate their financial rehabilitation, the Government took over their debt to the central bank and consolidated it into a 100-year loan to be repaid in annual installments from the budget. Measures were taken to improve the budgetary position—in the first instance by a reduction of expenditures—but it was expected that new tax measures and better tax collection methods (once the price level was unified) would allow for a step-up in the Government’s role in economic development.

On the external side the exchange and restrictive system was substantially reorganized. The par value of LT 2.80 per U.S. dollar was retained, but a surcharge of LT 6.20 was imposed on outward payments. On the buying side all invisibles as well as proceeds from some of the nontraditional export goods were to receive a premium of LT 6.20 per U.S. dollar. The proceeds of other goods, the production of which was based largely on agriculture, received a premium of LT 3.20 per U.S. dollar, and certain agricultural products in respect of which Turkey commanded a major market position were accorded a premium of about LT 1.20 per U.S. dollar. As the program in addition envisaged a substantial balance of payments deficit, the exchange system promised to provide the central authorities with substantial, noninflationary revenue, which could be used for development financing. The net proceeds from the application of surcharges and premiums were to be channeled into a special fund to provide resources for investment by state economic enterprises until such time as they could generate their own savings on a substantial scale.

In order to ensure that the inflow of resources from abroad would be directed into productive process and not into hoards in anticipation of renewed inflation, individual licensing was confined to semiluxury goods and machinery. Raw materials and spare parts, as well as assorted consumer goods, were given global quotas allocated on a half-yearly basis, and payments were transferred promptly. In the first instance, all imports had to be paid for by letter of credit—a measure designed to strengthen external confidence in Turkey’s economy and thus gradually to restore the country’s creditworthiness. External borrowing other than by the Government was prohibited; this measure was intended, in part, to reinforce domestic credit restrictions. In agreement with the creditors, all payments on external debt were suspended, pending agreement on their consolidation and rescheduling. These measures were designed to create internal confidence that the new trade and payments regime was permanent and that henceforth foreign supplies would be available when needed, so that hoarding of foreign goods was purposeless and wasteful. All this was reinforced by a package of new foreign credits approaching some $275 million, a part of which was tied to specific projects but most of which was provided for general balance of payments financing.

What made the program succeed? The main fact was the political realization that nothing else would advance the country toward its major objective. However, at the time the stabilization of the economy was seriously undertaken, the Government in power was greatly weakened politically. As explained earlier, between 1956 and 1958 it lost the allegiance of the intelligentsia as well as of the military, and there was a revolution in the spring of 1960. However, the new Government fully embraced the 1958 program; it claimed that it could implement the program better. Between then and now the revolutionary regime has been replaced, first by an all-party national coalition and more recently by a Government formed by a party which relies to a large extent on the support of people who elected the party that adopted the 1958 program. All of these Governments were and are committed to pursuing the economic development of their country in conditions of reasonable stability. This firm adherence to a single policy reflects the lesson the nation learned during the period 1954–58.

The other factor which facilitated the achievement of the goal was the fact that, once the nation was relieved of the inflation-generated fever, past investment combined with new imports from abroad helped to produce goods and services relatively quickly. Thus there was quick and tangible evidence that stability pays.

Finally, the adoption of a 5-year development plan in 1962, for which the preparatory work had started as part of the 1958 stabilization program and which was later supported by the Organization for Economic Cooperation and Development’s Consortium to Aid Turkey, must be considered an important factor. It gave the new and growing business community a firm, calculable range of probability in regard to economic prospects. To the younger and better-educated generation, it gave a sense of direction and a target. If anything, the young people took the plan for a rigid law of the society and made it difficult for the Government to adjust some aspects of the plan to the changing circumstances for fear that it might be accused of deserting the plan’s objectives. This also underscores why the Government is committed to maintaining reasonable price stability—without it the sustained and effective implementation of the plan would be impossible.

