8 Adjustment and Economic Growth
- James Boughton, and K. Lateef
- Published Date:
- April 1995
Good Policies, Weak Results
I start with a paradox: the thrust of the policies favored by the Bretton Woods institutions has had demonstrably beneficial effects on the economic progress of many countries but the results of their structural adjustment programs—which embody the institutions’ policy recommendations—have been patchy, at best. In broad terms, the institutions’ approach to policy improvement in developing countries can be boiled down to three fundamentals:
- avoiding large macroeconomic imbalances;
- working in cooperation with, and in support of, the private sector, and through market signals rather than in opposition to them; and
- taking maximum advantage of opportunities in foreign trade and for the attraction of foreign investment.
There is substantial cross-country evidence that this type of policy strategy produces economic results superior both to what has gone before and to available alternatives. In addition to the results of academic investigations, an appeal to the recent histories of major countries and regions appears to demonstrate the strategy’s efficacy. The remarkable response of the Chinese people to the rolling back of central planning, the encouragement of private enterprise, and the gradual liberalization and opening up of the economy is a case in point. Of longer standing are the extraordinary results achieved by the East Asian “miracle” countries—countries that departed in important ways from the standard model favored by the Bretton Woods institutions but that nonetheless observed the three fundamentals spelled out above. Less dramatically and with the help of large but undependable capital inflows, Latin American countries that a few years ago appeared hopelessly mired in the debt morass have also achieved an economic turnaround on the basis of similar policy changes. India, too, shows signs of shrugging off its economic lethargy in response to a like package of policy changes.
In each of the cases cited above, the positive connection between adjustment and development is palpable. Even in troubled sub-Saharan Africa, there is supporting evidence, as the World Bank’s (1994) study, Adjustment in Africa, assembles fairly persuasive evidence linking improvements in policies and performance.
However—and here is the paradox—the evidence on the economic consequences of structural adjustment programs, which incorporate the same policy strategy, does not point to strong results. Assessment of the impact of structural adjustment programs is fraught with difficulty, particularly because we can only guess at what would have happened without a program. However, enough expertise has developed, and enough evidence accumulated, to provide some firm indicators. The following generalizations are among the principal results of the empirical literature on the consequences of adjustment programs supported by the Bretton Woods institutions.1
- Programs have limited revealed ability to achieve their own objectives. Although there is consistent evidence for both Bretton Woods institutions that programs are associated with improvements in export performance and other balance of payments indicators, programs do not make much difference to economic growth or inflation. In the case of the IMF, most tests indicate no significant correlation between programs and changes in GDP growth. Evidence on World Bank programs is more mixed: some tests show a similar absence of significant association; others indicate more positive results. The recent Bank report on Africa shows as many adjusting countries slipping back as those accelerating their growth. One reason for the poor growth results is that structural adjustment programs are associated with reduced investment levels, a joint result of reduced public investment levels and sluggish private sector responses to program measures. Evidence on inflation is similarly indeterminate, with price-reducing and price-raising influences tending to offset each other.
- Programs have high mortality or interruption rates. Over half (53 percent) of all IMF stand-by, extended Fund facility, and structural adjustment facility (SAF) programs were discontinued before the end of their intended life in 1980–93; 61 percent were discontinued in 1991–93. As of April 1993, only 5 of a total of 26 programs under the enhanced structural adjustment facility (ESAF) had been completed within their planned period, and 8 had apparently broken down altogether. Three fourths of World Bank adjustment loans had installment tranche releases delayed because of nonimplementation of policy conditions in 1980–88, the latest period for which data are publicly available. By no means do all of these departures from the plan represent “failures,” but enough of them do for the two institutions to be concerned.
- There is little evidence of a strong connection between structural adjustment programs and implementation of policy reforms. In the case of the IMF, even balance of payments improvements are not strongly connected with program implementation;2 the Bank’s Adjustment in Africa (1994, p. 216) similarly reports an absence of correlation between macroeconomic policy improvements and adjustment lending.
- Structural adjustment programs seek to achieve improved economic performance by raising the quality of domestic policies and strengthening institutions. However, the evidence reveals that programs have only modest impact on key policy variables and even less on institutions. There is little evidence that programs exert restraint on the core IMF program component of domestic credit,3 or of strong influence by the Bretton Woods institutions on budget deficits, with much slippage in the implementation of fiscal conditionality. The institutions’ conditionality does, however, exert a decisive and sustained influence on the exchange rate. There is also quite a strong association with reform of other price variables, such as interest rates, agricultural producer prices, and the deregulation of consumer prices. However, they have far greater difficulty in influencing institutional change, for example, in financial sector reforms and privatization programs. The World Bank’s Adjustment in Africa (1994) judges that only 6 out of 29 adjusting countries had achieved decisive improvements in macroeconomic policies (the most important of which, Nigeria, has since jumped off this pedestal), and that about one third of “adjusting” African countries still combine poor macroeconomic policies with extensive interventionism.
- Even the above limited claims probably overstate the degree of program influence, because some of the changes would have been introduced in any case. Moreover, many of the reforms are not sustained, and some governments regress, reverting to old practices or introducing equivalent interventions through the back door.
In the light of this evidence, it seems justified to describe the effectiveness of structural adjustment programs as patchy, at best. Given the strongly positive results achieved by others that have followed the three-pronged policy strategy described earlier, the puzzle is to understand why structural adjustment programs have such limited revealed potency. The remainder of this paper tries to explain this paradox.
We should note here that the explanation is unlikely to lie with the influence of exogenous shocks, as the success-story countries identified earlier also experienced shocks but overcame them.
Various other possible explanations suggest themselves. The problem might lie with weaknesses in the detailed design and sequencing of structural adjustment programs (as distinct from their broad thrust). The Bretton Woods institutions themselves are apt to point to frequent and major deficiencies in what they call governments’ “political will,” or with what might more fruitfully be thought of as the internal political conditions bearing upon program execution.
I shall return to these explanations later but in what follows will concentrate on two additional clusters of explanations, to argue that structural adjustment programs (a) would be strengthened if they were based on a more satisfactory appreciation of the linkage between medium-term adjustment and long-run development; and (b) are far too reliant on a mode of trying to achieve change (conditionality) of very limited proven effectiveness.
The Adjustment-Development Link
Adjustment as Catharsis
At some risk of oversimplification, the Bretton Woods institutions’ positions on this can be characterized as viewing adjustment as a preliminary to the resumption of sustainable growth and development. The Fund, for example, often describes its programs as “laying the foundations” for resumed economic growth. The World Bank has similarly tended to view its 1980s shift into adjustment lending as transitional, a response to the particularly severe disruptions caused by the second oil shock, the associated world economic downturn, and then the breaking of the debt crisis. It initially thought adjustment could be completed quite quickly, and, although it now accepts that adjustment often takes a long time, it still appears to regard the task as a preliminary to a resumption of development (and a return by the Bank to its traditional project-lending and sector-lending focus).
Two further considerations reinforce this view of adjustment as catharsis. First, the Bretton Woods institutions (and the wider creditor community) have tended to define the solution of the debt problems of middle-income developing countries in terms of the restoration of creditworthiness: the language of transition again. Second, as the structural adjustment movement developed, increased emphasis was placed on the need to rectify past interventionist policy mistakes, the implication being that once the policy framework had been corrected, the adjustment task was essentially accomplished. On this view, then, structural adjustment is a phenomenon of the late twentieth century.
Of course, no one believes there is any stark dichotomy between adjustment and development, and the institutions have never, to my knowledge, articulated any definitive view of how they see the connection. That may be part of the problem. I nevertheless think it is fair to characterize their view in terms of adjustment as catharsis.
Adjustment as Continuous Adaptation4
An alternative view sees a permanent need for economies to adapt to changing circumstances, and this adaptation as intrinsic to development. All economies are constantly in a state of flux, buffeted by developments in the rest of the world, by shifts in the composition of demand, and by technological change. There is thus an ever-present need to respond to—and take advantage of—such changes in the economic environment. The imperative to do so has been intensified in recent decades as economic interdependence has increased, with the rise of trade and international capital movements relative to domestic economic activity, and as the pace of technological change has accelerated. There are rich rewards for those who find ways of leading this expansion; increasingly, none can afford to be left out.
