de Larosière on need for adjustment of policies
This symposium is being held at a vital moment in African economic history, when African countries are faced with accelerated inflation, slow growth, rising balance of payments deficits, and a relatively onerous external debt burden. These changes are taking place against the background of a harsh world economic situation, and in that context it is now being widely recognized that countries cannot continue to finance their deficits without adjustment in their policies. . . .
This adjustment effort will have to be comprehensive, encompassing not only the financial measures but also actions to improve the saving performance and the efficiency of investments. The immediate aim of such an effort will, of course, be the reestablishment of domestic and external financial balance. But let me stress that the ultimate objective of the adjustment policies is to increase real domestic savings and to improve the productive base of the economy. I propose today to concentrate on the role of financial policies, especially fiscal, monetary, and exchange policies.
It seems to me that, based on the experience of African countries, the primary role in the adjustment process must be ascribed to fiscal policies. These policies are required to perform two important functions, namely, (1) to manage aggregate demand, and (2) to promote development through raising resources to finance new investment. Although there could be an apparent conflict between these two objectives, I believe that the thrust of adjustment policy would be to make these two objectives mutually reinforcing. Countries have to re-examine their expenditure priorities, not only with a view to reducing the present large budget deficits, but also to generate public savings to finance productive investments. In many African countries, budget expenditures in relation to the size of their respective economies have reached an unsustainable level, and fiscal policy should aim at restraining their growth. This will no doubt involve difficult social choices regarding education, housing, health, and even public employment. But these choices have to be made. I recognize that taxation policies could also reduce budget deficits, but in many countries, because the tax burden has reached a high level, the main orientation of taxation for the present should be toward reforming the tax structure, with a view to improving resource allocation and achieving a more equitable distribution of the tax burden, rather than to raising revenues.
I would also like to refer to the role of public enterprises. Whether to have public enterprises or not is a political decision, and in Africa their importance has been growing. But it is imperative that they operate efficiently, so as to avoid losses and not become a drain on the public exchequer and, in fact, to generate adequate returns on investments in them. There is a tendency for governments to make them an instrument of social policy, imposing on them stringent price controls and other cost burdens. As a result there is no lack of examples of countries where these enterprises are incurring losses which are financed by either treasury resources or bank borrowing.
As regards monetary policy, it is clear that its role must be complementary to that of fiscal policy. If fiscal policy continues to be expansionary, monetary policy could become counterproductive, if called upon to bear the sole burden of adjustment. For in that event an undue restriction of credit and other similar measures could adversely affect the productive base of the economy, including public enterprises. The same will be true if reliance is placed on direct administrative actions, such as price controls, consumer subsidies, or import controls to contain the adverse effects of expansionary policies on inflation and external trade.
Nevertheless, it is generally contended that the scope for operating monetary policy in less developed countries is limited in view of the underdeveloped nature of their financial markets. However, judging by more recent evidence from countries across the continents of Asia, Africa, and Latin America, this belief does not seem to be well supported. It is no doubt true that the degree of financial intermediation in less developed countries in general, and in Africa in particular, is low, and the diversity of financial assets is limited. But this by itself should not imply that monetary policy is likely to be ineffective or that it has no role to play. In fact, experience has shown that some monetary actions can become more difficult to implement as financial intermediation becomes increasingly sophisticated. Thus the present stage of financial markets in Africa permits the pursuit of a vigorous and well articulated monetary policy. There is less demand for financial assets because of the low level of savings and because the real return on those assets is either low or negative. It is precisely in such situations that monetary policy can bring about a transformation in the financial system of countries by ensuring a stable monetary environment and by maintaining a realistic interest rate structure.
In my opinion, control of monetary aggregates is an essential aspect of monetary policy. If the monetary authorities do not have at their disposal, or choose not to utilize, effective policy instruments to control those aggregates, they could expect problems to emerge in the form of inflation and current account deficits. . . .
Two of the most effective policy instruments in less developed countries are interest rates and the exchange rate. I am aware of the concerns of policymakers in your countries regarding the relevance and effectiveness of both of these instruments. I think the reluctance to use these instruments is motivated by development considerations. It is felt that increasing interest rates, or depreciating the exchange rate, would increase the cost of development projects and adversely affect the financial outcome of existing enterprises, thereby stifling development and accelerating inflation. While appreciating these concerns, I believe that these instruments, if correctly used and supported by appropriate demand management policies, can in many cases add strength and flexibility to economic management and thereby favor the long-term pursuit of development objectives. Development is an ongoing process where everyday decisions are to be made as to the allocation of resources. These decisions are vitally influenced by relative prices and, if relative prices are wrong, then the ensuing allocation of resources is also likely to be less efficient and more costly. The exchange rate and interest rates are two of the most significant prices which directly affect the relative prices of domestic and imported products and factors, and saving and investment decisions.