The Experience of Finland

As the third case, we shall review the inflationary developments in Finland and the efforts by the authorities of that country to restore stability. Finland is a primary producer of a specific character; forestry and wood-processing industry in the late 1930’s provided about 16 per cent of net domestic product at factor cost. Manufacturing and handicrafts (which were heavily dependent upon forestry products) accounted for about 26 per cent and agriculture, for 21 per cent. A large part of the income of the farmer stemmed from periodic sales of timber, the cutting of timber in the winter, and the movement of the wood to collection centers and processing mills.

The economy of Finland was greatly disrupted by World War II. Moreover, as part of the peace settlement with the U.S.S.R., Finland had to cede some 10 per cent of its territory. This entailed the loss of about 24 per cent of the existing industrial equipment and the need to resettle on the remaining territory some 12 per cent of the total population of about 4 million, or nearly half a million people. Also, much of the lost territory comprised the best arable land. A glance at the map will reveal that arable land in Finland is a highly prized possession. To create it in areas with reasonable climatic conditions, a great deal of effort has to be exerted. Thus, as a result of the peace treaty the country was faced with the task of having to create farms for a large part of the transferred population. This was motivated by several reasons, the most important being the strong political feeling that farmers were the basis of a stable noncommunist society. At the same time it was believed, and the war experience tended to confirm this belief, that, in view of its exposed political situation, Finland must maintain an agriculture which could feed its people, should the country be cut off from other sources of supply.

During the postwar period Finland was obliged to establish new metal-working and shipbuilding industries in order to comply with the demands for war reparations made by the U.S.S.R. These demands obliged the Finns (after some scaling down of the payments) to transfer capital goods and ships to the value of $500 million during the period 1945–55.

The channeling of resources into new industry and agriculture, while maintaining investment in existing industries and while paying reparations, would have taxed to the breaking point even the best fiscal and monetary system. On top of this, as evident from the ideology which guided the resettlement of the farms, there was a sharp struggle between the farmers and workers concerning the exercise of political power within the country, which was actually reflected in a struggle for a larger share of the national product. Under these conditions, a price-wage spiral was bound to, and did, develop. It persisted until the stabilization of the economy in 1957.

Following the elimination of the wartime inflation in 1945, the national unity evoked by the need to survive helped to keep inflation within reasonable limits. In this effort, in addition to assistance from abroad—especially from Sweden—Finland was assisted by extremely favorable terms of trade. Prices of timber and timber products rose more than those of any other single product during the 1940’s and early 1950’s, and these products represented 70–80 per cent of all Finnish exports. However, as the pressures to fulfill the reparation obligations subsided, and when the efforts of the Communist Party to take over in 1948 failed, the struggle of one social group (the workers) to reduce the burden which it carried in subsidizing agriculture and in re-equipping the new settlers on land became more intense. This led to a sharp upward wage movement, which was followed by price rises and the intensification of trade and payments restrictions in 1952. While Western Europe, following the recovery aided by the Marshall Plan, maintained its historic expansion in the 1950’s in conditions of remarkable price stability and with an increasingly freer trade and payments system which contributed to the growing self-confidence and buoyancy of their societies, Finland struggled along with rising prices and increased reliance on bilateralism, which led to a diversion of trade from its traditional markets in the West to Eastern European countries. Its GNP and standard of living were rising but at a much smaller rate than those in Western Europe. One question that arises here is why there was no threat of a runaway inflation as in Turkey. The answer seems to lie in the opportunities of profitable trade that existed between Finland and the Eastern European countries; Finland was able to export its goods on highly remunerative terms to these countries, which were experiencing great scarcity for them, and to import, in turn, many of the raw materials it needed at prices broadly conforming to international prices. In addition, the rising prices for wood and wood products on the Western European markets allowed Finland to maintain its exports of primary products, although they did not expand to their full potential. These outlets, and the infrastructure expenditures, helped to maintain domestic employment at a reasonable level.