Economies’ responses to these stimuli will result in long-term changes in their productive and institutional structures, of the type studied by such writers as Kuznets, Chenery, and Syrquin. Inflexible economies can expect retarded development, with disjunctures between demand and supply creating bottlenecks, foreign exchange shortages, inflationary pressures, and other dislocations.
Various contemporary examples can be cited of the evident importance of flexibility for economic development:
- The well-known success of the newly industrializing countries of East and Southeast Asia in taking advantage of opportunities in world markets for manufactured goods. This region has been characterized by the speed with which it has been able to accommodate rapid adjustment and structural change and the apparently low social costs incurred in the process.
- The starkly contrasting failures of the former Soviet Union and other former communist countries of Eastern Europe to keep abreast of modern industrial technologies, trading opportunities, and changing consumer preferences, attributable in part to the rigidities of central planning.
- The great difficulties created for many of the economies of Africa by their failure to diversify their export bases in response to trend declines in world real prices for their traditional commodity exports.
- Concerns about the long-term growth-retarding effects of “euro-sclerosis,” seen as eroding Northern Europe’s ability to remain internationally competitive, and about a perceived general loss of flexibility among mature industrial economies, for example, as articulated in Olson (1982).
Adjustment can, in the adjustment-as-continuous-adaptation view, be thought of as induced or planned adaptation, with adjustment policies as the instruments deployed to achieve the desired adaptations and to enhance the economy’s flexibility. Structural adjustment can then be viewed as measures targeted at structural variables, particularly the productive system and the human, physical, and institutional infrastructure.
There is a good deal of congruence in the policy implications of these two views of adjustment. There is agreement that adjustment can be consciously promoted and that the policy environment makes a crucial difference to the responsiveness of an economy. There is also agreement about the potentially heavy costs of deferred adjustment. If governments decline to act or seek to avert change, the economy will still be forced to respond to outside pressures, but it will be able to do so only by imposing heavy, avoidable costs on its citizens. There is also much in the characteristic policy content of programs supported by the Bretton Woods institutions that is congruent with the needs of long-term adaptation: the importance of prudent, well-designed macroeconomic management, of measures to raise the efficiency of markets, and of improving incentives for structural adaptation, of which the exchange rate is a price signal of exceptional importance.
In these ways and others, structural adjustment programs typically seek to move the institutional and policy environment in directions that enhance economy-wide flexibility. However, there are also important ways in which the policy implications of the two views of the adjustment-development connection diverge.
The adjustment-as-continuous-adaptation view focuses attention on the factors impacting on the long-term flexibility of an economy, and these tend to go well beyond the main thrust of structural adjustment programs supported by the Bretton Woods institutions. In all developing countries, this focus draws special attention to the importance of institutional development, which is crucial to economic adaptation and for reducing transactions costs in the face of increasing structural complexity (North, 1990). In low-income countries, the improvement of education and other investments in human skills is also crucial, together with other measures that can increase economies’ technological capabilities. So too is industrialization, which in various ways adds to economies’ capacity to adjust.
In other words, structural adjustment programs can be seen as too narrow, neglecting important aspects of the task of raising economies’ flexibility. Sometimes, indeed, structural adjustment program policies may get in the way. For example, adjustment programs supported by the Bretton Woods institutions rarely contain much by way of an industrial policy apart from the liberalization of trade and investment regimes, but in low-income countries industrial firms often do not have the managerial and technical capacity to be able to withstand, let alone take advantage of, heightened competition from imports and greater openness.
In other respects, too, the concentration in most structural adjustment programs on moving away from interventionist policy stances and on “getting prices right” is too narrow. It is important to attend to a wider range of factors bearing upon technological capabilities, institutional development, information flows, skill creation, the adequacy of the infrastructure, and the provision of other public goods. Indeed, to the extent that programs supported by the Bretton Woods institutions are associated—as they are—with reductions in public sector services and investments, they may make it harder for economies to adapt.
There is also the matter of time perspectives. Under adjustment as catharsis, the idea that the World Bank (but not the Fund, whose permanent responsibility is to offer support for countries needing to strengthen their balances of payments) should revert to its traditional project-lending focus after a transitional period of structural adjustment lending has some plausibility. It has none if we see the need for economies to adapt, and for international assistance with that task, as an indefinite requirement, intrinsic to the long-run development that is the Bank’s remit, and not merely a phenomenon of the late twentieth century.
A further respect in which the approaches of the Bretton Woods institutions may get in the way of long-term adaptation brings us to the second line of explanation of the relative ineffectiveness of structural adjustment programs, which relates to the processes through which change can be effected.
Conditionality and the Processes of Reform
The perspective of adjustment as continuous adaptation views the adjustment movement of the last 15 years as simply the latest episode in a history of economic adaptation at least as old as the invention of money and trade, although the circumstances of the early 1980s meant that it was an unusually intense episode. What was truly unique about it, however, was the extent to which the intellectual and policy impulse for change came from outside the affected countries. In many countries the Bretton Woods institutions played a lead role, a tendency greatly enhanced by the move of the World Bank into structural adjustment lending and the initiation by the IMF of its two structural adjustment facilities. The last decade and a half have seen a veritable explosion of conditionality-related policy changes in developing countries.
Table 1 shows the rapid growth in adjustment lending by the World Bank since the early 1980s, with the number of new loans increasing fivefold over the period. The trend is less clear in the case of the Fund, but by the last period shown it was making an unprecedented large number of high-conditionality (excluding SAF) structural adjustment loans.
|All credits||Structural adjustment1||World Bank|
|Number||Value 2||Number||Value 2||Number||Value|
Includes extended Fund facility, SAF, and ESAF credits.
In billions of SDRs.
In billions of U.S. dollars.
Latest IMF data to April 30, 1993; latest World Bank data to June 30, 1993.
Includes extended Fund facility, SAF, and ESAF credits.
In billions of SDRs.
In billions of U.S. dollars.
Latest IMF data to April 30, 1993; latest World Bank data to June 30, 1993.
In addition to the growing number of governments entering into structural adjustment arrangements with the Bretton Woods institutions, the number of policy stipulations per credit has also been increasing. Conditionality in World Bank structural adjustment programs has always been wide-ranging, and its staff’s tendency to be overambitious in program design has been a recurring source of concern in internal Bank evaluations of its adjustment lending. This self-criticism has not, however, prevented further proliferation of policy conditions (see Table 2).
|Preconditions (prior actions)||9||18|
|Other policy commitments||18||21|
In the sense that their observance is required if a loan tranche is to be released, and thus similar in status to IMF performance criteria.
In the sense that their observance is required if a loan tranche is to be released, and thus similar in status to IMF performance criteria.
A specific but not unusual illustration of this conditionality is provided by an unpublished World Bank report on Uganda, a country still trying to rebuild its public administration after the ravages of prolonged civil war. This report sets out a total of 86 specific policy commitments for 1991/92–1993/94, of which 79 should have been undertaken or initiated in fiscal year 1991/92 alone.
In the IMF, the tendency toward proliferation is most obvious with its ESAF programs. The range of policy conditions in these is considerably wider than in traditional stand-by arrangements. Preconditions have been extensively used, but the starkest evidence on proliferation was provided by Polak (1991, p. 14), who noted that the number of performance criteria rose from less than 6 in the period 1968–77 to 7 (1979–84) and then to 9½ (1984–87). A principal reason for this proliferation is that Fund conditionality now goes beyond its traditional demand-management concentration to stipulate supply-side measures, for example, as regards trade liberalization, pricing policies, or privatization, but these extensions are additional to its traditional demand-management stipulations. Under pressure from some members of its Board, the Fund has also begun to take a more active interest in the impact of its programs on vulnerable groups, including spending on social welfare programs.
There have also been important changes in the Fund’s thinking on fiscal conditionality (Tanzi, 1989), which have further increased the intrusiveness of Fund conditionality. Internal staff papers now write disparagingly of the past tendency of programs to go for “quick fixes” and to overconcentrate on aggregate spending ceilings. Detailed attention is now paid to improving the content of government expenditures, as well as to tax reforms and other revenue-raising measures, to raise the “quality” of fiscal adjustment.
