Growth-Oriented Adjustment Programs : Proceedings of a Symposium held in Washington, D.C., February 25-27, 1987

INTERNATIONAL MONETARY FUND

• Publisher: INTERNATIONAL MONETARY FUND
• Year: 1987
• eBook ISBN: 9781451970005

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Session 1 Bank-Fund Papers

World Bank Programs for Adjustment and Growth

Constantine Michalopoulos: Director, Economic Policy Analysis and Coordination
Economics and Reasearch Staff
World Bank

The experience of developing countries in the last decade has helped dramatize the importance of macroeconomic policies for sustaining economic growth and adjusting successfully to unfavorable external shocks. The external shocks of the period showed up the structural weaknesses and the limited flexibility in many developing countries’ economies—factors that frequently stemmed from their own economic policies.

Developing countries have responded with significant changes in their economic policies in the last few years. Nevertheless, in 1987, developing countries as a group clearly have not recaptured the growth momentum required to restore the per capita consumption levels of the early 1980s. Some, through the pursuit of effective policies, have by and large avoided the crises of recent years. A few, after sustaining significant declines in income and output, have been able to restore their growth momentum. In far too many others, however, the adjustment process remains incomplete. Moreover, a great deal of the adjustment that has taken place has involved severe compression of investment and imports with detrimental consequences for future growth.

In the aftermath of the Seoul meetings of the World Bank and the International Monetary Fund in October 1985, an international consensus has evolved that restoration of growth in the developing countries requires the concerted efforts of these countries, international institutions (especially the World Bank and the Fund), bilateral donors, and commercial banks. In particular, it has been recognized that the World Bank and the Fund should play a coordinated role in helping developing countries develop policy packages to restore growth and creditworthiness (Development Committee (1986a)).

This paper attempts to answer three questions. First, what should be the main focus and content of domestic policy reform designed to promote sustainable growth in developing countries? Second, what are the implications of past experience with designing policies for adjustment and growth for future Bank programs in support of policy reform efforts in developing countries? Third, what kind of financial packages are suitable to support adjustment with growth in different country settings and what are the issues the Bank faces in putting together such packages?

In attempting to answer these questions, the paper explores the analytical underpinnings of, and developing country experience with, policy reforms aimed at adjustment and growth. It emphasizes a few policies recognizing that the details of policy prescriptions must be adapted to specific country circumstances. Next, the paper examines the experience of recent World Bank programs supporting policy reform in member countries. The lessons of this experience and the issues raised can also be helpful for designing new programs, which is the focus of this paper. But the limitations of this experience should be also recognized at the outset. The available evidence is far less comprehensive than comparable evidence on the project side. Moreover, many of these programs were introduced during periods of massive internal and external disequilibria, which in turn affected both the emphasis and the effectiveness of programs.

The last section of the paper presents conclusions and implications of the analysis for future World Bank programs. An effort is also made to identify areas where the understanding of the effects of policies is incomplete and additional analysis and research are needed.

The scope of the analysis is limited in that it does not address, except in passing, such critical issues for developing countries’ growth and adjustment as developments in the international economic environment and in industrial countries’ policies that affect the prospects of developing countries, the prospects for commercial bank lending and other private capital flows, the flow of official financing, nor issues of debt restructuring. The paper also does not address issues of Bank program implementation, such as the aspects of conditionality, disbursement, monitoring, and donor coordination on which program effectiveness depends. It would have been impossible to do justice to these important issues within the confines of a single paper.

The Problem of Adjustment with Growth

Structural change is the essence of development. Adjustment to changing domestic and international circumstances is a continuous challenge to all countries. At present the international community’s attention and the focus of this paper are directed on the acute problems of adjustment and growth facing two specific sets of developing countries—a group of highly indebted middle-income countries with debt-servicing difficulties and the countries of sub-Saharan Africa.¹ In the former, annual gross domestic product (GDP) growth in 1981-86 averaged 0.6 percent (but -0.5 percent if Brazil is excluded). In the latter, growth over the same period was -0.4 percent. Output per capita fell over this period for both sets of countries.

The level of development, the institutional and political framework, and the constraints on structural change and growth vary from country to country. But there are some important similarities.

First, a number of countries in both groups have macroeconomic imbalances resulting in a high rate of open or suppressed inflation and unsustainable rates of domestic absorption. Macroeconomic stabilization is needed in these countries in order to restore the basis for future growth.

Second, debt burdens are heavy in both sets of countries. Servicing this debt absorbs a significant amount of domestic savings. Restoration of growth requires action to raise the productivity of existing and new capital and to increase the investment rate from current levels.

Productivity, however, is often impaired by distorted factor and market prices by inefficient public sector enterprises and by a structure of incentives that has helped create inward-looking uncompetitive industries. To finance higher investment, it is necessary to raise domestic savings. But there are serious constraints on how much savings can increase. Marginal savings rates must exceed 50 percent or more in some highly indebted middle-income countries for long periods in order to service debt, make up for lower external financing, and provide a margin for additional investment. It is difficult to raise marginal savings rates, however, if per capita consumption has been stagnant or declining as it has for some time, especially in sub-Saharan Africa (Development Committee (1986a)).

Third, restoration of growth also requires a rapid expansion of exports in order to be able to transform domestic savings into the payments in foreign exchange. Additional foreign exchange earnings are needed to service their large external debt obligations—as well as to finance the higher volume of imports typically associated with increases in investment. This in turn requires a change in the composition of output in favor of trade. Such a structural shift is especially difficult in sub-Saharan African countries, which have relatively inflexible and undiversified economic structures. Moreover, the size of the structural change required has been magnified and the problems of adjustment exacerbated by a significant deterioration in the terms of trade of most primary commodity exporters.

