A W 0 R L D B A N K B 0 0 K( Boom, CrisiIS, laMan andAdjustment The Macroeconomic Experience of Developing Countries I. M. D. L ITT L E * R I C H A R D N. C OO E R W . M A X C O R D E N * S A R ATH R AJ A PAT I R A N A A W O R L D B A N K B O O K Boom, Crisis, and Adjustment The Macroeconomic Experience of Developing Countries The World Bank Comparative Macroeconomic Studies series includes country studies that were used in the preparation of this synthesis volume. Studies now published or forthcoming from the World Bank cover Brazil, Colombia, Costa Rica, C6te d'lvoire, India, Indonesia, Sri Lanka, Thailand, and Turkey. For information on these books and related studies, contact the Office of the Pub- lisher, The World Bank, 1818 H Street, N.W., Washington, D.C. 20433, U.S.A. Boom, Crisis, and Adjustment The Macroeconomic Experience of Developing Countries I. M. D. LITTLE RICHARD N. COOPER W. MAX CORDEN SARATH RAJAPATIRANA Publishedfor the World Bank OXFORD UNIVERSITY PRESS Oxford University Press OXFORD NEW YORK TORONTO DELHI BOMBAY CALCUTTA MADRAS KARACHI KUALA LUMPUR SINGAPORE HONG KONG TOKYO NAIROBI DAR ES SALAAM CAPE TOWN MELBOURNE AUCKLAND and associated companies in BERLIN IBADAN ( 1993 The International Bank for Reconstruction and Development I the world bank 1818 H Street, N.W Washington, D.C. 20433, U.S.A. Published by Oxford University Press. 200 Madison Avenue, New York, N.Y. 1001 6 Oxford is a registered trademark of Oxford University Press. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior permission of Oxford University Press. Manufactured in the United States of America First printing December 1993 Third printing May 1996 The findings, interpretations, and conclusions expressed in this study are entirely those of the authors and should not be attributed in any manner to the World Bank, to its affiliated organizations, or to members of its Board of Executive Directors or the countries they represent. Library of Congress Cataloging-in-Publication Data Boom, crisis, and adjustment : the macroeonomic experience of developing countries / Ian M.D. Little ... [et al.]. p. cm. Includes bibliographical references and index. ISBN 0-19-520891-9 I. Structural adjustment (Economic policy)-Developing countries- Case studies. 2. Economic stabilization-Developing countries- Case studies. 3. Developing coucnries-Economic policy-Case studies. I. Little, lan M.D. HC59.7.B576 1994 339.5'09172'4-dc20 93-27208 CIP Contents Preface ir 1. Introduction 2. A Brief Survey of the World Economy 8 Institutional Developments 9 Structural Changes in the World Economy 12 Major Economic Events /6 The Intellectual Climate 25 3. The Period of Cheap and Easy Credit: 1973-1979 29 Optimal Policy Reactions to Exogenous Changes 31 The Policy Responses of the Countries Adversely Affected by the 1974 Terms-of-Trade Shock 34 Three Gainers from the 1974 Terms-of-Trade Shock: Indonesia. Nigeria, Morocco 38 The Coffee Boonm 40 The Investmient Booms in Sixteen Countries. 1974-81 42 The Uses of Borrowing 49 Summing Up the Period 1973-79 51 Appendix 3A 54 4. Heading for Crisis: 1979-1982 74 The Situation in 1979 7,4 The 1979-81 Shock-s 76 The Policy Reaction 82 Indonesia Compared with Mcxico and Nigeria 93 The Nature of the Crisis and Its Causes 96 vi Boom, Crisis, and Adjusimeat 5. A Slow Recovery for Most: 1983-1989 103 Conditions in the Early 1980s 105 The Record of the 1980s 107 The Policies of the 1980s 118 The Heightened Importance of Official Lending 123 Economic Circumstances at the End of the Decade 125 A Postscript on the Early 1990s 127 Appendix 5A 128 Appendix 5B 147 6. Inflation in the Eighteen Countries 150 Historical Overview 150 Adjustment Inflation, Spiral Inflation, and Monetization: A Framework of Analysis 154 Inflation and the Current Account: The Tradeoff Model 159 Inflation, 1973-78: Bubbles and Adjustment 160 Ten Low-inflation Countries, 1979-89: Bubbles and Stabilization 163 Three Moderate Inflation Countries, 1979-89 168 Conclusion 171 7. Stories of High Inflation and Stabilization 174 Brazil: High and Variable Inflation, 196089 174 Argentina 185 Chile 192 Mexico 195 Turkey 202 Indonesia: Inflation and Stabilization, 1961-70 205 The Sources of Inflation in Six Countries: Summary 209 Stabilization Experiences of Six Countries: Summarv 210 Four Stabilization Issues 211 8. Exchange Rate Policy: Devaluations and Regime Changes 219 Historical Overview 220 Effects of Devaluations 228 Exchange Rate Regimes 240 Appendix 8A: Meaning and Measurement of the Real Exchange Rate 258 9. Trade Policies: Tightening and Liberalization 264 Historical Overview 265 Trade and Exchange Rate Policy 273 The Etfects of Trade Policy Episodes 274 Effects on Current Accounts 275 Conlenil vii Effects on Fiscal Balances 278 Import Starvation": Effects on Imports and Outputs 280 Six Country Stories 283 Conclusion 289 Postscript 291 Appendix 292 10. Fiscal and Monetary Policies 298 The Central Govemment Budget 299 Trends in Govemment Revenue 305 Financing 305 State-Owned Enterprises 311 State and Local Government 316 Financing: Debt and Seigniorage 317 Seigniorage 321 Fiscal Policy and Stabilization 324 Monetary Structure and Policy 327 The Demand for Money 328 Interest Rate Policy 332 Role of the Central Bank 335 Summary 342 11. Macroeconomic Management and Long-Run Growth 344 Growth, 1970-89 346 Some Growth Regressions 348 A Comparison of Shorter Periods 350 Crises and Investment 351 Investment Efficiency 353 Macroeconomic Policy and Savings 358 Summary and Conclusions 359 12. The Political Economy of Stabilization and Adjustment 360 Form of Govemment 362 Tradition, Convictions, and Institutions 374 Interest Groups and Extemal Actors 381 Summary 391 13. Conclusion: The Lessons of Experience 394 Boom, Crisis. Adjustment 395 The Crucial Role of Fiscal Control 398 Inflation, Exchange Rates, and Trade Policies 399 Macroeconomic Policy and Growth 401 Political Economy: Any Lessons'? 402 viii Boom, Crisis, and Adjustment Policy Advice 403 Caution 404 Annex 1: Country Studies 405 Annex II: Tables 409 Notes 415 References 433 Index of Subjects 447 Index of Names 453 Preface This volume is one outcome of a research project initiated and financed by the World Bank in 1986, entitled, "Macroeconomic Policies, Crisis, and Growth in the Long Run." The aim of the project was to look in depth at the macroeconomic ex- periences of many developing countries in Africa, Asia, and Latin America. to compare their reactions to the crises they faced in the seventies and eighties, and to consider, among other things, the implications for long-run growth. The empha- sis was comparative and reflected a search for policy issues. In the end, the project explored the macroeconomic histories of eighteen countries from the late sixties to the end of the eighties. Studies of the experiences of seventeen countries were commissioned. This volume has drawn not only on these studies but on many oth- er books and articles and on World Bank and International Monetary Fund data sources. We refer to these in the text and in footnotes. The project, directed by Sarath Rajapatirana of the World Bank staff and an author of this book, faced as its greatest challenge the problem of presenting pri- mary data as consistently as possible. A research project like this does not just take figures from one source blindly but compares different sources and takes note of the statistical situation in different countries. Thus, it is really an education in cau- tion, in not making judgments based on small changes in figures, and in not being misled by neat tables and regressions-let alone by sophisticated techniques rest- ing on the basis of very shaky primary data. In general we have used World Bank and International Monetary Fund figures for our comparative work and our main tables, but these do not always tell precisely the same story as data used by our country authors, or other sources, coming from national sources. If we had another five years we could reconcile all these figures, and we could also detemline more precisely which figures rest on very shaky primary sources and which have firmer bases. Here it can only be noted that for some countries the statistical base is quite tenuous. Nigeria is a clear example. and not the only one. The reader should bear this in mind all the time. ax X Borm. Crisis, and Adjustmnent We are indebted to many people, starting with the authors listed in appendix 1. and the many other authors to whom we refer. Anne Krueger. former vice pres- ident for economics at the World Bank, and Deepak Lal. then research adviser, both played major roles in the initiation of the project. This is also true of the fol- lowing advisers for the project, who made important contributions to the develop- ment of the country studies at several conferences: Mario Blejer, Guillermo Calvo, Domingo Cavallo. Vittorio Corbo, Dennis de Tray, Juergen Donges, Bo Karl- strom, Allan Meltzer. and Laurence Whitehead. We also wish to acknowledge the great help of Jariya Charoenwattana, Jennifer Gordon, V. Hugo Juan-Ramon, Miguel Kiguel, Margaret Kienzle, Michael Lewin, Flora Paoli, Pedro Videla, Che- rian Samuel, and Debbie Wetzel. Anita Bhatia's role as the project's coordinator, followed by Charles Dade, was invaluable. This book is a joint effort of all four authors, but the primary authorship was divided up as follows: Ian Little drafted chapters 3, 4, 5, and 11. Max Corden drafted chapters 6, 7, and 8, Richard Cooper drafted chapters 2. 