Nonetheless, there was a price that had to be paid for the inflationary illness: Finland was only able to maintain the level of its exports of primary products to the increasingly more competitive markets of Europe, but it did not benefit from the rise in demand in these markets which was taken up by the more efficient Swedish, U.S., and Canadian industries. As Finnish costs were rising, increasingly the “zero line” 4 of exploitation of timber was coming down from the Arctic closer to the middle of Finland, and thus the volume of national resources that could be exploited was reduced. Finland’s industrial output, produced by factories equipped to make reparation goods, continued to be exported to Eastern Europe because of a lack of investment resources necessary to retool these factories to produce goods that could be sold on all markets. Indeed, even to sell its traditional exports to the West, Finland had to rely on bilateral trade and payments agreements. These worked in favor of the partner countries, which, being assured of a fixed quota in Finland’s market, raised their prices while Finland had to charge world market prices for its own products. Thus, the terms on which it traded with the West, which were in Finland’s favor in the late 1940’s and early 1950’s, turned against the country mainly as a result of its own policy. As profits in timber dwindled, the raw material base shrank and investible funds had to be used to finance public works projects to absorb workers released by the timber industry in various regions of the country. These were where they were least needed; the result was a diminution of resources for productive investment with detrimental effect on the productivity of the economy as a whole. For a while a periodic sharp restraint on credit and an improved food supply situation at home, as the early investments in farming began to pay off, helped to prevent an uncontrollable inflation. The rise in real disposable national product, as the burden of reparations gradually lightened, also helped the situation. It became noticeable, however, that the workers became the real victim of the inflation, although their contract provided for a periodic adjustment in wages should the cost of living index show a specific increase (5.5 per cent adjustment in wages for every 5 per cent rise in prices). Often various budgetary subsidies were used to keep the index from rising—usually on items having an important weight but not necessarily fully representative of the cost of living of the workers. These subsidies did cost a large amount of money, and the funds were secured at the expense of productive investments. The timber-processing industries suffered considerably from a lack of investment funds, which further reduced the competitiveness of the economy.

To improve their situation the workers demanded in the spring of 1956, as workers in Austria had in 1951, a wage contract which would fully anticipate the possible price rises during the contract period and also regain some of the ground lost in 1954–55. The demand led to a 19-day general strike, which was settled with the workers getting a substantial wage increase (about 7–9 per cent), but, as this was not based on a well-conceived stabilization policy, the gain was soon dissipated by large price increases. The experience of a 19-day general strike, which entailed heavy hardships for the workers, caused substantial losses to industry and also to forest owners (who, in this case, were small farmers). The evidence that the gains of the strike were short-lived, and the appearance of many other signs that the economy was steadily weakening while the neighboring Scandinavian countries were steadily improving the well-being of their people and the competitive strength of their economies, led the political and economic leadership to realize that to obtain their objectives a new set of policies must be evolved during the summer and autumn of 1956.

What was the underlying concept of the new policies that were evolved in the next 2 years? It was realized that, in order to restore domestic tranquility, it was essential to provide a rising standard of living to farmers and workers alike, and to increase the number of productive jobs in the nonrural sector of the economy. That meant new investment in the timber-processing industry and the establishment of a cost structure in the economy which would allow the fuller utilization of the country’s raw material base (e.g., by moving the timber “zero line” as close as possible to the Arctic). Second, it meant policies that would allow the economic use of the industries built up to produce reparation goods for the U.S.S.R. The achievement of these policies in the first instance meant the restoration of the economy’s competitiveness and the adoption of measures which would permit the channeling of resources into investment with a view to sustaining the competitive strength. It also meant the introduction of policies that would stimulate public and private saving and the inflow of foreign capital to accelerate the development process and thereby assist in creating the expectation that within a foreseeable time Finland would resemble the other Nordic countries in its structure of income and consumption.