Where the Bretton Woods institutions have led the way, bilateral donors have, in varying degrees, followed (Hewitt and Killick, forthcoming, 1995). It is increasingly common for the granting or disbursement of bilateral aid to be made conditional on continued compliance with the institutions’ conditionality, but several donors have not stopped there. There have been a number of well-known cases where donors have stipulated political reforms in the directions of improved observance of human rights, reduced military spending, accountability, and democratization. A number of donors have also widened the net of policy conditionality, going beyond the Bretton Woods institutions to insist on measures for environmental protection, poverty reduction, enhancement of the role of women, and private enterprise development. Some have further attached conditions to the ways in which governments use counterpart funds generated by program support.
This proliferation tends to undermine the development of indigenous policymaking capacity. Relatedly, conditionality can give the impression that programs are being imposed upon a reluctant government even when that is not so. Such public perceptions may undermine the legitimacy of a program and hence the likelihood that it will be implemented and sustained. Even where that does not occur, external determination of program content will weaken what the World Bank calls the government’s sense of “ownership” of the program, which may well be the most important determinant of its success.
It is surprising that little attention has been paid to the findings of a report by the World Bank (1992a), which provided substantial, statistically highly significant evidence on the importance of this factor. This report assessed program ownership by the extent to which the initiative for the program’s policies was local or external, the level of intellectual conviction in the appropriateness of its measures, the extent of support from the top political leadership, and efforts toward consensus-building among the wider public, and tested for correlation between this variable and its assessment of the satisfactory outcomes of programs. The result was that the extent of government ownership predicted the satisfactory outcomes of adjustment programs in three fourths (73 percent) of all cases, with most outliers explained by exogenous shocks. Ownership was high in most programs achieving good outcomes and low in most unsatisfactory programs. In the absence of ownership, governments evade commitments and regress when opportunities arise.
Unfortunately, conditionality, being essentially coercive, undermines ownership.5 Its imposed nature can result in resentments by the ministers and officials who must implement the measures—and live with their consequences. In the more extreme cases, public perceptions of imposition can undermine the legitimacy of programs and strengthen opposition to reform. (For this reason, the Bretton Woods institutions’ complaints of “weakness of political will” by governments that were mentioned earlier are often unhelpful.) Berg (1991, pp. 217 and 219) has put the point trenchantly:
Explicit conditionality coexists uneasily and indeed may be incompatible with the notion of local “ownership” of adjustment programs [It] gives the impression of being imposed from outside, even when it is not. It causes liberalization ideas and policies to be identified with outsiders. Local critics attack the “World Bank’s austerity program” or the “World Bank’s liberalization scheme”; foreign reporters write about it in the same way …. The overall effect is to discourage the growth of local “ownership,” discredit the policy ideas at issue, and delay the growth of political responsibility.
The Bretton Woods institutions deny that conditionality is coercive or that programs are imposed, but the degree of imposition is more common than they are willing to admit. This is strongly confirmed by evidence in the World Bank report just cited (1992a) showing that government ownership was regarded by Bank staff as “low” or “very low” in half of the programs (40/81), and “very high” in only one fifth (16/81).
There is no equivalent information on the Fund, but there is a strong presumption that similar considerations apply with at least equal force, not least because many of the World Bank structural adjustment programs analyzed were accompanied by Fund programs. That the Fund has been unforthcoming on this subject is not, I suspect, because it thinks ownership is unimportant, but because it has particular difficulties in dealing with this subject. Many of these difficulties arise from the crisis conditions in which governments often turn to it, the intense pressure of work under which its country staff commonly operate, the speed with which its programs are prepared, and their relatively short-term nature. In such circumstances, with negotiating missions commonly lasting two or three weeks, its staff does not have time to ensure that the government is fully “on board,” just as the government often will not have time (even when it has the inclination) to undertake the consultations and public information necessary for consensus building.
However, the Fund’s modalities of operation compound these intrinsic difficulties. Its key document is the “letter of intent,” in which the borrowing government formally presents the policies it will undertake to promote program objectives. Herein, it might be said, lies program “ownership.” However, these letters, although ostensibly from the government, are still almost invariably drafted in Washington, with the government left trying to negotiate variations in a draft presented to them. It is difficult to imagine a procedure more subversive of ownership. The practices of the Fund flatly contradict the obvious good sense of the World Bank report (1992a, p. 15) that “one good indicator of ownership is the borrower’s willingness and capacity to prepare the letter [of intent].”
Such modalities are apt to result in programs that governments do not regard as their own and of which, therefore, they will implement only the inescapable minimum. Consequently, some governments have become adept at finding ways that do not formally contravene agreed policies but that effectively restore the status quo ante. One of the difficulties is that, by insisting on major policy changes, the Bretton Woods institutions ipso facto become important players on the domestic political stage but do not have the ability to assemble a coalition of interests sufficient to sustain the reforms, particularly if the economic crisis abates and the pressures diminish.
Here is a classical principal-agent problem, with differences in goals and interests between the principals (the Bretton Woods institutions) and the agents (implementing governments); inadequate incentives for the agents to promote principals’ objectives; asymmetrical information; and high enforcement costs.
There are hence large advantages to “homegrown” programs, which avoid such dilemmas. This helps explain the examples cited earlier of favorable Asian and Latin American experiences that apparently owed little to direct participation by the Bretton Woods institutions (as distinct from the positive indirect influence of their advice and technical assistance). The most successful adjusting group of countries are the East Asian “miracle” countries (note, for example, the Republic of Korea’s successful response to its large debt problems of the mid-1980s), but their efforts owe little or nothing to Bretton Woods institution adjustment programs. Indeed, in important and well-known ways, most of them departed from the orthodoxies of the Bretton Woods institutions. The same local ownership appears to characterize the reform process in China and India. More tentatively, it is not clear that much of the restoration of creditworthiness in heavily indebted Latin American countries owes much to conditionality in structural adjustment programs. Conversely, sub-Saharan Africa has undoubtedly been subjected to more conditionality per capita than any other region—and has achieved the least adjustment. Politically motivated changes in domestic government attitudes to macroeconomic management appear to be the decisive factor.
Being a product of domestic political and policy formation processes, homegrown programs more faithfully reflect domestic goals and priorities and are less likely to be sabotaged during implementation. In the ideal case, the program will be consensual, based on wide consultation and public information. Even without that, the government must take into account how the resulting social costs and political opposition are to be managed—something the Bretton Woods institutions are not well placed to do. By definition, such programs are tailor-made to suit local circumstances, and they tap superior local knowledge of the economy. The probability of sustained government commitment to the chosen path of reform is enhanced.
Evidence is accumulating that the nature of a country’s polity—and the interventions that emanate from it—exerts a decisive influence on national economic flexibility, for good or ill. Political systems have hampered adaptation in sub-Saharan Africa, which has been marked by long-term government persistence with dysfunctional policies. Conversely, it is widely agreed that governments in East Asia have been highly successful in promoting adaptation and experimenting with different policies, being quick to drop those that have not worked and to try alternative measures. The relative autonomy of the state in these countries, that is, its relative freedom from the influence of pressure from special interest groups, has been the central influence on the state’s responsiveness and (tacitly) the resulting flexibility of the economy. Thus, Wade (1990) identifies the following factors to explain the success of Japan, the Republic of Korea, and Taiwan Province of China: centralization of a decision-making structure employing the best managers; insulation of decision makers from all but the strongest pressure groups; a powerful executive not beholden to the legislature; the absence of a powerful labor movement; the absence of conflicts between the owners of natural resources and manufacturers; and decision makers’ perception that their legitimacy is grounded in economic success.
Thus, even though the thrust of the policy reforms promoted by the Bretton Woods institutions is desirable, their programs can get in the way by undermining the building of local capacities and responsive political systems that alone will permit adjustment to be sustained over time. They can get in the way for a more prosaic reason, too: the proliferation of conditionality aggravates the already formidable pressures on the cadre of key administrators in often weak and poorly manned public administrations, increasing the probability of slippage in program execution. Overall, the explosion of conditionality seriously affects the cost-effectiveness of structural adjustment programs. It increases the associated information and opportunity costs. The ever-growing influence of external agencies in socioeconomic policies, to say nothing of political processes, also increases investor uncertainties about the future policy environment and the sustainability of reform.
I do not want to argue that conditionality is never effective, however. It—and the money that comes with it—probably works best when it tips the balance between evenly poised domestic forces promoting and opposing policy reform, enabling vested interests to be bought off, or confronted. But in general, I suggest that, to be effective, measures to promote adaptation must emanate from an understanding by responsible ministers of the actions necessary, with policies emerging organically, as it were, through local decision and implementation processes, and tailor-made to domestic conditions in a way that is only feasible when designed locally. The success of homegrown programs is far from guaranteed, of course, because the possibility of misdesign is still present and shocks can supervene. However, they stand a better chance of success than the opposite case of Washington-designed programs that are to a substantial degree wished on more or less reluctant governments desperate for money.