10. and 12, and Sarath Rajapatirana drafted chapter 9. Chapter 13 was jointly drafted. Although the World Bank sponsored this project, it is in no way responsible for its contents. The views expressed should not be regarded as the views of the Bank nor should statistics that are cited be regarded as Bank-endorsed. Chapter 1 Introduction Until the ]970s, research on developing countries was mainly concerned with longer-run structural issues. With the harsh economic shocks of the early 1980s and the ensuing debt crises in countries throughout the world, attention turned increasingly to macroeconomic policy and its relation to growth. Growth rates declined in many developing countries in the 1980s because of these macroeco- nomic problems and-some have argued-because of the adjustment policies that were subsequently followed. This book is a product of that mounting inter- est in the macroeconomic policies of developing countries. There is now a large body of literature on this subject, particularly on the implications of accumulated debt and on the impact of the "orthodox" economic policies that have been followed. This literature has dealt primarily with a small number of Latin American countries-notably Argentina, Brazil, and Chile- and one of its principal objectives has been to compare attempts at stabilizing inflation, both the successes and the failures. To that extent, it has been some- what unbalanced. In an effort to remedy the situation, this book brings a consid- erably broader perspective to this area of research. It covers eighteen developing countries in four continents, and inflation is but one of the many issues discussed. Our central purpose here is to review the macroeconomic experiences of these eighteen countries over the years 1974 to 1989. Three distinct periods emerge within this time frame: (a) 1974-79, which covers the time from the first oil shock to the second, when the ease of borrowing on the world capital market led to spending booms in many countries; (b) 1980-83, which was the period of crisis. and (c) 1983-89, the subsequent period of adjustment and, in many cases, growth recovery. At times, we go back further, as far as 1965, to get the proper perspective. and at other times, for countries where there have been important changes, we carry the story forward as far as 1992. We are particularly interested in policy reactions to external shocks and in stabilization or destabilization poli- cies, along with their implications for growth over the longer term. Our aim has 2 Boom. Crisis, and Adjustnent been not only to compare the experiences and reactions of these countries. but also to understand why they have differed. To determine why some countries suffered bigger shocks than others, and why some reacted differently to similar shocks, we investigated whether the shocks were external or internal in origin; what roles fiscal, monetary, exchange rate, and trade policies played: what degree of inflation occurred and why; and what effects macroeconomic policies had on growth. This exercise has yielded some vital lessons for future policies. Much of this book may be regarded as story telling informed by theory. Its conclusions were arrived at by thoroughly pragmatic or eclectic procedures. Giv- en the limited availability and quality of the data, we were unable to estimiate a completely specific dynamic model to deal with the episodes and problems that are the subject of this book. We have taken note of a large body of cross-country econometric research concerning the impact of nmacroeconomic policies or outcomes (inflation, real ex- change instability, investment, for example) on growth, the relationship between exchange rates and the trade balance or exports, and so on. Usually such research is based on data drawn from many more countries than the eighteen studied here. We have also engaged in cross-country econometric research ourselves (reported mainly in chapters 5 and 11), often with uncertain results. The problem with such work is that many of the numerous factors that may affect the dependent variable are themselves both interrelated and difficult to measure. The so-called indepen- dent variables are seldom really independent. Even though multicountry regres- sion analysis often produces equivocal results, it is a natural conmplenient to the' kind of country-intensive work reported here. Intensive studies of many country experiences and of many particular epi- sodes of the kind presented in this volume are particularly valuable because they can generate ideas and suggest cause-and-effect relationships between both eco- nomic and political variables that were previously unrecognized or underempha- sized. This in turn may not only influence theorizing and model-building but also have a more immediate and beneficial impact on policy formation. Any such con- tribution may, of course, extend to countries other than those studied. Past mac- roeconomic theory has been inspired by the experiences of very few countries- primarily Great Britain and the United States and a few developing countries in Latin America. We hope to widen the group of countries whose experiences influence generalizations, theorizing, and hypothesis testing in the field of macroeconomics.1 Table 1-1 gives some information about our group of countries. In terms of gross domestic products and populations, the group provides a large representa- tive sample of the total developing world. It includes the five largest developing economies other than China, namely, Brazil. India. the Republic of Korea, Mexi- co, and Indonesia. Five others-Turkey, Argentina, Thailand, Colombia, and Pa- kistan-can also be described as large, for in 1989 their gross national products (GNPs) measured US$35 billion or more.2 We chose only countries that were Table 1.1 Basic Data on Eighteen Countries, 1965-90 GNP per capita Average Average annual GDP, Population annual growth inflation rate, External debt Debts /990 mid-1989 1990 rate, 1965-90 1980-90 as % of GNP, rescheduled Country (mrillions US$) (millions) (US$) (%) (%) 1990 1982-88 Argentina 93,260 32.3 2,370 -0.3 395.2 61.7 * Brazil 414,060 150.4 2,680 3.3 284.3 22.8 * Cameroon 11,130 11.7 960 3.0 5.6 56.8 Chile 27,790 13.2 1,940 0.4 20.5 73.6 * Colombia 41,120 32.3 1,260 2.3 24.8 44.3 Costa Rica 5,700 2.8 1,900 1.4 23.5 69.2 * C6te d'lvoirc 7,610 11.9 750 0.5 2.3 203.9 * India 254,540 849.5 350 1.9 7.9 25.0 Indonesia 107.290 178.2 570 4.5 8.4 66.4 Kenya 7.540 24.2 370 1.9 9.2 81.2 Korea, Rep. 236.400 42.8 5,400 7.1 5.1 14.4 Mexico 237,750 86.2 2,490 2.8 70.3 42.1 * Morocco 25.220 25.1 950 2.3 7.2 97.1 * Nigeria 34,760 115.5 290 0.1 17.7 117.9 * Pakistan 35,500 112.4 380 2.5 6.7 52.1 Sri Lanka 7,250 17.0 470 2.9 11.1 73.2 Thailand 80,170 55.8 1,420 4.4 3.4 32.6 Turkey 96,500 56.1 1,630 2.6 43.2 46.3 Note: The "technical notes in World Development Report 1992 explain the meaning and methods of calculation of the figures in the first five columns. The average annual inflation rate (column 5) is measured by the growth rate of the GDP implicit deflator, while other figures of inflation rates in this book refer to the growth rate of the cost-of-living index-but the two measures nonnally tell very similar stories. Extemal debt in column 6 refers to the total extemal debt stock, long- and short-tenn. For column 7. note that Cameroon's debt was rescheduled in 1989. Source: World Development Report /992 (for the first five columns). Column 6 is from the World Bank's World Debt Tables 1991-92, Volume 2. Column 7 comes from the Intemational Monetary Fund and chapter 4 of this volume. 4 Boom, Crisis, and Adjustment market economies at the time-that is, we excluded the ones that used to be de- scribed as "centrally planned." The group actually includes all the large develop- ing market economies other than Egypt, Iran, the Philippines, and Venezuela. It also includes Nigeria, which is by far the largest economy in sub-Saharan Africa, but steep depreciation of its currency reduced the value of its GDP to slightly less than $35 billion in 1990. In addition, we looked at some relatively small econo- mies: Chile, Morocco, Cameroon, Cote d'lvoire, Kenya. Sri Lanka, and Costa Rica. Chile has had some remarkable economic experiences that have been much analyzed, but the literature on the macroeconomics of the other smaller economies is sparse. In 1990 the dollar value of the GDP of all the countries combined was about 60 percent of the dollar value of the gross domestic products of all develop- ing market economies combined. As table I -I shows, the countries are certainly diverse-so the diversity of ex- periences we report should hardly be surprising. At one end of the spectrum, five countries have a population in excess of 100 million each, while at the other end, seven have a population of 25 million or less. Six of the group count as low-in- come countries and twelve as middle-income countries, but the low-income coun- tries include all those with a large population, apart from Brazil: namely, India, Indonesia, Nigeria, and Pakistan. Countries with high per capita growth rates over the period 1965-90 (3 percent or more) are Korea, Indonesia, Thailand, Brazil, and Cameroon (in that order). In contrast, Argentina, Nigeria, and Chile had near- zero average growth over that period. The top performers between 1980 and 1990 were Korea, Thailand, Indonesia, India. and Pakistan, while C6te d'lvoire, Nige- ria, Argentina, Mexico, and Cameroon were at the bottom, with negative per cap- ita growth rates (see table 5-2). The great dispersion in per capita growth rates and the outstanding performance of Korea are certainly striking. The countries are also diverse in other respects. Three (Indonesia, Nigeria, Mexico) are big oil exporters, and their stories have been much affected by this fact, whereas all the rest-except Colombia and Cameroon (both also oil export- ers) and Argentina (close to self-sufficient)-are oil importers. Four have experi- enced high inflation in recent years, with annual average inflation rates of 40 percent or more in 1980-90; at the other end, nine averaged inflation rates of 10 percent or less. Eight of the countries had to reschedule their international debt in the period 1983-88 and were described by the International Monetary Fund as "countries with recent debt-servicing difficulties." This troubled group-consist- ing of Argentina, Brazil, Chile, Costa Rica, C6te d'lvoire, Mexico. Morocco, and Nigeria-receives much attention in this book, as it has in both popular and aca- demic discussion. Some of the other ten countries had quite high debt ratios but, as will be shown, their economic performance on the whole turned out to be much more favorable. In general, the theory underlying this book is quite standard and also eclectic, with no particular commitment to Keynesianism, monetarism, or rational expec- tations. We certainly do not find support for extreme versions of any of these schools of thought. The theory of macroeconomic policy for developing