The measures adopted were as follows: (1) The budget (about half of which was for investment expenditures) was to be balanced from noninflationary sources, and government borrowing from the domestic capital market was to be reduced. This was made possible by a reduction of subsidies previously paid from the budget to keep the cost of living from rising. (2) Agreement with the trade unions that they would be compensated for only two thirds of the actual rise in prices. In the poststabilization period, wage negotiations would revert to the normal collective bargaining process with productivity improvement a key guide. (3) A substantial devaluation (of some 28 per cent) and radical change in the trade and payments system.

The devalued rate was applied to all transactions, but the sawn timber industry retained only a small fraction of the benefit of the devaluation, as the remainder was taxed away; other timber-processing industries retained a much larger percentage, while the former reparation industries retained the full benefit of the rate adjustment. The export tax, which was to be renewed by a special board on a half-yearly basis, had a twofold effect: it provided the budget with resources which otherwise could not be obtained from Parliament, and it helped to keep the prices of timber (stumpage prices) more or less on the predevaluation basis, thus allowing retention by the processing industry of the profits from devaluation, stimulating the investment effort of the industry, and avoiding increases in the real income, and hence the consumption, of the smaller forest-owning farmers. (The proceeds of timber sales are ordinarily used by the farmers to finance their major purchases of durable consumer goods as well as for investment in their farms.)

A so-called Helsinki Club was established under which Finland terminated its bilateral trade and payments agreements with Western European countries and established for them a number of global quotas. Within these quotas, Finnish importers were free to choose their suppliers from any of the Western European countries. The quotas were reviewed annually with the partner countries in a joint meeting in Helsinki. By this move suppliers were suddenly made aware that they had to compete both in price and in quality for the Finnish market. The competition was so strong that within 1 year, according to a calculation by the Bank of Finland, the foreign exchange cost of comparable imports fell by some 15 per cent. This was a substantial help toward the stabilization of prices, especially as it also induced a rundown of large inventories of imported goods held in Finland prior to the devaluation, as it no longer paid to keep them. As a result of the move to reduce inventories and the conservative fiscal and monetary policy, imports in the first year after the devaluation did not rise (although their structure changed somewhat) but exports rose sharply, and foreign exchange reserves rose from $77 million before the devaluation (September 1957) to $191 million at the end of December 1958. On December 29, 1958, Finland was able to introduce formal nonresident convertibility of the markka.

The results of the operation were remarkably successful. Finland was able to achieve an average rate of growth of some 6 per cent in real GNP from 1958 to 1965. It was able to play its full role in the European Free Trade Association, liberalize its trade in relation to other countries, and, on the whole, provide full employment for a growing population. Most of this was achieved by the effort of the Finnish people alone, although Finland did borrow abroad on long term about $1 billion in that period.

The experience of Finland clearly indicates that the crucial factor in the success of the stabilization once again was the political decision of the nation to halt the progressive weakening of the economy as a result of inflation. A program of action which, in a relatively short time, was able to assure a rise in the real income of all segments of the population was no doubt of great importance in preventing retrogression. Here, the important factor was the sharp rise in the supply of exportable products, which responded well to the devaluation, and the competition of foreign suppliers for the Finnish market, which kept the rise in prices following the devaluation more moderate than might have been expected.


The three inflationary situations that were described above had different origins, but they had one common feature: inflation persisted because important segments of the population felt that the existing policy made possible the achievement of their social objectives. In Austria the entrepreneurial class was earning large profits and restoring its war-lost wealth. This situation was facilitated politically by the trade unions because their actions and policies were governed by fears of prewar stagnation. They hoped that the policies of governmental control over the economic life of the country could prevent such stagnation from re-emerging. They also considered that the price-wage agreements would help to bring about a change in the distribution of income in favor of the workers. In Turkey the farmers and the new entrepreneurial class profited for a time from the policies introduced and maintained by the Government, i.e., the periodic upward adjustment of agricultural prices and the large-scale expenditures on infrastructure, especially those which widened the market economy and thus gave increased opportunities to the farmers to sell their products at better prices. In Finland the struggle for an increased share of the national product was found to be an acceptable policy by all parties concerned, as long as the national product was rising and, at each turn of the spiral, one group or another gained for a time without diminishing the absolute income of the others. It was only when improvement for one group could be obtained by absolutely diminishing the income of the others that the struggle became so fierce as to threaten the political stability of the society.