Other Constraints on the Effectiveness of Conditionality
Besides the ownership problem, various other factors limit what it is realistic to expect to be achieved through conditionality.
First, the Bretton Woods institutions suffer from resource problems. Arguably the most serious of these is inadequate knowledge. The circumstances of each country differ. Each economy has its special structural characteristics and problems. Policies and other economic variables interact with each other in complex ways. To be effective, adjustment programs must be tailored to these local particularities. A great deal of in-depth country knowledge is therefore necessary for well-founded programs—more knowledge than it is often reasonable to expect of hardpressed staffs in Washington.
In the face of inadequate knowledge, the danger is that the institutions will fall back on institutional orthodoxies and more or less standard prescriptions. Moreover, the large number and ambitious scope of country programs described earlier add to pressures for the adoption of standard recipes. Pressure of work and the inherent limitations on the freedom of action of the Bretton Woods institutions increase the difficulties of coping with the complexities and uncertainties of devising tailor-made adjustment packages. Martin (1991, p. 35) has observed the consequences of these tendencies in Africa:
IMF staff were overworked, especially because they had to reconcile positions with the World Bank and take account of creditor-government pressure. A larger number of African countries were applying for loans more often …; and conditions were proliferating, demanding new expertise …. Time pressure, notably in functional departments, often meant that staff did not understand the country’s economy or politics, or had not enough experience of African adjustment to be flexible. They tended to absorb the Fund’s view of the country in the briefing paper.
The managements of both Bretton Woods institutions deny any mechanistic application of standard formulas and insist that their staffs tailor programs to country circumstances. But there is a frequently-complained-of gap between management aspirations and what happens in practice, to which there is no easy solution. It is an intrinsic difficulty with conditionality as a mode for achieving change. The danger, of course, is that some programs turn out to be ill fitting or unrealistic, and that they result in avoidable adjustment costs—another recurring developing country complaint.
The knowledge constraint is compounded by problems with staffing—problems of numbers and of turnover, not of competence. The numbers aspect has particularly affected the IMF, which in recent years has seen a large increase in the number and labor-intensity of its programs (particularly since the emergence of a major group of European economies in transition, the introduction of ESAF, the associated policy framework paper mechanisms, and the Fund’s welcome increased use of review missions) while their boards have shortsightedly prevented them from recruiting parallel increases in professional staff.
The turnover aspect of the problem refers not so much to staff movements out of the Bretton Woods institutions (although their terms and conditions have become somewhat eroded, also because of board pressures), but to movements within each institution. Developing country officials complain often and strongly about the delays and other costs imposed by this turnover. Thus, an official of an African government in private correspondence has written of the problems caused by lack of continuity:
To give an example, a new Exchange and Trade Relations (ETR) man was sent with the IMF mission earlier this year.6 It took at least two missions for him to get to grips with [this country’s] case, and only on his last mission did he look comfortable. However, he has been transferred so the next mission will bring a new ETR man. This will significantly increase my workload as I will have to “educate” him on [my country], answer endless questions and supply lots of information that has already been given in the past. This has also been the case in other areas of the “away team.”
In addition to these extra costs, high turnover and the erosion of mission self-confidence that results aggravate the knowledge problem and can lead to an appearance of institutional inflexibility and arrogance in negotiations.
Finance is a third resource constraint. This, however, is too large a subject to go into here. Suffice it to say that there are still too many under-funded programs and that it is easy to exaggerate the extent to which structural adjustment programs have a catalytic effect on net inflows of capital from other sources.
A further constraint can be called the rigor problem, referring to pressures from major shareholders or managements for program measures to appear tough and far-reaching. This constraint is associated with the trend toward the proliferation of conditionality and has various adverse consequences. It discourages governments from seeking assistance (a large problem for the take-up rate under the ESAF) or leads them to delay until all other options have been exhausted, so that programs too often have to address crisis situations. They strain the limited policy implementation capabilities of borrowing governments, causing “noncompliance” and suspicions of bad faith.
Alternatively, when combined with continuing pressures on staff to maintain the level of adjustment lending, these pressures give rise to “paper programs”—the penning of ambitious-seeming commitments to reforms that both parties tacitly understand but which cannot or will not be implemented. Thus, Berg (1991, pp. 219–20) argues that conditionality
tends to encourage a game in which differences are reconciled more on paper than in reality and agreements are framed so as to meet conflicting needs—the country’s need for understated, flexible conditions that will not involve rigid, risky, or excessively difficult commitments, and the World Bank’s desire for conditionality that is as firm and explicit as possible.
There is a good deal of pretense in conditionality: paper agreements that the staffs of the Bretton Woods institutions know cannot stick but that are intended to impress managements and boards and to “keep the money moving,” or just to give the appearance that borrowing governments are being treated equally.
In either situation, a consequence is to reduce the credibility of reforms, reducing program capacity to influence expectations and investment decision making, and undermining the prospects for good responses to future reforms. This helps explain the sluggishness of private investment response reported earlier.
Finally, there is what can be called the unequal treatment constraint, which takes two forms. One occurs among borrowing governments, in breach of the Bretton Woods institutions’ principle of uniformity of treatment, defined by the Fund to mean that “for any given degree of need the effort of economic adjustment sought in programs be broadly equivalent among members.” Unequal treatment arises chiefly as a result of lobbying on behalf of favored countries (ex-colonies, strategic allies) by governments of major shareholders. It has been particularly a problem for the IMF, for which there are several well-documented cases, but it has also seriously affected the World Bank as it has moved into policy-related lending. It is perhaps now of diminishing concern, following the end of the Cold War.
The second form of unequal treatment is one of asymmetry between developing and developed countries, with the former required to endure a degree of institutional involvement in policy formation that would not be tolerated for a moment by governments of industrial countries, which routinely discount the “surveillance” advice of the IMF. Note that this is not strictly an asymmetry between deficit and surplus countries, as the position of the United States demonstrates.
Both these inequalities of treatment undermine the legitimacy of the Bretton Woods institutions’ conditionality, weakening the motivation of governments confronted with demands to implement their commitments and further reducing the credibility of program measures.
Reconsidering the Link Between Adjustment Policies and Supporting Finance
Now to the hard part: to suggest alternatives to the approaches criticized above. If the Bretton Woods institutions are to diminish their reliance on conditionality as a mode for trying to achieve policy and institutional reform while still offering financial support for adjustment efforts, how should they proceed?
First, they should recognize what I believe is true, that their main contribution to successful adjustment in developing countries has been through their influence on the contemporary intellectual climate in which policy issues are debated and their persuasion of governments and their advisors through the regular contacts that occur. If there has been a tendency to overstate what has been accomplished through structural adjustment programs, there has also (because it is hard to demonstrate) been underacknowledgment of this intellectual influence on the “silent revolution” that has occurred in many governments’ attitudes toward economic policies. On this view, the turnaround in Latin America can still be viewed as a success story for the Bretton Woods institutions, although not one achieved principally through the specific conditionality of structural adjustment programs.
An implication, then, is that the Bretton Woods institutions should seek ways of maximizing this influence. One possibility that suggests itself—desirable for other reasons, too—is that both the institutions should decentralize their activities and bestow more genuine authority on their in-country offices. Perhaps the World Bank should institute a tradition of regular consultations analogous to the Fund’s Article IV consultations. The research activities of the two institutions have a crucial role to play in this, subject to two cautions: (1) they should avoid any tendency to confuse the reportage of research with propaganda, as seriously erosive of intellectual credibility; and (2) they should ensure that their researchers do not become estranged from field operations, so that the latter do not reflect best professional practice. Of course, none of these actions could guarantee that all governments would be sweetly reasonable. However, an incentive mechanism is at work here: governments that make a mess of their countries’ economies are apt to become unpopular and fall from office.