countries Introdu( tion 5 would require a completely separate book, although it would certainly benefit from the kind of material presented in this volume. Here, we draw on bits of theory wherever necessary and expound it briefly where appropriate. or sometimes we take it as known when it is straightforward textbook theory. The textbook theory of internal and external balance-especially its "'depen- dent economy" version-provides the most useful framework for the discussion of adjustment problems in chapters 4 and 5. It shows that usually the current ac- count of the balance of payments can only be improved through a reduction in do- mestic expenditure (absorption)-combined with policies that "switch" demand away from tradables toward nontradables, and supply from nontradables to trad- ables, if an unnecessary fall in total output is to be avoided. Without such "switch- ing," the reduction in domestic demand required to improve the current account would result in excess supply and unemployment in the nontradable sectors of the economy.3 Chapter 2 reviews world economic developments over the study period, pro- viding background for the stories that follow. Chapters 3, 4, and 5 then move ahead with a detailed historical account of the macroeconomic experiences and policies of the eighteen countries, with a heavy emphasis on comparisons. Above all, it is essential to "get the story straight" before attempting to arrive at any gen- eral conclusions. Although there is some similarity in the external shocks, more striking is the diversity of policy reactions and of the various domestic factors with which external shocks interacted. Chapter 3 deals with the period after the first oil shock and before the crises of the early 1980s; the story here is one of funds flowing readily from the world capital market and many countries borrowing heavily. As a consequence, their economies boomed, but the foundations were also laid for the later debt crisis. Chapter 4 tells of the crisis of the early 1980s-actually many different crises, and many different policy reactions. Chapter 5 covers the adjustment period between 1983 and 1989, sometimes going into 1990, a period in which some countries launched major structural adjustment programs involving trade and other liberal- ization measures, and the growth rates recovered in some cases. At the same time. many struggled to cope with the debt problem they inherited from the earlier two periods, and two (Argentina and Brazil) went through episodes of very high (and briefly even hyper-) inflation. Drastic shifts in resource transfers took place at this time owing to higher interest payments and reduced current account deficits-in some cases inward transfers were reduced, and in others they shifted outward. We compare this and the previous period and try to relate the extent of the shifts in resource transfers to various economic outcomes. In chapters 6 to 10. we deal with critical issues that span the entire study pe- riod, sometimes going back to well before 1973: inflation and inflation stabiliza- tion, exchange rate policy, fiscal and monetary policies, trade restrictions. and liberalization. Chapter 6 looks at thirteen countries in which inflation rates have generally been low or moderate. Almost all had inflation "bubbles" in the two pe- riods 1973-75 and 1980-82. A distinction is made between adjustment inflation, 6 Boom. Crisis, and Adjustneni spiral inflation, and inflation resulting from the monetization of fiscal deficits. Ad- justment inflation is essentially temporary and results from relative price adjust- ments necessitated by various shocks, for example. an improvenment or deterioration in the terms of trade; spiral inflation refers to the continuous process wherein wage increases follow a devaluation and set in motion further devalua- tion, and so on; and the last category refers to cases in which inflation results from an inadequate fiscal policy. Of course, continued monetization is also necessary to sustain spiral inflation. Chapter 7 recounts the high-inflation experiences and the stabilization policies-sometimes successful, sometinmes not-of five countries, including Argentina, Brazil, and Mexico, the three largest debtors of the 1 980s. It also describes the high inflation and stabilization episode of Indonesia during 1961-70. Chapter 8 takes up the complex exchange rate policies and chianges in exchange rate regimes of all the countries over the whole period. Of particular in- terest is the effect of various regimes on inflation. In chapter 9 we survey the changes in trade regimes over the study period, noting the importance of variations in quantitative import restrictions as policy re- sponses to balance of payments problems. We also draw attention to the important episodes of trade liberalization and explore the relationship between trade policy and exchange rate policy. In chapter 10 we turn to fiscal policy, and what is largely an adjunct of fiscal policy, monetary policy. We point out that fiscal policy in de- veloping countries, in contrast to that in developing countries, has rarely helped to stabilize output and sometimes has been a significant destabilizing factor. Further- more, we show that state-owned enterprises, and occasionally provincial govern- ments, have had a large hand in their countries' fiscal problems, and that many states have relied on seigniorage as a source of revenues, sometimes for the gov- ernment's budget and sometimes off the budget. Some policy conclusions are pre- sented in these five chapters, although they are drawn together in chapter 13. Chapter II is concerned with the effects of macroeconomic policy on long- run growth. The many factors that affect long-run growth-some of which have their roots in history and sociocultural as well as political conditions-operate mainly, if not wholly, through material investment and its productivity. or througlh changes in the quality of the labor force. Our work was not concerned with the de- terminants of the latter, or with research and development. The chapter is thus lim- ited to investigating the effects of macroeconomic policy on the ratio of gross investment (as normally defined to exclude investment in human beings) to GNP and the efficiency of investment. Instability appears to be one element accountino for the huge differences from country to country in the relationship of investment to growth: it affects the quality of investment, as well as the level of investment in relation to GNP. Of the doubtless many other influences on the quality of invest- ment, the manner in which public investment choices are made receives particular attention. Chapter 12 asks why governments pursued particular policies; why they re- acted in different ways to often similar shocks: why some were more ready to monetize budget deficits and generate inflation, and to allow it to continue, than JfltrofjUr lion 1 7 others; why some reacted quickly and some slowly to crises. The subject hiere is political economy, and the questions examined are of the kind economists tend to bypass, or at least fail to treat systematically. At the time of writing, there is a growing awareness of the importance of this subject. It has become clear to us that these questions deserve a book of their own, and chapter 12 only makes a start. We distinguish between the influence of con- viction on policymakers' decisions-conviction shaped by historical experience. by ideology, by their training-and the influence of the ability to control-that is, to achieve the policies they wish to achieve. Success in this area of endeavor de- pends, among other things, on the strength of the government, the power of pres- sure groups, and institutional arrangements. Chapter 13 draws together the conclusions of the various chapters and sum- marizes the implications for policy that seem to emerge. It asks what lessons can be learned from this particular historical experience of boom, crisis, and adjust- ment in eighteen developing countries. The Rate of Devaluation: Two Definitions There are many references to devaluations, real or nominal. in this book. The rate of devaluation can be expressed in two ways. Suppose that the exchange rate of the Indonesian rupiah is changed from 702 per dollar to 970 per dollar. Hence, the dollar value of the rupiah has fallen from 0.00142 to 0.00103. An index would show a decline. and the proportionate fall is 27.5 percent. The first method defines this as the rate of devaluation. The advantage of this method is that it conforms with the idea that "devaluation" represents a fall in value. Note, however, that the rupiah value of a dollar has risen from 702 to 970, which represents an increase of 38.2 percent. The second method defines this increase as the rate of devaluation: "the" exchange rate is then the number of rupiahs per dollar. The advantage of the second method is that it indicates the extent of the domestic price effects of the devaluation, and thus the incentives for the switching of production and demand that are created by the devaluation. In this book we use the second methold. Chapter 2 A Brief Survey of the World Economy This chapter reviews trends in the world economy over the period 1965-90 that had an effect on stabilization and development in our eighteen countries-and in- deed in all developing countries. Two that stand out are the continued rapid growth of world trade during tihe period, especially exports of manufactured goods from developing countries, and the emergence in the early 1970s, as in the 1920s, of a world money and capital market to which many developing countries had ready access. Also important are the move from fixed to floating exchange rates, started in March 1973; two sharp increases (1974 and 1979-80) and one sharp fall (1986) in oil prices: dramatic movements in the prices of several other primary products, notably coffee and copper: a mild economic recession and two deep ones (1975 and 1982): a large appreciation of the U.S. dollar against other leading currencies, followed by an equally large fall (1985-86): and a debt crisis for many developing countries in the mid-I 980s when voluntary external lending virtually ceased. Broadly speaking, the 1960s and early 1970s brought