Taking first interest rate policy, here the tendency has been to keep interest rates low and relatively unchanged. But you will agree with me that it is necessary to ensure that those who provide savings and hold financial assets of one kind or another are adequately rewarded. In an inflationary situation, and with low interest rates, the real yield on financial assets such as bank deposits or government bonds turns negative and tends to discourage private savings. Developing countries are generally characterized as having a shortage of capital, and an important bottleneck in the process of capital formation is the inadequate flow of monetary savings to finance investment projects, rather than the lack of profitable investment opportunities even at a high interest rate. Furthermore, when rates are kept artificially low, outflow of private capital may ensue, and domestic credit must be rationed in some way; if this is done in an arbitrary manner, it can also adversely affect investment. We must remember that a major portion of bank deposits belongs to the low-income earners. It should be clear then that a realistic interest rate policy—by which I mean a policy guaranteeing remunerative yields to deposit holders—would, in fact benefit a large segment of low-income earners in your countries. I am not advocating that interest rates be fixed by the sole consideration of promoting savings. In addition, the authorities will also need to pay attention to the rate of return on capital so that new investment would not be discouraged but, on the contrary, would be helped by the availability of more real resources forthcoming from savers. There is little doubt in my mind that in the present inflationary context the balance is in favor of high rather than low interest rates.
What applies to interest rate policy also holds true for exchange rate policy, because the exchange rate, like the interest rate, is also a price which affects directly the relative prices of domestic and imported products and factors. If domestic costs of exports are out of alignment with those of competitors, countries with overvalued rates would lose export markets. Similarly, if the prices of imports are relatively low, consumers would prefer imported commodities to domestic products, and imported factors to domestic factors, thereby adding to the already acute unemployment problems. . . .
I should caution you that what I have said so far should not be interpreted as my advocacy of only an upward movement in interest rates and a downward movement in the exchange rate. Policies should be operated in a flexible manner, depending upon what the given developments in the economy warrant. . . .
We stand today on the threshold of a new decade, and the economic outlook is one of singular uncertainty. In facing the years immediately ahead, and in devising policies to meet the difficulties before us, we shall need two qualities above all: courage and imagination.
It will require courage to avoid the “easy solutions,” which are no solution at all, and notably the temptation to finance unsustainable deficits by borrowing, without taking the necessary accompanying measures of economic adjustment. It is this important element that I have stressed today.
But we will also need greater imagination to resolve the problems we face, and nowhere is this more important than in the field of international financial arrangements, which is my particular concern. If we do not pursue imaginative solutions at the level of the monetary system itself, we shall fail individual countries which are making efforts to adjust, because resources will not be channeled to them in sufficient quantities and on realistic terms. The present financial system may need to be complemented by new arrangements.
One of the problems is to provide countries with adequate instruments in which to invest their reserves—instruments that are sufficiently attractive and secure.
One contribution to this aim is to create a substitution account in the Fund which would allow a significant amount of official reserves to be diversified into an SDR asset without passing through the exchange markets. This account would strengthen the role of the SDR in the international monetary system. . . .
Another essential problem relates to the financing of the deficits of less developed countries. There is a need for the recycling of a substantial volume of funds from the surplus countries to those countries which are adjusting adequately but require finance on appropriate terms in order to undertake the structural measures necessary to enhance the supply side of their economies and to address the problems of the current energy situation.
… I believe it is the Fund’s responsibility to work for solutions to the problems of financing and adjustment. Only through international cooperation can we hope to achieve a set of arrangements which will underpin the efforts of individual countries to cope with the difficult problems which face them.
The World Bank: image and reality
Q. Why don’t we start off by talking about the major aims of your information and external relations efforts?
A. Well, what I’ve been trying to do in these 12 years is to create a sense of trust in the Bank amongst the rich countries that give money and lend money to the Bank, and amongst the developing member countries that borrow. We want to make everyone aware that our sole concern is with the real development of each of our borrowers. That is not easy. We also need to build trust that we are prudently and efficiently using the funds of which we are “trustees”; and that we are using them to create sustainable development as speedily as possible. And we need to persuade people that we are to be trusted for our knowledge about the development process; that our research, our analysis, and everything that goes with that is genuine and first class.
Q. But of course there have been criticisms of the Bank, mainly along two lines. First, what do you say to the statement that the Bank is too much a Western rich man’s club?