It also follows from the earlier comparisons of the policy implications of the adjustment-as-catharsis and adjustment-as-continuous-adaptation views of the relationship between adjustment and development that a broader view and a longer time horizon are needed to comprehend the strategic importance for economic adaptation of such factors as the development of skills and institutions and industrialization, and to rely less on getting prices right (important though that is). Such a perspective might also encourage the Bretton Woods institutions to better focus on the main thrust of what programs are seeking to achieve over time, steering them away from the temptation of (an actually unattainable) “fine-tuning” of policies and economies and its associated proliferation of policy stipulations.
Above all, the Bretton Woods institutions should be willing to say “no” more often to governments with a weak commitment to reform and should insist that all programs be prepared by the borrowing governments. The willingness of governments to draft their own letters of intent or of development policy should be a minimum obligation; they should never be prepared by the institutions’ staffs in Washington. The Bretton Woods institutions should refuse to play the paper conditionality game; their staffs should be assessed on the quality of the adjustment lending they undertake, not the volume—a recommendation at the macro level similar to that in the Wapenhans report on improving the quality of World Bank project lending (see also Wapenhans, 1994), but applicable also to the IMF.
Implementation of these recommendations should result in a reallocation of financial resources away from reluctant adjusters and client states, releasing more for the committed adjusters. If it is correct that domestically designed adjustment programs are more effective, they should further induce larger additional inflows of foreign capital, private and public (as again apparently exemplified by Asian and Latin American cases).
It would, however, be important not to confuse unwillingness to adjust with the limited technical capabilities of some developing country governments. Technical assistance to enhance such capabilities should be even more freely available, but it should be independent of the Bretton Woods institutions, so as to minimize conflict of interest problems, and this assistance should never be imposed. Imposed advisors are no more effective than imposed policy reforms, as forcefully conveyed by the World Bank Vice President responsible for Africa (Jaycox, 1993):
Donors also relied too heavily on foreign experts, even when qualified Africans were available. This did little to foster a receptive environment for the transfer of skills. In fact, it was often bitterly resented. Over reliance on technical assistance also brought many difficulties. Expatriates were frequently chosen for their technical skills rather than their ability to pass on those skills. This, coupled with operational difficulties, pulled foreign consultants into operational support at the expense of capacity building.
A further implication of my recommendations is that the required broadening of programs and insistence that they be home designed would require the Bretton Woods institutions to be more pragmatic and pluralistic in their assessments of programs. Willingness by the World Bank to countenance measures of the type associated with Japan, Korea, and Taiwan Province of China are an example. Moreover, the recommendation of greater country selectivity would necessitate greater restraint by governments of major shareholders from lobbying on behalf of favored applicant governments. The end of the Cold War will, it is hoped, facilitate such restraint.
I have prepared a formal paper for this session on the experience of the low-income countries with adjustment and growth (see annex). Taking a look at the audience for today’s session, I see many familiar faces and many former colleagues in both the Fund and the World Bank but also in government—colleagues with whom I have worked on the implementation of reform policies and with whom I have shared the difficulties of trying to create growth in very low-income countries. I think that many of them would be disappointed if I were merely to read a paper. I propose instead to review a few of the major items on our agenda and to share my thoughts and experiences with you. In turn, I will to try to draw on this experience in order to convey some of the lessons for adjustment and growth. In the process, I hope to touch on a wide range of issues: what developing countries are currently doing, what they could do better, what they should do better, how they could be helped, how they are not helped sometimes, and the social and economic environment for many of these countries, which continues to be difficult.
As the only former Prime Minister in the Fund’s management team, I have a responsibility for ensuring that the political perspective of the adjustment process is shared with the Executive Board of the Fund. Although at the technical level neither the Fund nor the World Bank has any wish to interfere in this area, it is important that we begin to look more closely at the political process in each case, which, in the final analysis, is what shapes decisions. One can design the best adjustment program and have the best people in office, but if the political commitment is not present, even the best program will remain, as Professor Killick said, merely a program on paper. Adjustment programs are also influenced by factors of chance: the terms of trade, international interest rates, the generosity of the industrial countries, and so forth, all of which can help to improve the outcome of the adjustment process in developing countries even in the absence of longer-term structural measures.
I will not bore you with a detailed account of the experience of these countries in the 1980s and the early 1990s, with which we are all familiar. The results have been disappointing for many countries, both in Africa and in some other areas of the world. As noted in my background paper, the results have been mixed in part because individual country performance has been mixed, in terms of both policies and the time path that was envisaged. To be sure, the external environment over the past 15 years has also been a mixed blessing for low-income developing countries: changes in the prices of commodities benefited some countries and burdened others, while the high level of interest rates and other exogenous factors have essentially determined the evolution of some economies from time to time. The accumulation of large amounts of external debt is another important element in the analysis of the adjustment and growth of low-income countries since 1980.
What, then, are the lessons for adjustment and growth? As I said, the economic performance of the low-income countries has been weak, and their efforts to raise saving to support investment, growth, and development have been very disappointing. In drawing lessons from this experience, policymakers in the countries concerned and outside advisors need to understand how the policies and prospects of low-income countries can be strengthened, especially in terms of sustained higher growth and improved living standards for the people of these countries.
These observations lead me to the central question: has our approach to adjustment been a failure, as Professor Killick indicated, or has there instead been a failure to adjust? To address the first aspect of this question, whether adjustment programs are supportive of growth, we must first ask another question: what conditions are most conducive to generating higher growth? We know that there is no simple set of policy prescriptions. Nevertheless, in all regions of the world and across the political spectrum, there is now basic agreement on the main thrust of economic policy. It is now widely understood that a country cannot run a large fiscal deficit over a long period without consequences for inflation and the external accounts. It is also evident that a restrictive monetary policy is not possible in all low-income countries, given the structural elements of their economies. Moreover, as a former governor of a central bank, I would also say that it is now clear that monetary policy cannot by itself work to reduce inflation, ensure an adequate level of financing in the economy, and instill the necessary confidence in the economy. Fiscal policy, therefore, is at the core of the adjustment process, especially for low-income countries.
Different economic and social settings clearly influence the level of saving, the trend of saving, and the capacity to save. Looking at specific policy actions, a great deal of reliance has obviously been placed on measures to raise fiscal revenue, however defined. In many low-income countries, for various reasons, the level of taxation is very high; it is very difficult to bring this level down, of course, owing to the need to finance current outlays and, in particular, to provide for investment. How, then, does one deal with a system in which very high tax rates, especially customs duties, coexist with very low wages for the officials charged with implementing these policies? Such a system would seem to meet, albeit unconsciously, all the requirements for corruption. Take, for example, the circumstances of a typical civil servant in an African country: this individual might very well be responsible for the well-being of 10–20 family members, or even a whole village; clearly, a very high level of expenditure has been imposed on him by social factors, and he finds himself in a job in which clearly not all the mechanics are working properly. These are the kinds of issues that I think we need to look into in more detail when we give advice to the officials of low-income countries. As I have already noted, there is now a broad consensus on which policies are right, but also on which policies are wrong.
I would now like to turn to certain elements of structural reform and, in particular, the need to improve efficiency in the allocation of resources in low-income countries. Typically, low-income countries have a large number of public enterprises, mainly because of historical factors, such as the lack of private saving and the relatively favorable terms of trade for many of these countries in Africa in the first years of independence, and because the public sector is widely viewed as the main provider of employment and investment. Public enterprises are intended, at least in the minds of many politicians, to help to improve the social conditions of the country, but they have increasingly become merely institutions that provide employment. To sustain a high level of public sector employment and meet the increasing costs of operating public enterprises, tariffs had to be raised. This, in turn, has led to a situation in which public enterprises are over indebted and their capital stock is ill suited to the needs of a developing economy. In the transportation sector, for example, trains and buses are typically old and have not been well maintained.
How does one go about ensuring a healthier public sector? Should public enterprises be restructured, as is often suggested, or privatized? Should subsidies be eliminated over an agreed period? As everyone recognizes, politicians clearly prefer the smoothest approach. In a low-income country dependent on external financing and the external environment, over which it has no influence, the best approach is to take a bold decision and to implement forceful measures. In my view, trying to restructure a public enterprise whose financial operations are wildly out of line with good management practice is more difficult than opting for privatization; and it is certainly easier to go in the direction of changes that will create higher and more sustained employment.
In addressing these issues, it is helpful to keep in mind the underlying aim of economic policy, namely, to improve living standards for the majority of the population. Better living standards mean, among other things, lower tariffs for the consumer and more plentiful buses and trains. Obviously, political circumstances differ in each case: for example, whereas some countries can see merit in keeping a number of enterprises in the public domain—the so-called strategic sectors—others consider it necessary for domestic political reasons to keep certain enterprises in the public sector but to operate them in accordance with the principles governing private sector entities.