outstanding economic growth and, until 1973, relative price stability. This pattern broke in the mid- 1970s with a commodity price boom, the first oil shock, and the deepest recession since the 1930s. Consolidation in the late 1970s was interrupted by a second oil shock, associated with a revolution in Iran. That episode, along with stringent efforts in several large industrial countries to control inflation, led to a second serious reces- sion in 1981-82. The combination of heavy borrowing through earlier difficulties, high interest rates, and recession produced the debt crisis of 1982-83. After a set- back in the late 1970s and early 1980s, growth in the industrialized countries re- sumed. For developing countries, however, the 1980s were years of adjustment, relative stagnation, and, for some, accelerating inflation (see table 2-I ). The chapter opens with a review of the institutional developments over the study period, that is, those connected with formal management of the world econ- omy. The dominant trends in international trade and finance and the major events of the period are discussed next. The concluding section provides a brief comment 8 A BrieJ Snrvey of the World Etconomy 9 Table 2.1 Growth and Inflation, 1965-90 (percent a year) 1965-73 1 973-80 1980-90 GDP growth Industrial countries 4.4 2.5 3.1 Developing countries 6.2 5.1 3.2 Per capita 3.7 3.0 1.2 Inflation Industrial countries GDP deflator 5.4 9.3 4*5 Exports (U.S. dollars) 5.6 12.0 2.6 Developing countries GDP deflator 9.7 24.9 61.8 Nonoil exports (U.S. dollars) 4.5 12.5 0.2 Source: Calculated fronm IMF Infernatrional Financial Statislics 1 990), and World Bank, WVorld Delel- opment Report, 1992. on the intellectual or philosophical climate of the day, which influenced both na- tional and international economic decisionmaking. Institutional Developments After the Second World War and the chastening experiences of the 1 930s, nations became intent on building a basic framework for economic relations among na- tions. The monetarv elements of this framework were largely embodied in the Bretton Woods Agreement, which laid down basic principles and established the International Monetary Fund (IMF) and the lnternational Bank for Reconstruction and Development (later called the World Bank). In their current account transac- tions, countries were to make their currencies convertible at fixed exchange rates (except for a 2 percent margin of fluctuation). The fixed rates could be adjusted, with international agreement, to correct a "fundamental disequilibrium" in inter- national payments. and controls could be imposed on capital movements. Coun- tries were to be free. within this framework, to pursue diverse economic and social objectives, and in particular to pursue policies to achieve full employment. The IMF was to oversee the rules and to lend funds to tide countries over temporary im- balances in payments or to ease their adjustment from disequilibrium to a position of payments equilibrium. The World Bank was to intermiediate between the pri- vate capital markets of the world and capital-short countries, since it was assumed, after the experience of the 1930s. that private lenders would be loath to lend abroad any time soon. 10 Boom. Crisis, and Adjusimnicn No country was obliged to agree to the Bretton Woods arrangements, but over the years most chose to do so. The exceptions were the Communist countries, for whom currency convertibility was fundamentally inconsistent with central plan- ning; and Switzerland, which remained cooperatively outside the arrangements until the early 1990s. when it decided to join. The principles governing trade among nations are embo(died in the General Agreement on Tariffs and Trade (GAYT). The foremost of these is the rule of non- discrimination among trading partners. The GATT also provided for the settlement of disputes, including in extremis controlled retaliation against offending practic- es, and committed nmembers to a gradual liberalization of trade from the highly re- strictive regime prevailing in 1947. Initially' only a few countries adhered to the GATT, but by 1990 about 100 of the 150 members of the I MF and World Bank had joined in. There were no analogous formal arrangements governing foreign investment. Trade in primary products was in principle covered by the GATT, but some felt from the beginning that an effort should be made to temper wide swings in the prices of priniary products. In the 1950s, countries made various attemipts at reach- ing international commodity agreements. but only the ones for tin (founded in 1956) and rubber (dating from 1979) endured with much content, and tin col- lapsed in 1986. The Bretton Woods system of fixed but adjustable exchange rates was even- tually undermined by two structural flaws. First, the system was directly or indi- rectly (through the U.S. dollar) based on gold, yet at a fixed nominal price, monetary gold supplies could not grow rapidly enough to support the unexpectedly rapid economic growth that took place in the I 950s and 1 960s. The deficiency was filled by the U.S. dollar; but as the ratio of foreign-held dollars to U.S. gold grew over time, the gold convertibility of the dollar became increasingly doubtful, giv- ing rise to the possibility of a run on the U.S. gold stock-and, more seriously, to a breakdown of what seemed to be a well-functioning set of international financial arrangements. To deal with this possible problem, countries in 1967 agreed to the creation of special drawing rights (SDRs) at the IMF. That is to say, a "paper gold" would be created from tinie to time to satistv the need of agrowino world econo- my for additional owned reserves that, unlike the (lollar, were not some country's national currency. Two allocations of SDRS took place, in 1970-72 and in 1979- 81. both for relatively modest amounts. This solution came too late to deal with the problem adequately, a run on U.S. gold did occur, and in August 1971 U.S. President Richard Nixon suspended indefinitely the gold convertibility of the U.S. dollar. Second. the Bretton Woods system relied on changes in fixed exchange rates to correct a fundamental disequilibrium. By the time authorities recognized that a disequilibrium was "fundamental," everyone else had come to see it as well. Peo- ple could speculate on the possibility of a step change in the exchange rate, and if they correctly guessed when a change would occur they could profit at the expense of the authorities, selling a currency before depreciation and buying it afterward. A Brief S.urvev of the World lE( conov 11 Effective controls on capital nmovements turned out to be crucial to making the system work. Through leads and lags in payments. it was possible to speculate even through trade transactions: in anv case. somIe important countries did not ac- cept the desirability of having controls on capital mlovenments (nor were thley re- quired by the rules, only permiitted). and did not have then. As world carpital nmark-ets revived, currency speculation became easy and extensive. In 1972-73 large movenments of funds from dollars into European currencies induced a nun- ber of countries to abandion fixed exchange rates. In Marchi 1973 floating exchange rates among major currencies became general. Developing countries then had to decide whether to float their currencies as wel,. and if not, where to peg their cur- rency. Their responses are discussed at length in chapter 8. In 1978 the IMF s Ar- ticles of Agreement were formally amended to abandon bothi the commnitmiient to gold and the conmnlitment to fixed exchange rates. The experience of the early I 970s suggested that policynmakers neede(d to do more continuous monitoring of world econonmic developments. In 1974 thle ImF established an "interinm commalittee' of twenty (liter twenty-two) finance nlilisters ton meet twvice annually with that objective in mind: 1975 saw the first of what sub- sequently became annual economic sunmnmit nieetin-s among five (later seven) heads of government of the major industrialized democracies. Not satisfied with general floating, eight European countries in 1979 create(d the European nmonetary systeml (EMS), which, like the Bretton Woods system, re- quired a declaration of "central" exchange rates but nmd(e the margins of variation around these central rates wider. Under the EMS, changes in central rates were fre- quent during the initial period, 1979-87. and ettorts were nmade to coordinaite the nonetary policies of members. The EMS currencies, which camse psychologically to center on the Germnan mark, floated against the U.S. (ollar, the Japanese yen, the British pound (until Britain joined the EMS in I 990)). and other currencies. At first, the U.S. dollar gradually appreciated against the EMS currencies, by about 75 percent between 19X() and the end of 1984. but by 1986 it had fallen back to the 1980 rate. This sharp nmovement anmong major exchange rates had a significant in- fluence on foreign trade flows, on comnilodity prices as conventionally measured (usually in dollars), and on the real value ot dollar-denominated externazl debt. nmuchi of which had been acquired1 by the early 1980s. By the mid-I1960s most of tthc industrialized countries had eliminaited tlicir ex- chanee controls on foreign trade.2 A round ot miultilateral trade neootiations. known as the Kennedy Round. concluded in 1967 with the industrialized countries reducing taritfs on manufactured goods by about one-third. over a period ot eighit years. Even before the conclusion of the Kennedy Round, developing countries, througlh the UN Conference on Trade and Development (UNCTAD) and o*lter fo- runs, pressed hard to have the G.AYV requiremilent tor nondiscrinminiation dropped. In its stead they wanted unreciprocated tariff reductions that would not be extend- ed to developed countries. Gradually this ideia caimle to be accepted. and( by the mid-1970s the European Community, Japan, the United States, and other devel- oped countries had exten(led duty-Iree treatmlent to many manufactured goo(ds and 12 Boom. Crism. and Adfl dtmolre processed foodstuft's coming from developing countries, under the generalized systern of preferences (GsP). This erosion of a fundamental GATr