A. The International Bank for Reconstruction and Development was founded in 1945 as part of the postwar economic and financial settlement, at the insistence of the poorer countries who wanted to ensure that there was one section of the rich countries’ institutions which was partly devoted to improving the lot of the underdeveloped countries. That has now become the Bank’s sole objective. It is true that the ultimate control of the money subscribed as capital remains with the subscribers of the majority of capital. But the very large sums, which are raised by Bank borrowing against that capital guarantee, are in effect allocated by the Bank management for the greatest benefit of the greatest number of our developing members.
Q. Then, of course, there is the other view—that the Bank is an extravagant institution that wastes the resources intended to help the developing countries.
A. That criticism comes mostly from people who just don’t wish to devote any money to development assistance. Usually it can be ignored; but when it is in fact seriously put forward by those concerned with development, we need to respond to it. It was seriously put forward a few years ago in a report by a key committee of the United States Congress, and we responded to every single charge made by that committee, effectively bringing that report to a full stop, because the charges that were made were not true, or were not relevant. The one criticism that constantly comes up is that the Bank staff are well paid. We should note that these complaints come always from representatives of rich countries, who say the Bank is “wasting their taxpayers’ money.” We are not. If we are spending anyone’s money, it is the money which we earn as interest on loans from the poorer countries. And I can tell you that the poorer countries do not wish to have poorly paid, inefficient, second-class advisers.
Q. What are the main conclusions that you would draw from the Bank’s experience in trying to get the rich and the poor countries to cooperate in a common development effort?
A. I would say rather depressingly that the chasm in outlook separating the North and the South, the rich and the poor countries, is as wide as ever. But the World Bank—as a development institution which represents both rich and poor members equally—has grown in size and importance. Every week in this place representatives of our 130 odd member countries, from the poorest to the richest, sit around our Board table and seek to find out what they have in common on practical measures to increase the productivity and so the wealth of the developing world. Our pragmatic, practical, active, project-oriented productivity efforts have been most effective in bringing together the rich and the poor countries.
Q. What particularly contributes to the Bank’s ability to bring the two sides together?
A. To give an unpopular answer, I think the main reason for such success as we have had in bridging the chasm has been our growth in sheer size as a lending institution. In 1968 all the Western aid indicators were pointed down. On October 1, 1968, Mr. McNamara made his now famous first speech to the Governors of the Bank, saying he intended to double Bank lending in the next five years. In that same first year we visited each of the developing continents and carried the message that the Bank was going to bring more, much more, assistance. And I believe that effort stopped for the time being a real breach between the South and the industrialized world.
Q. Would you say that the outside institutions where North-South issues are being debated have been mostly concerned with principles and therefore have been bogged down, whereas the Bank’s advantage has been that it is concerned with the practical aspects of development assistance?
A. That is a very good point. In a way it is what I am driving at by my emphasis on the Bank’s growth and size. The resources available by 1973 had reached a critical mass at which the Bank could take effective action. The record of successful projects in nearly 100 countries was by the end of Mr. McNamara’s first five-year term concrete evidence of the Bank’s real concern with development.
Q. You speak about the first five years. What’s happened since then?
A. 1973 was the beginning of Mr. McNamara’s second term and it was the beginning of a lot of changes. At the Annual Meeting, which was held in Nairobi that year, he outlined his plans for a major Bank program in rural development; this was a shift in sector policy, but much more important, it marked a fundamental change in Bank philosophy—a decision to lend for labor-intensive poverty-oriented projects aimed at almost half the population of many countries, who were to be found scratching a bare living from the soil. The new program aimed at making the poorest villagers—the smallholders and tenant farmers—more productive, and thus at creating “wealth” at the point where it was most needed, rather than let it trickle down through layers of middlemen. That is now the key to Bank development strategy, and I believe we have spread the word around the whole developing world.
Q. What do you see as the principal contribution that the Bank is making today to the international development effort?
A. There are three very different ways in which the Bank contributes to the global development effort. First, a philosophic contribution that I mentioned earlier. We are trying, along with many others, to convince all our members that they have a real mutual interest in the rapid development of the less developed countries. Second, an intellectual and pragmatic contribution: to create an understanding that any real and lasting growth in the developing world must come from greater productivity amongst the low productive elements of society. Third, a wholly practical contribution: by investing upward of $10 billion each year in development projects we do in fact make the poor world more productive, and more able to spread “wealth” widely amongst its people.