In each case, once the stage was reached when all important segments of society realized that they could not gain from inflation, or that further inflation would mean a sacrifice of overriding national values, a political will emerged to support a policy of stabilization.

The second lesson that emerges from these three examples is that in order to ensure the success of a stabilization program the period of readjustment and the necessary transfer of resources must not be too long. For the failure to achieve tangible results within a reasonable period is very likely to weaken the political consensus that favors stabilization policies. In an industrial economy, the shift of resources toward the production of internationally traded goods following devaluation can be brought about with relative promptness if monetary and fiscal policies continue to maintain internal equilibrium while providing further stimulus to such a shift. Nevertheless, the process can be accelerated, and some of the problems of readaptation greatly eased, if external resources are available to step up investments in those sectors where profitability has been improved by the exchange rate change. Problems of adaptation are more difficult in an agricultural economy where a change in the pattern of production not only must await the end of the existing crop seasons but also is limited by the need to acquire knowledge and skill in shifting to new products and by the time that must elapse before new investments come to fruition.

To shorten the period and to facilitate the transfer of resources it may thus be crucial that additional real resources be put at the disposal of the economy at the time of stabilization. Stabilization policies themselves help to release resources for economic use which hoarding, either at home in the form of inventories or abroad as capital flight, has withdrawn from use, as a hedge against inflation. But this occurs only after the public is convinced of the irreversibility of the stabilization process. Hence, in most cases, resources to facilitate the stabilization process in its early stages need to come from other members of the society of nations or international institutions. On numerous occasions the Fund has been helpful to members in this regard. It has provided resources either alone or in association with other organizations and member countries, either generally or in the form of a stand-by arrangement which, because of the policy commitments contained therein, also provided assurances that the member would maintain a certain set of policies designed to achieve the objective of the stabilization plan. This, in turn, speeded up the process of spontaneous return of resources to the national economic life and thus enhanced the chances of success for the effort.

Third, as inflationary pressures commonly stem from and are abetted by deficits in the government budget, requiring increasing recourse to the central bank, the heart of a stabilization program lies in far-reaching changes in fiscal policies to eliminate recourse to the central bank or to reduce such recourse to moderate limits. This, in turn, facilitates the provision of adequate bank credit, without risking the re-emergence of inflation, for the readaptations that the nongovernment sector must make in its production and investment plans.

The fourth observation worth mentioning is the role that favorable external factors may play in the prompt fructification of stabilization efforts. In the examples discussed above, the fact that world market prices of raw materials were falling and that the German and Italian economies were staging sharp recoveries were important contributors to the success of the Austrian stabilization. The sharp increase in the demand for timber and timber products in 1959 greatly assisted the Finnish stability.

Les politiques de stabilisation : le cas de certains pays d’Europe pendant les années 1950