principle came at a price, however. First. the European Community and the United States stiff- ened considerably their "safeguards" against import disruption. Second, textiles were excluded from GSP treatment and, moreover, the special arrangements gov- erning trade in cotton textiles were extended in 1974 to cover woolen and man- made textiles under the Multifiber Arrangement, designed to restrain the rate of growth of exports of textiles and (mainly) apparel from developing countries. At the Tokyo Round of multilateral trade negotiations from 1973 to 1979. par- ticipants again agreed to reduce tariffs on manufactured goods by about one-third over a period of eight years and to tighten the rules of GAYT somewhat and extend its reach. Thus between 1968 and 1987 there was a steady reduction in tariffs and other barriers to imports into the major industrialized countries. This liberalization enabled developing countries to expand their nonagricultural exports, as many of them did. Import liberalization in developing countries, in contrast, was much more spotty and limited, until the mid- I 9X0s some countries even increased their restrictions on imports. as discussed in chapter 9, partly in response to the eco- nomic shocks they were experiencing. The Uruguay Round of multilateral trade negotiations was launched in 1986 with the explicit objective of extending the reach of GATT into international trade in services and some aspects of foreign investment. By the end of 1992 this round was still in session because of disagreements over trade in agricultural products, which had not been resolved in previous rounds either, and over the protection of patents and trademarks. The European Community and Japan especially lined up against the liberalization of agricultural imports, while Brazil, India, and a number of other developing countries, joinedi on a few issues by Canada, resisted strong protection for patents and trademarks. International agreements were in place at various times during the study pe- riod to limit fluctuations in commIlodity prices, notably on tin, coffee, sugar, cocoa, and natural rubber. By the late 1980s only the rubber agreeimient, which was struc- tured differently fromii the others, was still functioning satisfactorily.3 Another im- portant agreement was the extension in the late I 970s of national control over the manaaernent of niarine resources out to 200 nautical miles from the coast; this de- velopment represented a large-scale national appropriation of territory.4 Structural Changes in the World Economy The institutional developmients in the quarter century from 1965 to 1 990 were ac- companied by important changes in the growth and composition of world trade, the geographicatl pattern of trade, and the world mioney and capital market. Worl(i exports, aided by trade liberalization, grew at tile compound annual rate of 12.7 percent a year in dollar terms. They grew more rapidly than total world A BriejSune e! f the World Econon,y 13 output, as they had done during the period 195(-65. Total exports from develop- ing countries grew nearly as rapidly, because of a particularly strong increase in their exports of manufactured goods. Whereas in 1965 only 26 percent of total ex- ports from developing countries were manufactured goods, including senlipro- cessed nonferrous metals, by 1990 the share of manufactures had more than doubled to 53 percent. This change was due not only to the rise in relative impor- tance of exporters such as the Republic of Korea and Hong Kong, but also to the growth of manufactured exports from the countries of lIatin America, where man- ufactures as a share of exports hiad risen from only 7 percent in 1965 to 32 percent in 1990. Brazil. once a classic exporter of prinmary products (92 percent of exporns in 1965). recorded 53 percent of its exports as manufactured gooods by 1990. Be- tween 1969 and 1989 manufactired g oods rron) developing countries grew from 5 to 13 percent of OECD imports of manufactures. Sub-Sahiaran African countries. however, still export mainly primary products, as do the mlajor oil-exporting de- veloping countries. These changes in export composition have important implications for inter- pretino movements in the terms of tra(le. It is no longer appropriate, if it ever was, to associate movements in the prices of primary prodticts in relation to manufac- tured goods with the termis of trade of developing countries. As noted, many de- veloping countries have become substantial exporters of manufactured goods and. similarly. many are significant importers of primary prodJucts, especially petro- leum and staple foods such as grains, but also in somile catses cotton and other in- dustrial materials. The most noteworthy teature of the geographic pattern of trade is how little it changed in its main features over the quarter century. Developino countries as a group accounted for 27 percent of world exports in both 1965 and in 1988, for in- stance (table 2-2). Surprisingly, the nonoil exporters of this group gained slightly at the expense of oil exporters, although the latter increased their shaire tempo- rarily during the periods of large oil price increases. The large changes were among nonoil exporters. In particular, the export share of several east and south- east Asian countries rose markedly over this period as a whole, reflecting also a rapid growth of output and income in those countries. In contrast, the export share of the developing countries of Africain and ttec Western -lenmisphere declined sig- nificantly, by two and three percentage points, respectively. By 1990 Korea alone was exporting more than all of Africa. (The year 1990 saw a slowdown into reces- sion in Britain and the United States. so imports of raw m.ateriaLIs were unusually depressed: oil prices, however, were temporarily higher after Iraq's invasion of Kuwait in August.) Similarly. the share of industrial countries in worl(d exports was virtually un- changed. until the late 1990s( remainino at about 73 percent, and within this group the share of industrial Europe rose only slightly despite the removal of barriers to intra-European trade during the early part of the period. Japan's share rose sharply, however. from 5 to 1(0 percent. while thlat ot the United States declined tromii 16 to 12 pcrcent.5 14 Boom, Crisis, and Adjusimeni Table 2.2 Share of World Exports, Selected Years (percent) 1965 1978 1990 United States 15.9 11.8 11.8 Japan 4.9 7.9 8.6 Industrial Europe 44.7 44.5 47.9 Developing countries 27.3 30.4 26.3 Oil exporters 6.2 12.6 5.7 Nonoil exporters 21.2 17.8 20.6 Four Asian tigersa 1.6 3.8 8.8 Africa 4.7 3.8 2.3 Western Hemisphere 6.8 4.8 3.0 a. Korea, Taiwan (China). Hong Kong, and Singapore. Note: Excludes the fomier U.S.S.R. and several smaller Communist countries. Source: IMF, international Financial Statistics (1989, I 991). A third significant development in the world economy was the re-emergence of an effective world money and capital market. The Euro-dollar market started in London in the late 1950s and grew rapidly during the 1960s, but remained a mar- ket mainly for banks and other prime borrowers in developed countries. By the late 1960s, however, a number of developing countries had tentatively entered the market, maturities had lengthened, and there were new instruments for credit. By the end of the decade, Euro-currency credits to developing countries were roughly half a billion dollars a year. The international bond market also revived. The Euro- currency market was given a fillip by the first oil shock, since London-based banks found themselves flooded with funds from the newly rich oil-exporting countries. Bank lending to developing countries grew rapidly, reaching $44 billion in 1981, before receding sharply following the 1982 debt crisis. The money and bond mar- kets continued to grow, but the heavily debt-ridden developing countries no longer had ready access to them. Other developing countries, however, continued to bor- row in these markets. Official development assistance, another feature of the post-World War 11 pe- riod, continued to grow in nominal terms throughout our period, although less rap- idly than private capital flows until the debt crisis. In real terms these flows were two-thirds higher by 1988 than they had been in 1965. Table 2-3 sets out bilateral development assistance and other capital flows to developing countries. Members of the Organization of Petroleum Exporting Countries (OPEC) offered extensive development assistance when their earnings and surpluses were exceptionally high; this assistance peaked at $9.6 billion in 1980 but by 1988 had declined to $2.4 billion. Net new lending, including structural adjustment loans, by the World Bank and its affiliate, the International Development Association, grew from $2.5 billion a year in the early 1970s to a peak of $25 billion in 1986. The dominant movement was in private capital, which rose fivefold from 1973 to 1981, only to Table 2.3 Total Net Resource Flows to Developing Countries Billions of current U.S. dollars" Billions of U.S. dollars at 1989 prices and exchange rates Development Other Desvelopment Other Year assistance oficial Prite Totalh assistance official Private Tota 1970 8.2 1.0 7.0 20.0 33.2 4.0 28.3 80.9 1971 9.1 1.2 6.9 21.9 34.1 4.5 25.9 82.1 1972 9.8 1.4 9.6 24.2 32.7 4.7 32.0 80.7 1973 12.7 2.3 15.0 33.9 36.3 6.6 42.9 96.9 1974 16.5 2.6 12.2 37.5 43.1 6.8 31.8 97.9 1975 21.0 3.3 23.8 56.6 47.0 7.4 53.3 126.8 1976 20.3 3.3 22.2 56.6 44.3 7.2 48.4 123.4 1977 21.0 3.3 28.8 67.0 41.9 6.6 57.4 133.6 1978 34.0 5.4 46.8 106.0 57.6 9.2 79.4 179.7 1979 31.7 5.7 53.9 104.1 48.5 8.7 82.5 159.3 1980 37.5 8.0 66.0 128.4 52.4 11.2 92.3 179.5 1981 37.2 9.2 74.3 139.1 54.6 13.5 109.0 204.0 1982 33.8 10.3 58.2 116.0 51.2 15.6 88.1 175.6 1983 33.9 8.5 47.8 94.8 51.7 13.0 72.8 144.4 1984 34.8 12.7 31.7 85.4 54.5 19.9 49.6 133.7 1985 37.0 11.6 30.5 83.1 57.4 18.0 47.3 128.8 1986 43.9 11.9 26.7 81.8 54.0 14.6 32.9 100.6 1987 48.2 13.3 33.7 92.6 51.1 14.1 35.7 98.2 1988 51.4 14.1 43.8 107.2 50.7 13.9 43.2 105.8 1989 52.9 12.6 48.3 123.3 52.9 12.6 48.3 123.3 1990 62.6 16.2 60.8 144.2 55.9 14.5 54.3 128.9 a. A hillion is 1.000 million. b. Includes voluntary grants. Source: OECD. Development Assistance Committee. /6 Bwem, Crisis. a7nd Adjuistment fall to one-thir(d that level in 1986. In real tenrs, private capital nmovements were lower in 1986 and 1987 than they had been in 1973. Finally, and not least, the International Monetary Fund (IMf:) provided sub- stantial emnergency cre(dit to developing counltries inimiiiediately following the two niajor oil price increases and world recessions. As note(d previously, tlhe IMF was created to police certain rules of international tinancial behavior and to provide temiporary support to countries experiencing temporary balance oj paymnents dif- ficulties or undertaking an adjustmnent program to restore payments equilibrium. Thne rules regarding fixed exchange rates were fornially alteredl with an aniend- ment to the Bretton Woods Articles of Agreemient in 1978. but those concernino convertibility on current account were not altered. Paradoxically, the role of the IMF increased significantly qftrc the so-called collapse of the Bretton Woods system in 1971-73. Its lending rose sharply in 1974-76, partly out of its ordinary resources. but it also acquired extraordinary loans from1 the large ind ustrial (C-10) countries and from sonie OPEC mlenibers, and it created an "oil ftacility' to help finance oil-imiporting countries while they were adjusting to the higher oil prices. The number of new IMF loans dropped in 1 977-79, but then rose sharply again in the early I 980)s. with) net new credits peak- ing at $11.3 billion in 1983 and total outstanding credit reaching $38.6 billion in 1985. The IMF played two other roles as well. First. it offered menber countries pol- icy advice on how to adjust to their payments positions. On large loans, the IN1F stipulated policy conditions for disbursenment of the loan, but it was available for advice under other circumiistances as well. Second, governments and banks came to regard IMF endlorsement of a country's adjustment policies as a seal of ap- proval on debt rescheduling and new lending. both with respect to otficial debt and bank debt. as discussed further below. ItF approval assured lenders that a vi- able program had been undertaken.6 Major Economic Events Several dramiiatic econonmic events also occurred during the period. To start, the fixed exchange rate feature ot the Bretton Woods systenm broke down in the early 1970s. That was followed by two sharp increases in the price of crude oil, the most impor- tant con,nio(lity in world trade and a necessary input to all modxern economies. As notedl the decade of the 1960s had brought developed and developing countries alike outstanding economic growth, probably unprecedented in history. at moderate rates of inflation. In the late 1 960s the postwar current account surplus of the United States virtually disappeared. but the (deterioration was blunted by a strony inflow of capital. due mainly to tight money. When monetary conditions eased in the small recession of 197(-71. capital flows reversed and the overall 1.S. payments deficit swung from a surplus of $2.7 billion in 1969 to a deficit of A Brief Survey oJ' thle Wir/dl E(A>ornv 17 $11 billion in 1970 and to $30 billion in 1971. These were enormous sums in their time and flooded the rest of the world with dolla.rs, a flood that was augmented through pyramiding in the London-based Euro-dollair market (on whicih more be- low), such that the dollar foreign exchiange reserves of other countries rose by sub- stantially more than the U.S. deficit. Under fixed exchange rates, increases in foreign exchange reserves increase domestic money supplies. A few countries, notably the Federal Republic of Ger- many, were able to sterilize much of the inflow. but money supplies in most coun- tries increased by substantially more than the rise in foreign exchange reserves. This trend suggested that concern for the balance of payments was the principal source of monetary discipline for these countries: when that was relaxed, restraint on domestic monetary expansion was also relaxed. In any case, starting with Can- ada (in 1970), followed by the United Kingdom (in 1972), one country after an- other attempted to insulate domestic monetary conditions from external influences by floating its currency. Generalized floating began in March 1973. That year also produced the highest rate of growth in the industrialized coun- tries (5.7 percent) and in the world that had been seen since the Korean War boom year of 1950 (see figure 2-1). As a consequence of strong fundamental demand. and of changes in agricultural policies in the fonrer Soviet Union (leading to large imports of grain), world commodity prices more than doubled between early 1972 and early 1974, before receding in the 1 974-75 recession. For our eighteen coun- tries. the prices of sugar, copper. and phosphates were especially important. (Cof- fee and cocoa prices, however, were to rise much more in 1975-77, following a severe frost in Brazil; we discuss this event at greater length in chapter 3.) Some of the price increase was undoubtedly speculative in origin. reflecting among other things concern with rising inflation.7 In October of this boom year came the Yom Kippur War between Israel and Egypt, followed by the Arab embargo on oil sales to the United States and the Netherlands, and the decision in December by OPEC ministers to raise crude oil prices more than threefold, from $3.70) to $11 .65 a barrel. This price increase, effective January 1. 1974, was probably the largest one- quarter economic shock the world economy has ever experienced. More than 10 percent of world payments for trade were redirected in a single quarter. It created an acute dilemma for policymakers in all countries. A sharp increase in oil prices not only pushes up the general price level (= inflation), but in the short run also leads to a reduction in output because of the large change in the (listribution of in- come between oil consumers and oil producers. Since demand for oil is inelastic in the short run, the need for households and firms to spendn more for oil products implies they have less available for other purchases, so output declines and unem- ployment rises. Macroeconomic management is thrown into confusion as coun- tries try to tight both inflation and unemployment at the same time, but with different emphases, and thus find themselves faced with secondary balance of pay- ments problems. Governments of oil-importing countries also had to decide whether to adjust fully to the higher oil prices, even thoughl they nig,ht prove to be 18 Boo/7n (Crisis. andAdjus,ntern Figure 2.1 Price and Output Gap Developments in the Seven Largest OECD Economies, 1970-92 Percent 15 10 5 0-Mn -5 I I I | I I -I 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 _ Output gap GN/GDP deflator Note: Based on 1987 GDP weights and cxchange rates. The oLtptII gap is de[lned as the ditlcrence between actiual ,and potentiail OuEtpuit in reiation to poteltial output. A positive value means that thc economliy is operat,ing ahovc its potcntiall ind a niega,[ive va,lu,c that there is slack in the cconoily. GNP/GI)P dellator is calculated as percentage chan,ge tromil the previou.s yvar. Sou,,,,. OECI) L o,tiomnc Outlook 49 (jlIIV 1991). temporary (as some eminent economists predicted), or whcther to borrow to cover their increased import bills. The United States and Germany, followed with a lag by Japan, put greater weight on fighting inflation; most other cotintries, developed and less developed alike, chose to proceed on course and borrow as necessary to cover increased ex- penditures on oil. Funds were amply available, since oil-exporting countries found themseives with revenues far in excess of what they could spend in the short run, and placed their surplus funds in the Euro-currency market, to be re-lent by banks to oil-importing countries. In 1974-75 a conmbination of oil price increases and contractionary policies in several major countries produced the sharpest decline in world econonmic activ- itv since the Second World War. It was the first OECD-wide recession, in the tech- nical sense ot a decline in real gross national product for more than two quarters.9 The recession, of course, increased the borrowing requirenments of those countries A Brief Survey of tie Vi4rl/d hEonotvy 19 that attempted to maintain their economic growth; by the same token, the heavy borrowing to support continued spending mitigated the depth of the recession. Over tinie the oil-exporting countries increased their expenditures to match their now higher incomes, and their large current account surplus of $67 billion in 1974 became a small deficit of $2 billion by 1978. Oil prices continued to rise slowly in nominal terms but declined slightly in real terms from their 1974 level (see figure 2-2). OECD growth was back to 4.2 percent, modestly lower than during the 1960s, but respectable. The year 1978 suggested a return to normalcy. But an Islamic revolution occurred in Iran in early 1979. Iranian oil produc- tion dropped sharply and world oil prices began a steep rise that was to persist for over two years, from $12.70 a barrel for Saudi light in 1978 to $33.50 a barrel in 1982. Oil-exporter current account surpluses rose to $103 billion in 1980, and again oil-importing countries were faced with rising price levels (since fuels are an important input to modem economies) combined with declining demand for nonfue1 production. The macroeconomic policy dilemnia was posed again, as it had been in 1974. More countries elected to fight inflation after the second oil shock, but a number continued to borrow heavily, joined on this occasion also by a number of oil-exporting countries-notably Mexico and Nigeria-whose spending plans ran ahead even of their much higher current revenue. So once Figure 2.2 World Oil Prices-Nominal and Real, 1970-88 U. S. dollars per barrel 34 32 _ - 30 - 28 - - 26 - 24- 22- 20 - 1 8/ 1~~~~~~~~~~~~~~~~~~~' 4 1 2 8 6 4- 2 - 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 Real (1 983 dollars) - - - Nominal Source: IMF linterniational Financial Statistics (various issues). 