On the problem of external debt, I would note at the outset that the responsibility for the rapid accumulation of external debt by low-income developing countries does not reside with these countries alone. The debt situation has evolved over the years, and the international community has done much to try to alleviate some of these difficulties. Even after a low-income country has rescheduled part of its external debt on the generous terms set forth in Toronto, Trinidad, and Dakar, however, policymakers are often faced with a situation in which they must choose between servicing external debt and mobilizing sufficient resources to pay wages and salaries for civil servants. It is clear which option most officials would choose in such a situation. In looking at ways to assist low-income countries, therefore, it is important to avoid the mistakes of the past: we would do well to remember that debt has both external and domestic aspects. In this context, I would underscore the need to ensure that beyond closely monitoring the financial position of the central government itself, peripheral agencies of the public sector should not be allowed to act as debt-creating vehicles. Global management of the public debt is indispensable; debt should be managed both externally and domestically.
Allow me to make a few comments on the broad issues of governance and transparency, upon which Professor Killick has already touched. These are important issues for every country. It is clear that government operations cannot be made transparent in the absence of a democratic environment. For any country, of course, the particular political system that is chosen is a matter for the people of that country to decide. When a country is dependent on the international community for part of its survival through financial and other forms of support, however, those countries making their support available cannot remain indifferent to the extent to which government operations are conducted in a transparent manner and as part of a democratic process. Low-income countries have to implement very difficult reforms because problems have been allowed to accumulate over the years. Resolving these problems can best be done in an environment in which there is a broad consensus on what needs to be done and how to do it. Thus, it is important to make sure that the general public understands fully the problems facing the country so that it can more readily accept the adjustment measures proposed by the government. It is not sufficient, as Professor Killick suggested, for a country to develop a program of its own and to obtain the approval of the international community; government officials have to make sure that the population understands the problems, and political leaders need to explain why certain measures are necessary, what type of time frame is necessary to implement them, how the burden will be shared, and, especially, that those who have most will contribute most to the solution. The political situation of adjusting countries is clearly not in the domain of the Bretton Woods institutions, but looking carefully at the nature and strength of the political process as it relates to policy implementation is, in my view, indispensable.
Finally, a piece of advice for those of us who offer advice to countries, especially to low-income countries: one should not be ashamed of accepting second-best solutions, because the political authorities must be able to explain the solution to the country as a whole to ensure that decisions are well understood, are accepted, and can be implemented on a sustained basis over a long period. Thus, when an opportunity to make progress presents itself, it should be seized. Demonstrating a better understanding of the difficulties facing the authorities in the process of implementing reforms is, in my experience, as indispensable to the success of an adjustment program as any assistance that may be offered along the path of reform.
Ariel Buira remarked that Killick had made a number of very important points with which he was in very substantial agreement. Part of the problem with adjustment programs was that the Fund traditionally had felt that it did not have a responsibility for development, and that its responsibility was very short term in nature. That perspective was evident in the view that the Fund was a monetary institution, and that it had to preserve its monetary character and the revolving nature of its resources. In the light of its perceived role as a short-term monetary institution, the Fund had tended to rely very heavily on demand-management policies, leaving aside other aspects of adjustment and development. Killick was absolutely correct in saying that successful adjustment required a much longer and broader view; the process went far beyond demand management and required a number of structural changes, including in areas such as education and technological development.
Taking a longer and a broader view required substantially more financing, but the Bretton Woods institutions were subject to limited resources. The major contributing countries had difficulty in increasing those resources; in fact, over the years, the relative size of the Fund had declined to the point where its resources were minuscule in proportion to world trade. Furthermore, the Fund did not make use of all available resources: the Fund had an enormous amount of liquidity, even leaving aside its gold holdings. Currently, annual access to the Fund’s general resources was set at a limit of 68 percent of a member’s quota, but in practice average access was closer to 40 percent of quota.7
The underlying reason for not making better use of the Fund’s resources lay in the tension between countries that were creditors to the institution and those that were its debtors. Creditor countries wished, not unreasonably, to take the view of lenders, lending as little as possible with as many conditions as possible. Killick rightly pointed out that such a policy became somewhat self-defeating, in that the success of programs had been limited, they were overburdened with conditions, and governments did not identify to any great extent with them. He was also correct in saying that success depended on governments’ identifying with the policies of the program, which meant that successful programs were those designed by the governments themselves. Implementation of such a policy required placing a certain amount of trust in the governments to which the Fund was lending, giving them considerably greater leeway than at present to design their own programs. Clearly, that was the right approach.
Ishrat Hussain commented that the useful distinction that Killick had drawn between adjustment as a transition and adjustment as a continuous adaptation could be reconciled by reference to the different initial conditions that countries faced. In countries that had allowed their economies to accumulate significant distortions over time, characterized by the accumulation of large black market premiums, large fiscal deficits, and large losses in the financial sector and public enterprises, there was a need for large, discrete changes in the economy—what might be called a purging process. Once those roadblocks had been removed, it would be possible to move to a process of continuous adaptation, in which marginal changes could be made in response to either external or internal shocks. A useful analogy in that respect was of a road littered with boulders and big stones, which took a long time to remove; once they were removed, however, one could accelerate, slowing down from time to time only to remove small pebbles. Such an analogy was certainly relevant to the East Asian example, where countries had continued to adapt and respond to changes. They had not allowed distortions to multiply and accumulate over time and, therefore, had not needed to make the types of nonmarginal changes that had been necessary in Africa.
Layeshi Yaker noted that it was generally agreed that in the rapidly changing global economic environment, all economies—whether small or large—had to adjust and adapt to the changing environment. The center of the debate, however, was whether existing structural adjustment programs, especially in Africa, were an adequate framework for promoting sustainable development. Many had expressed doubt on the point, and the overall performance of African economies during the past decade and a half appeared to support the view that the current strategy was flawed. Indeed, the Managing Director of the Fund had recently noted that, while a number of developing countries had in recent decades achieved impressive rates of growth, “the main problem is, of course, that economic progress has been so uneven, bypassing hundreds of millions of the world’s poorest. About one in six of the population of the developing world live in countries where real per capita incomes have actually declined in the past decade, creating a fourth world that is concentrated in Africa.”8 During the 1993 Annual Meetings of the World Bank and the Fund, the Managing Director had vividly characterized the plight of Africa as “a sinking continent.” Yaker wondered whether those statements implied there was a need for an alternative framework, taking into account the failure of the current development strategies to engender sustainable growth and significant poverty reduction.
In Yaker’s view, it should be acknowledged that the continent of Africa, in crisis but with considerable potential, would benefit from a different development strategy; global security and sustainable and equitable world development could not otherwise be achieved. Against the rapid development of regionalism, especially within the OECD, the whole continent of Africa was in need of structural adjustment. Within that framework, an Africa in transition—including democratic South Africa—and Africa’s partners in the development process had the means to reverse those disturbing trends. A real solution to the debt problem would require adequate trade policies in favor of Africa—the only loser in the Uruguay Round—and a massive international plan for human and technology development, including infrastructure. In that context, it was worth mentioning that the treaty establishing a Pan-African Economic Community, which had been ratified by 53 African states, including South Africa, would shortly come into effect. More meaningful cooperation with the continental and regional institutions of Africa—including the Economic Commission for Africa, the African Development Bank, the Southern African Development Conference, the Economic Community of West African States, the Preferential Trade Area for Eastern and Southern African States, and the Maghreb Union—would bring about far-reaching positive results, providing development in Africa, employment in OECD countries, and improved global security, democracy, and human rights; in other words, a more equitable and harmonious world order.
Jo Marie Griesgraber said that she shared Yaker’s views. On the debt issue, many people had been working with the commercial banks, the Paris Club, and the U.S. Treasury to encourage the Treasury and the U.S. Congress to provide money for African debt relief. She asked Ouattara to explain, in his capacity as a senior Fund official, the responsibility of the Fund to assist countries, particularly in Africa, in reducing their debt to the Fund. The community of nongovernmental organizations was very supportive of the stated position of the U.K. Chancellor of the Exchequer on the possible sale of part of the Fund’s gold holdings for that purpose.