Cet article décrit les efforts déployés par le Fonds Monétaire International en Autriche, en Finlande et en Turquie en vue d’éliminer l’inflation, de rétablir la stabilité financière intérieure, d’élaborer des politiques de change réalistes et d’édifier ainsi les bases de la croissance économique. Bien que les origines de l’inflation décrites en détail dans l’article aient été particulières à chaque pays, leurs situations avaient toutefois un point commun : l’inflation persistait parce que d’importants secteurs de la population estimaient que la politique suivie leur permettait de réaliser leurs objectifs sociaux. Lorsque ceux-ci se furent tous rendu compte qu’ils n’avaient rien à gagner de l’inflation, l’opinion publique commença à soutenir une politique de stabilisation. Pour garantir la réussite d’une telle politique, il faut veiller à ce que la période de réajustement et le transfert nécessaire de ressources (soutenu par une aide extérieure en provenance d’autres pays et d’institutions internationales) ne durent pas trop longtemps, afin que la volonté politique d’atteindre les objectifs de la stabilisation ne risque pas de disparaître. Les programmes de stabilisation adoptés comportaient un certain nombre de réformes dont la plus importante était une modification de grande envergure des politiques financières en vue d’éliminer, ou du moins de réduire dans de fortes proportions, le recours au crédit bancaire. C’est ainsi que l’on réussit à établir les bases nécessaires pour financer le secteur privé sans remettre l’inflation en mouvement. Une autre mesure importante a été la réorientation des ressources du secteur intérieur vers le secteur extérieur ce qui fut énormément facilité par le maintien d’un taux de change réaliste.

Políticas de estabilización: experiencias de algunos países europeos durante los años 1950


El artículo que antecede reseña las experiencias que ha tenido el Fondo Monetario Internacional con motivo de su participación en los esfuerzos de Austria, Finlandia y Turquía por eliminar la inflación, estabilizar la situación financiera interna, implantar políticas cambiarias realistas, y sentar por consiguiente, las bases del desarrollo económico. Aunque las causas originarias de la inflación, que se describen por-menorizadamente en el artículo, fueron privativas de cada país, en todas ellas hubo una característica común: la inflación persistió porque importantes sectores de la población creyeron que las políticas en vigor posibilitaban el logro de los objectivos sociales a que aspiraban. Una vez que se llegó a la etapa en que todos los sectores importantes de la sociedad comprendieron que la inflación no les podía ser provechosa, surgió el ánimo de apoyar una política de estabilización. A fin de que tal política triunfara, el período de reajuste y la transferencia necesaria de recursos (afianzada por la ayuda externa brindada por otros países y por instituciones internacionales) no debía prolongarse demasiado, no fuera que la buena disposición para alcanzar la meta de la estabilización se desvaneciera. Las modificaciones de gran alcance que se introdujeron en las políticas fiscales a fin de eliminar o siquiera disminuir sustancial-mente la utilización del financiamiento bancario, constituyen un aspecto clave de los programas de estabilización que se implantaron. De esa suerte se sentaron las bases para financiar adecuadamente los gastos no públicos sin que la inflación surgiera de nuevo. Igual trascendencia tuvo la circunstancia de que se reencauzara la corriente de recursos del sector interno hacia el externo, a lo cual contribuyó notablemente el hecho de que se mantuviera un tipo de cambio realista.


Mr. Sturc, Director of the Exchange and Trade Relations Department, is a graduate of the University of Bratislava and the University of Chicago. He was formerly Deputy Director of the European Department in the Fund. Before he joined the Fund in 1946, he was Deputy Director of the Czechoslovak Government Information Service in the United States and a member of the Czechoslovak delegation to the Bretton Woods and San Francisco Conferences.


The various forms of assistance by the Fund and the particular policies which it has recommended—on the whole rather successfully—to help members to correct their temporary balance of payments disequilibria without unduly slowing down their economic progress are discussed in Chapter 3 of the Fund’s Annual Report, 1966, pp. 21–32.


Being a member of the Fund, the Organization for European Economic Cooperation (OEEC), and the European Payments Union (EPU), Austria was obliged to reduce reliance on quantitative restrictions and bilateralism, although even now, 15 years later, Austria conducts some 18 per cent of its trade on a bilateral basis with Eastern European countries.


Especially as its main competitor, Greece, suffered from the consequences of a civil war which ended only in 1949.


This is the line at which the cost of cutting and processing timber is higher than the sale price, thus leaving nothing for the owners of the timber.