20 Boom. Crisis, ond Adjustrnei again external debt took a sharp increase. As a result of the fight against inflation short-term interest rates rose much more in 1980-81 than they had in 1974 (three- month Eurodollar deposit rates averaged 16.9 percent during 198R. up from 8.8 percent in 1978). and a higher portion of bank loans carried floating interest rates, so debtors faced highfer interest payments as well as higher oil prices (see chart 2.3). As in 1974. a combination of the suddenly higher oil priccs and the contrac- tionary policies in leading industrial countries (Britain. Germany. Japan, and the United States) induced a second world recession in 1981-82. more severe (in re- lation to potential output) than the 1975 recession. Again, the recession depressed primary product prices and required many countries to borrow more than they oth- erwise woukl. And again, the tact of heavy borrowing itself mitigate(d the severity of the world recession. The combination of high accumulated debt. recession, and hiah interest rates (see figure 2-3) produced a debt crisis. Previously debtors could rely on a decline in interest rates in recessions to compensate in part for their decline in exports. Figure 2.3 Interest Rates and Nonoil Developing Country Terms of Trade, 1965-90 Percent 18 A 16 6 14 / 12 / 10 1965 ~ ~ ~~~ t97 195190185t9 4 2 0 -2 -4 -6 -81 -10 j11 11 1965 1970 1975 1980 1985 1990 - - - LIBOR Nonoil developing country terms of trade Som e: IMF InkIcn'luioal1 1IjJanciltisli(,s (various i IICs). A Bri Sunrey ev q/ i World Eononrlv 2/ After 1982, debtors were not only unable to borrow more, but they could not even roll over their current debts as they matured. Ironically, the debt crisis became a global issue when in August 1982 Mexico, an oil exporter, announced that it could not continue to service its debts. That produced a general hesitation by the major banks of the world to continue to lend to governments in developing countries. Several countries-Turkey, Poland. Costa Rica-had run into debt limits earlier, but with the Mexican crisis, the problem became generalized. Although some vol- untary lending continued. especially to Asian countries whose capacity for servic- ing debt did not seem so severely constrained, the rate of new voluntary lending declined sharply froms 1982 on. Net new bank lending to developing countries reached a peak of $44 billion in 1981, having risen sharply from $24 billion in 1979 and 1980X) by 1984 it was down to $8 billion, and by 1987 it had fallen to $4 billion.9 Since the willingness of banks to lend to any borrower depends on the perception that the borrower has access to other lenders, once some banks with- drew, others followed apace. thereby precipitating delays in payment. Borrowing is based on expectations about the future. It is easy. but beside the point, to criticize past decisions once we learn what the 'future" actually brought. It is therefore useful to recall the climate of expectations around 1980, when so much borrowing took place. Inflation in the leading countries was expected to continue at a high rate, without deleterious effects on growth. Oil prices, whiclh rose throughout 1979 and 1980, were expected to continue to rise, albeit at a much lower rate. Concretely, in 1980 the World Bank projected that unit values of ex- ports of manufactured goods from the industrialized countries would increase on average 8.4 percent a year for the coming decade, whereas in the event they in- creased only 4.6 percent a year. As a result, a ten-year fixed-interest loan nmade in 1980 ended up carrying a much higher real interest rate than was expected at the time. More relevant for nmany developing countries (although not for all, as noted above) was the price of primary products. A comiposite index (excluding oil) was projected in 1980 to increase on average 9.4 percent a year over the conling de- cade, for a real increase (in terms of nianufactured goods) of 0.9 percent a year. This index declined 0.5 percent a year, for a real decline of 4.9 percent a year- niore than five percentage points less than expected. About the same time, it was thought that oil prices would increase 3 percent a year in real temis for the indef- inite future, whereas in actuality they declined sharply fromz the levels of 1980. Oil-exporting countries borrowed against this expectation, and banks willingly lent to them. Sonie countries (most notably Brazil) launched large oil-saving in- vestments against the same expectation. again finding willing lenders. Similarly, the U.S. recession of 1982 was at first not foreseen, and then its magnitude was greatly underestimated. Furthemiore, interest rates failed to de- cline as rapidly as they had in earlier recessions, offsetting for debtors sonic of the inmpact of the decline in demand for their exports. The sharp reduction of new lending after 1982 gave rise to a net outward transfer of resources-defined as interest payments less net new borrowing-from 22 Booni, Crisis, an.d Adjustient many developing countries to their creditors. Of course, the debtor countries still had the assets that they had purchased with the loans, except where the borrowing had been used for current consumption, for example, in paying for higher oil bills or for current government expenditures or transfers. In some cases, it turned out. the assets purchased were abroad, in private hands, since the public borrowing was indirectly used to finance the outflow of private capital. sometimes called capital flight. The magnitudes were exceptionally large in Argentina, Mexico, and Vene- zuela, none of which maintained controls on private capital outflow in the early 1980s. The income on these privately held assets was not generally available for servicing the public debts. In other cases, the loans had been used tor large investments where the eco- nomic returns were dubious, especially in the 1980s, when growth had fallen off and oil prices had dropped from thieir 1981 highs. In still other cases, the borrow- ing had been used for successful investments, which added to national product more than was required to service the debts. The last category was not typical for many debtors. When a debtor within a country becomes unduly burdened, some kind of debt relief is usually provided-often under court-supervised bankruptcy proceedings. The international community groped toward an international equivalent for sover- eign debt during the course of the 1 980s. For debt to official creditors (arising from official export credits or development loans), procedures had already been worked out in the so-called,Paris Club, a committee of creditors relevant to any particular debtor country, chaired by the French Ministry of Finance. With a satisfactory pro- gram. endorsed by the IMF, official claims were rescheduled, in effect stretching the original maturities of the debts. Such rescheduling increased sharply during the 1 980s, from one or two a year during the 1970s to a local peak of twenty-one in 1985 and twenty-four in 1989. Nine of the eighteen countries covered in this study experienced debt rescheduling between 1980 and 1988.11 Early reschedul- ing involved extensions of maturity, often with a grace period, at unchanged inter- est rates. Following the 1988 Toronto economic summit, official creditors became considerably more generous and began to offer wider coverage and lower interest rates on some rescheduling. A procedure called the London Club, which was analogous to that of the l'aris Club, was developed by private bank creditors. In this case, a committee of lead- ing creditor banks worked out a program of rescheduling, rollovers, and new lend- ing in response to a satisfactory economic program, endorsed by the IMF, in the debtor country. Meetings of the London Club jumped from seven in 1982 to twenty- two in 1983. but then gradually dropped back to seven again by 1989. By then much of the commercial bank debt had been rescheduled, and the total had de- clined considerablv. Gradually, the conditions of debt relief became somewhat easier-with long- er extensions, longer grace periods, lower interest rates, and eventually swaps of bank debt for equity or for bonds that involved substantial reduction in principal. Between official and comniercial bank creditors together, $29 billion in principal A Brief Survey of the World Econonmy 23 and interest were rescheduled in 1985; the amount rose to a peak of $33 billion in 1987. but then dropped to $19 billion in 1989. Following the 1982 recession, the United States had a long period of steady growth, until 1990. Japan also enjoyed a period of steady growth, but the countries of Europe, other than Britain, remained anemic until late in the 1980s, with the re- sult that over the decade the industrial countries as a group grew nearly two per- centage points less than they had during the 1960s.12 Combined with a heavy debt burden, this lower growth had a number of repercussions in developing countries, whose growth during the 1980s was more than two percentage points lower than it had been in the 1960s. Lower growth in income and consumption in the indus- trialized countries means not only a slower growth in demand for products from developing countries. but also puts some downward pressure on the prices of pri- mary products, thus worsening the temis of trade of those countries that export pri- mary products. The 1982 recession and subsequent slow growth also reduced the world de- mand for oil. In 1980 and 1981 a number of analysts projected that world oil prices would continue to rise and would reach $45 or $50 a barrel by the mid-1980s. Some of the many energy-conserving investments made around the world were predicated on continued increases in oil prices. as was the heavy borrowing by such oil producers as Mexico and Nigeria. The demand for oil weakened, how- ever, and through 1985 oil prices dropped gradually from their 1981 peaks. In command over goods and services, they dropped even further. Declining oil de- mand led OPEC for the first time to assign production quotas to its members in 1982. thus meeting the formal condition for a cartel. Because assigned quotas tended to exceed demand, prices were maintained as high as they were only by substantial reductions in production by Saudi Arabia. OPEC's largest producer- from more than ten million barrels a day in late 1980 to less than three