On the matter of transparency, and on the importance of politics noted by Ouattara, she wondered what was the institutional position of the Fund in terms of opening up its own procedures and its papers, particularly the Article IV consultation documents—a move that the Governments of the United States and Switzerland, among others, appeared to endorse. As an intergovernmental institution, of course, the Fund was guided by the wishes of its member governments, but those same governments often argued that they had no direct influence over the decisions of the World Bank and the Fund. Therefore, it would be interesting to know what kind of example the Fund would make in terms of the transparency of its own documents and policies.
Manuel Guitián said that his comments were prompted by the very persuasive presentation by Killick, with whom he had had an exchange of views over an extended period. His impression was that the debate was often burdened by its terminology. He did not see adjustment as being equivalent to conditionality. In the Fund, adjustment was a continuous process, along the lines of the second of Killick’s characterizations. It was a process in which members regularly discussed their policies with the institution; the Fund did not deal with adjustment only when the use of its resources was requested. In that sense, the Fund had gone much further along the lines on which Killick had concluded his presentation: the influence of ideas on the process was very important; and influence was a two-way road, coming both from members to the institution and from the institution to members.
Perhaps the most important consensus that had emerged in the past 50 years was the importance of macroeconomic stability, policy measures to support the market, and international openness. All members had opened their economies to an extent that had not been foreseen at Bretton Woods—in respect of trade, as well as other current and capital account transactions. Guitián noted that Killick viewed that consensus as a paradox, however, because he saw very little relation between the policies and the achievement of the objectives. Perhaps the only way to reconcile the apparent paradox was to review the evidence that had led to his conclusion that the policies had not been effective.
Leszek Balcerowicz remarked that it would be a grave error not to distinguish between the principle of conditionality and the concrete manifestation of conditionality. The rejection of that principle would imply a return to project lending or nonconditional lending. One could certainly criticize details, such as inappropriate or excessive conditions, but the core principle of conditionality should be retained.
Killick responded that he could agree with many of the points raised by other speakers. He shared Buira’s view that pushing the Fund, and indeed the World Bank, in the direction of longer-term programs implied a need for more resources. It was important to bear in mind, however, as he had stated in his presentation, that the institutions should at the same time be more selective about the governments to which they provided support. Greater selectivity was a form of rationing and should, therefore, release additional resources in support of those programs endorsed by the institutions. Furthermore, he was less pessimistic than some about the prospect of obtaining more resources for the Fund and the Bank. The Fund’s ESAF, for example, was a relatively new source of additional financing; moreover, the U.K. Chancellor of the Exchequer had recently proposed what might be called a “super ESAF,” which would provide even longer-term support.
On Guitián’s point about the evidence, or the lack thereof, of the success of the consensus, he would refer to the evidence that he had cited earlier. In addition, he would note that a senior member of the Fund’s research staff, Mohsin Khan, had concluded a survey article on the evidence of the impact of Fund-supported programs with the observation that it would be hard to draw any strong conclusions from the evidence.9
Ouattara observed that the financing of an adjustment program was clearly related to its strength. In his remarks, therefore, he had advised low-income countries that, taking into account the external environment, it would be better to undertake stronger programs. Such an approach, in turn, implied a need for better communication within adjusting countries to garner the necessary support for the program and for the difficult measures that would be taken. Similarly, the prospects for resolution of the debt problem for low-income countries clearly depended on the sustainability of programs and the proper management of debt under various arrangements, such as the Paris Club.
With respect to transparency, further steps had been taken recently in the area of publishing Fund documents. As he had indicated in his remarks, however, adjustment programs should not be viewed as “Fund programs.” They should be viewed as programs of the Fund’s member governments; indeed, many countries had demonstrated the capacity to develop their own adjustment programs. The process of designing and implementing programs was continuous, of course, and by explaining the objectives and details of those programs within their own countries, governments could go a long way toward informing the international community at large about the work of the Fund. In any event, the Executive Board of the Fund was continuing to examine the issue with a view to making further progress.
In concluding the session, the Chairman, Luis Angel Rojo, commented that Ouattara appeared to side with those who were relatively optimistic about structural adjustment programs and who considered that, on balance, these programs had achieved a considerable measure of success in strengthening economic performance, even while admitting that growth performance in many cases had been disappointing. Killick seemed to fall on the more skeptical side, considering that the record of those programs was, as he had said, “patchy, at best,” and that they did not have much impact on inflation or economic growth, taking into account the available empirical evidence.
In fact, both speakers were in general agreement in underlining the need to pay much more attention to long-term considerations, to factors that affected the flexibility of the economy to face the continuous challenges of a changing environment. They had also both stressed the importance of institutional reforms and of structural adjustments, such as improving human capital and economic administration.
Killick had raised a somewhat polemic point related to conditionality, asking whether there had been an “explosion” of conditionality in recent years. He had gone on to question whether conditionality in fact negatively affected the results of adjustment programs and at the same time gave “recipient” governments the impression that the programs were not homegrown but imposed by an external institution. The issue was clearly controversial and, as in so many matters, reasonable people could be expected to disagree.
Annex: Alassane Ouattara
Experience of the 1980s and Early 1990s
Following broadly satisfactory growth, inflation, and external performance during the 1960s and 1970s, many low-income developing countries encountered serious economic difficulties in the early 1980s. These difficulties were the product of several factors: weak productive bases; periodic disruptions from poor weather and civil strife; and a clash between stark reversals of the terms of trade and rising borrowing costs on the one hand and expansionary financial policies on the other. Longstanding structural weaknesses were exposed and placed countries in a poor position to adjust to their setbacks while sustaining growth: elaborate networks of state intervention, ostensibly to make up for the fragile productive base, rendered the supply side of the economy inefficient and unresponsive to market signals. Often, the first response to the adverse developments was to borrow more to maintain domestic absorption in the face of a sharp drop in income. By the mid-1980s, in the absence of effective adjustment and recovery in the terms of trade, many of the poorest countries faced not only massive stabilization problems but also unmanageable external debt problems.
In the face of these harsh circumstances, there has been a growing realization by governments of the virtues of macroeconomic stability and financial policy discipline. Since the mid-1980s, with the support of the IMF and World Bank, many low-income countries have implemented major structural adjustment programs. How have the achievements under these programs measured up to the goal of higher sustainable growth and a broad-based improvement in living standards? When viewed against a backdrop of very weak starting positions and, for many countries, serious and persistent declines in the terms of trade, a considerable measure of success was achieved in strengthening economic performance. On average, output growth, trade volumes, inflation performance, and external debt ratios strengthened. There was, of course, considerable variation between individual countries.
But there have also been disappointments, particularly in countries in which the response thus far of investment to adjustment policies has been relatively small, and low domestic saving has persisted. This experience stands in contrast to that of other more successful developing countries, especially in East Asia, in which investment and savings performance has been strong. Also, notwithstanding the reform efforts undertaken and the progress achieved, conditions in many low-income countries remain harsh and their economies weak: during the 1980s and early 1990s, low growth rates have failed to keep pace with population growth in sub-Saharan Africa and have prevented a fundamental attack on poverty in Bangladesh, Pakistan, and India; the level of social indicators, such as health, nutrition, and access to primary education in Africa is poor and in a number of countries has worsened; and most of these countries, particularly in Africa, have seen little diversification of their economies and continue to rely on a limited number of commodity exports.
Lessons for Adjustment and Growth
The mixed economic performance following the renewed adjustment effort in low-income developing countries, especially the weak response of savings and investment, which are essential underpinnings to sustainable higher growth, raises several important questions. Looking to the past, has there been a failure in our approach to adjustment, or instead has there been a failure to adjust? Drawing upon the lessons of the past, how can we—policymakers and advisors—better fashion adjustment policies to strengthen prospects for sustainable higher growth and improved living standards?
To address the first question—whether adjustment programs are supportive of growth—we must ask another: what are the conditions most conducive to generating higher growth? Experience has shown us that there is no simple set of policy prescriptions that will yield higher and sustained growth: the links between policies and growth are both complex and indirect, and much remains to be learned about the underlying causal relationships. Different economic, social, and political settings influence the effectiveness of policies in promoting growth. Also, fostering sustainable growth is often a protracted process, yielding clear gains only beyond the short term and requiring steady policy efforts over a long period.