Fourth, additional financing from abroad can help restore growth and ease the domestic savings constraint. In middle-income countries, additional foreign borrowing, if utilized efficiently, can stimulate output and domestic savings. Provided domestic savings grow faster than investment (and depending on the productivity of investment and other factors such as the level of international interest rates), net borrowing and the ratio of debt to gross national product (GNP) can decline over time, and these countries’ capacity to service existing debt and maintain the momentum of growth can be restored.² But at present, new private capital inflows, on which these countries have traditionally depended for their finance, are severely limited (World Bank (1987)).

Additional capital flows to the low-income countries of sub-Saharan Africa need to be on concessional terms. Given the level of domestic savings, the existing debt burden and the productivity of the current capital stock and future investment, additional debt on commercial terms could not be serviced even if it were forthcoming, which it is not. But there are limits to the availability of new capital inflows on concessional terms, that is, Official Development Assistance (ODA), which ultimately must be obtained from developed country donors that also face budgetary constraints (Development Committee (1986b)).

Finally, implementation of macroeconomic stabilization and structural change can generate transitional costs in the form of unemployment. For example, a change in the structure of incentives is needed in order to promote a reallocation of resources more conducive to long-term growth. Productive resources are not redistributed instantaneously among alternative uses in response to changes in relative commodity and factor prices, however, and thus some temporary unemployment could result.

In addition to these general problems of structural change and growth, sub-Saharan Africa faces other long-term growth constraints. These include weak physical and human infrastructure, inadequate institutions, a rapid rate of population growth, and, until recently, severe drought that adversely affected agriculture, the mainstay of these countries’ economies (World Bank (1986c)).

Adjustment would be facilitated by a supportive international environment, which in turn depends critically on actions by industrial countries (Development Committee (1986a)). Regardless of the environment, however, promoting structural change and restoring growth necessarily entails further policy reforms by the developing countries themselves. In summary, these reforms should aim to restore or maintain macroeconomic stability, raise overall efficiency and factor productivity in their economies, raise savings relative to consumption, and restructure production in favor of tradables.

Analytical Framework of Promoting Adjustment With Growth³

Given these domestic policy objectives, what can economic theory and past experience tell us about the kinds of policies that developing countries should pursue? This section provides a summary review of experience on some of the key policy issues affecting structural adjustment and growth.

Stabilization and Adjustment

Experience suggests that the presence in any country of prolonged and significant aggregate imbalances—in the sense that the aggregate demand for resources exceeds the amounts of resources available internally or obtainable from abroad on appropriate terms—is inimical to longer-term growth. Such imbalances cannot be sustained indefinitely, and the longer the imbalances persist, the greater the subsequent adjustment needed and the likely adverse impact of stabilization on short-term output.

Macroeconomic imbalances usually manifest themselves in high and unpredictable inflation and periodic balance of payments crises. Significant inflation (open or repressed) is itself a source of resource misallocation and an impediment to growth⁴ (Fischer (1986), Yeager (1981)). Inflation is inimical to raising the savings rate and to channeling savings to productive investment. Uncertainty about future inflation rates leads to concentration of financial transactions in instruments with short- rather than long-term maturities, thus reducing the availability of funds for long-term investment. High inflation does not affect all prices and costs uniformly. At the same time, it makes relative prices volatile and reduces their information content for purposes of resource allocation. Finally, countries with high inflation frequently introduce interest rate and price controls. Interest rate controls result in negative real rates, which in turn lead to credit rationing, distort investment decisions, and reduce the size of the formal financial system. Price controls, on the other hand, encourage the development of black market profiteering and rent seeking while discouraging productive activities.

Periodic balance of payments crises result in cycles of expansion and contraction of economic activity that constrict investment and long-term economic growth. As part of the stabilization effort, absorption must be reduced to a level compatible with the level of output plus the sustainable current account deficit. Monetary, fiscal, and exchange rate policies are the main instruments of a stabilization program. Fiscal and monetary policy have mainly absorption-reducing effects while exchange rate policy has primarily expenditure-switching effects.⁵ The reduction in absorption needed to reduce inflation and to achieve a sustainable current account deficit will usually be accompanied by a reduction in the rate of growth of output. Indeed, a short-run slowdown in output growth is almost a prerequisite for successful stabilization because the success of stabilization depends on applying contractionary pressure to the economy as a whole. The slowdown in the economy will be less pronounced the greater the downward flexibility of product prices and wages and the greater the availability of external finance requiring less recourse to demand management policies.

The key issue for adjustment and growth is to find the combination of the three macroeconomic policy instruments that will, for any given level of external finance, attain stabilization objectives while also being the most supportive of future structural adjustment and the least disruptive to growth. In general, it might be more advantageous if a balanced approach is used and the burden of promoting overall adjustment is not placed on any single policy instrument. Naturally, if the overall macroeconomic imbalance can be traced to a particular cause, action to address that cause should be an important part of any stabilization package.

In recent periods, excessive absorption and inflation in developing countries have often been linked to large government budget deficits.⁶ Action in reducing such deficits is usually a prerequisite to stabilization. How these deficits are reduced has a bearing on growth and adjustment. If the burden falls primarily on physical and social infrastructure or essential maintenance activities, future gr...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Contents
• Preface
• Opening Remarks
• Barber Conable
• Michel Camdessus
• Session 1: Bank-Fund Papers
• Session 2: Country Study
• Session 3: Macroeconomic Policies for Economic Growth
• Session 4: Outward Versus Inward Policies
• Session 5: Structural Policies
• Session 6: External Financing
• Round Table Discussion
• Address
• Appendix
• Footnotes