Q. What about attitudes in the developing world toward the Bank?
A. There is a lot of criticism of the World Bank from the Third World on the ground that it is too big; too powerful; in particular, that it has too much power over the Third World and not enough “Third Worlders” in its management helping to shape its outlook. However, Third Worlders do expect support from the Bank; they do expect advice from it; and they do expect funds from it. So a very important part of changing the image of the Bank is to make the Third World feel the World Bank is their bank, and they are full partners in it, receiving help as a right. That is the truth and I have been trying to make it apparent.
Q. What about the Bank’s relations with the United Nations and its agencies? How have they been changing?
A. We have become much closer to the agencies than we were, and we’ve become much more involved. There is also a growing collaboration between the Bank and the main UN agencies. We have four cooperative programs, the biggest of which is with the Food and Agriculture Organization (FAO); another is with the United Nations Educational, Scientific and Cultural Organization (UNESCO). At this particular moment our policy planning staff is spending a lot of time working on the UN strategy for the 1980s; and the Bank’s input into that strategy will, I hope, be quite considerable.
Q. On the subject of international development, we’ve had attempts to identify the aims of global economic interests and strategies by international commissions such as the Pearson Commission in 1968-69 and the Brandt Commission in 1977-80. You personally have had experience with both Commissions. How would you say that these two Commissions differed in their aims?
A. Yes, I feel very proud of my association with both Commissions. The idea of the Pearson Commission was conceived in the Overseas Development Institute when I was its Director before coming to the Bank. Its aim was simply to see why the very high hopes of The Development Decade proclaimed in 1961 were not being achieved by 1968-69. The Commission had a majority of members from the industrialized world, and its conclusions were primarily addressed to them. These conclusions were—briefly—that there were no gimmicks capable of producing instant development, but that there was an urgency that demanded considerably greater efforts by the donor countries.
When I went to Bonn in 1977 to talk over the formation of the Commission with Willy Brandt, he told me that he couldn’t achieve his desired results unless he had a majority of members from the developing world—as he did. The Report reflects this; there is far more recognition of the views and aspirations of the Third World, and its criticisms of the present economic order. But ultimately Brandt like Pearson holds that there is no gimmick for instant development; that the industrialized world must increase with urgency their flow of resources primarily through existing methods and institutions; and that there are obligations on the developing countries to reform their national economic orders to ensure an equitable distribution of the fruits of development.
Q. Let’s move now toward your actual day-to-day work. What would you say about the world press? Do you think that it has been fair in covering Bank policies and operations?
A. No, I don’t. Not because it’s been critical—if you would set a city on a hill as high as the World Bank is, it is going to be seen by men and criticized. Nor do I blame the press for being reluctant to concern itself with the nuts and bolts of development, which is what the Bank deals with from day to day. What I would blame them for is that they are neglecting the real theme of the Bank’s work—the question of whether or not we can create a planetary system where increasing billions of people can live and have some sort of a decent life. Clearly this is a very interesting topic; but it is a topic that has proved terribly difficult to get into the minds of people who are worrying about five-year parliaments, four-year presidencies, seven-year headships of government, and so on. People ought not to be thinking about mere decades of development, but the half century of development. There are very few writers in the world press today who take the trouble to think in such long terms.
Q. Let me end on a personal note and ask you to look back on your 12 years at the Bank. What would you say were the most significant lessons you’ve learned—the things that you think about as you reflect on your years at the Bank?
A. The most interesting part of my experience here has been traveling throughout the Third World, visiting some 107 countries, with Robert McNamara. He is a man of genius who has educated himself in a subject he knew little about when he came here, and has made himself the leading expert on the problems of Third World development. I have been involved in those affairs for 30 years, and I shall continue to be after I leave the Bank; but one immense privilege of those travels was to meet all the leaders of the new world—the Third World. They are a remarkable set of people, who face gigantic problems in building their nations, and it makes me proud to have been associated in a small way with their efforts.
In fact, I am very proud to have been associated with the whole effort of the World Bank, and its staff drawn from the ablest in 100 nations: professionally skilled; personally dedicated to the ideal of producing a decent life for all people that on earth do dwell; increasingly aware of the urgency of our task, recognizing that if we do not provide for the rapidly increasing population, human society may be overwhelmed and destroyed by the extent of human misery.
It is that sense of urgency and purpose that pervades the Bank from top to bottom. In my opinion bringing the people of the world to recognize their mutual interest in development is the most vital task of world statesmanship. I believe the World Bank has given a lead that may be followed.
William Clark has succeeded Barbara Ward as President of the International Institute for Environment and Development with offices in London and Washington D.C.