Nevertheless, there is now a broad consensus among researchers and policymakers on some of the more important policy conditions necessary for sustained growth. A key element of this consensus is that macroeconomic stability is an essential foundation for sustained growth. For countries with severe financial imbalances, adjustment therefore sets the stage for stronger growth in the long term. At the same time, to reap the reward of higher growth, adjustment must not rest upon unsustainable restraint of domestic demand but should rather stem from policies that will help countries realize their long-term growth potential.
The main elements of adjustment programs are based on this consensus: first, a monetary policy consistent with low inflation; second, a public sector deficit that does not crowd out private investment and does not require inflationary bank financing or unsustainable borrowing from abroad; third, an exchange rate that is consistent with fundamentals and does not need to be supported artificially by unsustainable borrowing or exchange restrictions; fourth, outward-looking policies for trade and investment that encourage competition, the inflow of technology, and efficient resource allocation; and fifth, structural reforms aimed at improving the efficiency of resource use and promoting a supply response. Structural measures are crucial for improving growth prospects, without which domestic demand restraint will bear heavily on living standards and consumption and may undermine the political sustainability of the adjustment process. Structural reforms are also essential for financial stability: in many countries, distortions and rigidities stemming from official controls, poorly designed tax and expenditure policies, and weak public enterprises perpetuate economic weakness and are a stifling drain on the economy’s resources.
How does this consensus on adjustment for growth stand up against the experience of low-income developing countries? The evidence indicates that the largest improvements in macroeconomic performance occurred in countries that undertook stronger financial adjustment measures and, most strikingly, the most forceful structural reforms. By the same token, weak performance was the product of a failure to adjust sufficiently. Of course, policy adjustments were not the only factor at play during this period; others include the terms of trade, civil strife, and the degree of political commitment to reform.
Notwithstanding the progress achieved under many adjustment programs, there have been weaknesses: insufficient attention to rectifying social inequity, reducing poverty, improving the quality of public expenditure, building institutions, strengthening administrative capacity, and improving governance. An inadequate focus on these areas has, in turn, weakened the adjustment process and prospects for growth, as well as the domestic consensus for reform.
How Can We Strengthen the Growth Response of Adjustment Programs?
Reflecting upon past experience, there is clearly scope for efforts to improve our choices of policies so as to improve the size and speed of the response of savings, investment, and growth. Even if our understanding of all the issues is imperfect, this only makes them more deserving of attention; incomplete knowledge does not absolve the policy-maker of the responsibility to make policy decisions.
At the same time, we must be realistic: even though policies can be improved, the fruits of adjustment in terms of higher growth may become tangible only over time. In the short run, adjustment will involve inevitable costs for countries experiencing severe financial imbalances and facing external financing crises. In these circumstances, there is a pressing imperative to restrain domestic absorption and inflationary pressures, which may have a negative impact on growth in the short term. Also, while front-loaded structural reform is crucial to encouraging an early supply response, output may in the initial phase be adversely affected as capital and labor move to more productive uses in response to new market-based incentives and the dismantling of regulations. In this context, the availability of external financing—on appropriately concessional terms that do not compound the initial debt problems of these countries—can help ease the path of adjustment and reduce the adverse short-term impact on growth.
How can we improve the influence of policies on growth? As a first step, a number of policy areas deserve more attention by policymakers, advisors, and researchers.
First, the quality of fiscal adjustment must be emphasized. In deciding upon the mix and nature of revenue and expenditure adjustments, policymakers must be sensitive to their likely effects on growth. The quality of expenditure needs to be improved, and expenditures that are especially important for growth in the long term must be safeguarded during the stabilization effort. Attention should be paid to sound public investment projects, such as infrastructure that complements private investment and thereby maximizes their developmental impact. Unproductive expenditures, including excessive military spending, must be reduced, while nonwage outlays on education and health must be adequately funded. Investment in human capital is essential for stronger growth, as evidenced by the experience of the fast-growing economies of East Asia; it is the key to unlocking the full rewards of structural reforms and liberalized markets.
Improvements in the structure official revenues must also be sought. Tax reforms, including the reduction of high marginal tax rates, the broadening of the tax base, and strengthened administration, will enhance incentives for savings and investment, as well as improve fiscal management. Finally, a critical element in the fiscal adjustment process is the formulation of a clear medium-term fiscal strategy: expenditure and revenue adjustments in the short term in response to unforeseen developments should take account of their longer-term implications for savings, investment, and growth.
Second, policymakers must pay attention to the design of policies to speed the response of private investment in many adjusting countries. A number of factors come into play in this area. Where existing structural distortions are large, timely and strong reforms are essential. In particular, evidence suggests that for structural reforms to have a significant impact on growth, a critical mass is important. Also, to overcome the wait-and-see attitudes of private investors, it is important that policy commitments are seen to be both credible and sustainable. In this context, firm, preannounced plans for structural reforms, which in many instances take time to implement, can help encourage an early investment response. Although price, exchange, and trade liberalization has been implemented relatively quickly and can have rapid effects on growth, other crucial reforms—such as the modernization of the financial sector and restructuring of public enterprises—often take longer and need to be resolutely pursued for the desired efficiency gains to be realized. All of these measures call for a strong, credible, and sustained reform effort, which, in turn, takes political leadership and consultation: the public must be supportive of the thrust of reform.
Third, policymakers must work to strengthen policy institutions and overcome administrative constraints, so as to improve the ability to design and implement policies. In this regard, efforts must continue to focus on making effective use of the technical assistance provided by international financial institutions and other organizations. Progress in this area will also help improve the domestic ownership of policies. The transparency of operations of key institutions is also essential, so as to provide a clear set of rules by which the private sector can guide its decisions.
Fourth, more attention must be given to promoting efficient trade and diversification through maintaining an adequate level of competitiveness and strengthening the human capital and physical infrastructure. Such measures would place countries in a stronger position to respond to the challenges and opportunities presented by the completion of the Uruguay Round and reduce their vulnerability to the terms of trade. The process of economic diversification, however, takes time, and in the short term a level of reserves and external support sufficient to smooth the income losses stemming from temporary adverse movements in the terms of trade is important.
Fifth, external debt is an important factor in the equation for growth. By the mid-1980s, many low-income countries had high and often rising debt and debt-service ratios. If policies aimed at stronger growth are to yield durable gains, output growth must be based on sustainable financing inflows. Yet for many countries, the need to reduce large external borrowing requirements, as well as to meet obligations on a large debt stock, implies a significant reduction in the share of income that could be channeled into domestic absorption. They have been long in coming, but we are now on the verge of having in place mechanisms that, if implemented with sufficient flexibility, should bring the burden associated with the stock of debt to manageable levels. As these mechanisms are implemented, attention must shift from the debt “crisis” to the need for governments to adopt sound debt-management policies so as to maximize the development value of external borrowing. Such policies, together with firm and sustained domestic adjustment and reforms, are important for preventing the re-emergence of debt-servicing problems. Policies that can attract non-debt-creating flows are also important complements to prudent debt management. In addition, official financial support—on as concessional terms as possible—needs to be maintained to finance the enormous development requirements of these countries.
The implementation of adjustment and structural reform programs has, in certain cases, had a favorable impact on savings, investment, and economic growth. In other cases, however, the results have fallen short of program expectations. In reviewing these cases, it is necessary to note that international institutions cannot or indeed should not substitute for governments’ responsibilities to their people. For sustained economic growth in developing countries to materialize, governments must pursue this objective relentlessly and demonstrate their commitment to it continuously. Certain habits in the area of economic management and, more broadly, management of the public good must be put in place.
The progressive transformation of attitudes, the modernization of social structures, the emergence of consensus in countries adopting democratic structures, and the reinforcement of institutions are important elements for economic growth—elements that are not addressed today in adjustment and reform programs. Accordingly, while these programs contribute to placing economies on the path of sustained growth, governments should pursue sufficiently decisive actions to accelerate the process of development essential for a determined reduction in poverty and for an appropriately broad distribution of the benefits of adjustment and reform. The responsibility of governments and the efficient management of public affairs need to be closely associated with the more traditional aspects of programs if these programs are to meet their potential in contributing to growth and the well-being of the population.
As a concluding point, it is important to remember that the opportunity to implement sound policies and reforms should be seized when it appears, even when it may involve compromises. Although the luxury of first-best policies—and we have seen that the list is long—is one for which we should aim, it is often, in practice, one for which we can ill afford to wait.
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