million bar- rels a day in 1985. At this point, Saudi Arabia, having wamed on several occasions that it would not be the sole swing producer in OPEC. changed its pricing and pro- duction strategy, and oil prices quickly fell below $10 a barrel in early 1986. This sharp drop was a bonanza to oil-importing countries, such as Brazil and Korea, but it was a major financial setback to oil-exporting countries such as Mexico and Ni- geria. The lesson was apparently learned by OPEC members; restrictions were re- imposed on production, and prices rose in late 1986, but they remained about $ 10 a barrel lower than they had been in early 1985 ($18 as against $28). In real temis. after 1986 they were below the level of 1974, but not as low as they were in 1973. before the first major oil price increase (see figure 2-2). The broad story is revealed in table 2-4. which shows the emergence of large OPEC payment surpluses in 1974-76 and again in 1979-81, with corresponding deficits in the industrialized countries and the nonoil developing countries. With the sharp drop in the price of oil in 1986, that pattern was reversed, and a partial recovery began in 1987. Current account deficits of the nonoil developing countries show how borrowing evolved in these countries, since the current account. when properly 24 Boom. Crisis. and Adjustment measured, is equal to the change in net claims on foreigners. Gross borrowing was often higher than the current account deficit because funds were needed to cover the outflows by private citizens and to permit increases in foreign exchange re- serves. According to the current account deficits, borrowing increased sharply in 1974 and again in 1979, peaked in 1981, and then took a large drop after the 1982- 83 debt crisis. By 1987 the nonoil developing countries had a current account sur- plus of nearly $12 billion-a swting of $ 111 billion from 1981, indicating the great compression of imports experienced by many developing countries. Note that the sums of the rows in table 2-4 do not equal zero, nor on the whole do they even come close to it, as they should. l 3 After 1977, recorded payments for goods, services, and transfers greatly exceeded recorded receipts for these items. Table 2.4 Current Account Positions, 1968-90 (billions of dollars) Industrial Developing countries Year countries Oil-Exporting Other Total' 1968 4.5 1.3 -6.1 -1.2 1969 5.5 0.9 -5.4 0.0 1970 6.9 -1.0 -10.0 -4.1 1971 10.2 1.2 -12.2 -0.7 1972 8.0 3.5 -4.9 6.6 1973 13.6 6.6 -5.4 14.9 1974 -21.4 67.4 -30.5 15.4 1975 9.7 32.6 -39.8 2.5 1976 -10.5 37.9 -27.3 0.1 1977 -15.5 22.2 -23.0 -16.4 1978 14.7 -2.4 -32.6 -20.3 1979 -23.6 59.9 -48.6 -12.3 1980 -59.4 103.5 -76.1 -32.0 1981 -17.6 46.6 -99.3 -70.2 1982 -20.9 -9.3 -74.5 -104.7 1983 -21.7 -20.5 -38.1 -80.4 1984 -56.7 -5.9 -22.2 -84.7 1985 -48.9 4.0 -25.3 -70.2 1986 -16.3 -23.0 -12.1 -51.4 1987 -39.5 -4.2 11.6 -32.1 1988 -50.5 -13.0 5.4 -58.0 1989 -84.4 6.1 -17.7 -96.0 1990 -104.9 -4.2 -17.1 -100.5 a. Excludes the former U.S.S.R., several small centrally planned econonmies, and China before 1982. Source: IMF, International Financial Statistics, various issues, and Supplement on the Basance of Pay- ments (I 984). A Brief Suirv ey oj the W)orld Economy 25 So OPEC surpluses were less than they appear, or deficits by the other countries were less than they appear. These lirge discrepancies can be traced to three likely sources: (I ) imports into developing countries were overinvoiced, to conceal the export of private capital: (2) purchases of foreign services by governments, espe- cially OPEC governments during the large construction booms in those countries, were underrecorded by countries that exported the services. because of inadequate data-gathering procedures. and (3) interest and dividend payments to private own- ers of capital, mainly in developing countfies, are recorded by the countries in which the assets are located, but not by the countries in whichi the owners of the financial assets reside. The point is that a number of indebted countries were prob- ably far less indebted than the official figures suggest, but, as a practical matter, the foreign assets owned by their residents were inaccessible to the governments of the indebted countries. Thus, debt problems became mainly governmental debt problems. By the late 1980s the world economy again seenmed to have returned to some normalcy-a number of developing countries were working their way out from under their external debt, and growth was returning to Europe, in part because re- straints on intra-European trade were scheduled to be removed by the end of 1992. World attention became preoccupied with developments in Eastern Europe and the former U.S.S.R. However fascinating and important those developments were for the countries in question, and for the structure of international security, the only direct implication they hiad for developing countries was that they created a competing deniand for the linmited supply of official funds available from the rich countries. They also carried an intellectual message. as explained in the next section. The Intellectual Climate Economiiic policy, like other policy, is strongly influenced not only by events but also by the intellectual milieu of eachi era. The postwar international econonmic framework was strongly influenced by the Great Depression and by the ideas that came out of that experience. particularly the notion that governients could stabi- lize, and had an obligation to stabilize, aggregate demand so as to avoi(d high and rising unemploymient. These ideas sparked the so-called Keynesian revolution in economic thought. They sought also to avoid beggar-thy-neighbor actions by countries in search of higher domestic demand and employment-hence the em- phasis on trade liberalization and current account convertibility, a reaction in part to the exploitative bilateral currency arrangements of Nazi Germany in the 1 930s. Two strands of tilought have greatly influenced policy in developing coun- tries. The first originated with political leaders in the colonial world and their in- tellectual guides and supporters: the second originated witlhin the professional world of economics. 26 Boorn, Crisis. anti Adjustment Following decolonization and the dismantling of the great European empires, many intellectuals in the newly independent countries reacted negatively to Euro- pean firms and to European ways. Many felt the same about American firms and American ways because of the close association between the United States and Europe after the war, and because the United States was the leading and most out- spoken capitalist country. Instead, they found the U.S.S.R. intellectually appeal- ing, in part because of its anti-imperial stance, and in part because central planning appeared to have been successful in stimulating the growth of the Soviet economy during the 1 950s, while attaining a measure of equity. These dispositions were re- inforced by the economic development literature of Western economists, who em- phasized setting national targets for growth and investment and using government authority to achieve those targets through such instruments as control over credit and over the allocation of foreign exchange, and even through direct commands and government ownership of enterprises. The government was expected not only to provide a framework of physical and social infrastructure, such as commercial law and modern education, but also to serve as entrepreneur, investor, and manag- er of economic activity. The hopes for rapid development were so high that many leaders in develop- ing countries were disappointed with their economic performance in the 1 960s- ironically, since on average that performance was outstanding by historical stan- dards and is unlikely to be achieved in future periods. They chose to blame this poor performance on the international economic system, arguing that they had played no role in setting its rules (although many Latin American countries were represented at Bretton Woods) and that it was biased against the economic devel- opment of poor countries. Collectively, they assaulted the nondiscrimination pro- visions of the GATr, arguing for tariff and other trade discrimination in favor of developing countries. 1 4 These opinion leaders also wanted to carry the dirigisme of many of their do- mestic economies into the international arena, through such devices as interna- tional commodity agreements designed to raise average prices and international endorsement of producer cartels; government-compelled transfers of technology to developing countfies; government control over the employment, investment, and export behavior of multinational corporations; international sanction for free- dom to expropriate foreign-owned property with appropriate compensation, to be determined solely by the host country: and augmented transfers of resources to de- veloping countries, on concessional terms but with minimal conditions on use, through a variety of channels. These positions were set forth in several declarations and resolutions, starting with a ministerial level meeting of the Group of 77 (of developing countries in the United Nations) in Algiers in 1967 and culminating with passage by the UN Gen- eral Assembly in 1974 of the Charter of Rights and Duties of States. by a divisive majority vote. The key sticking points for the United States and several other in- dustrialized countries were the provisions concerning producer cartels, expropri- ation of foreign-owned property. and management of the international financial A Bricl Surv ey 0/ 1lc World Econonmv 27 system (especially the IMF). The general drift of many provisions. however. im- plied a degree of governmental involvement in economic matters that the indus- trialized countries (niost openly, Britain, Gerniany. and the United States) found uncongenial and ultimately unacceptable. The provisions did, ho.wever, reflect a point of view widely accepted around the world in the mid-1970s. especiallyadis- trust of private enterprise, and these attitudes underlay the booms in public invest- nment in developing countries discussed in the next chapter.15 Economiiists, meanwhile, had begun to doubt the wisdom of the "Keynesian" emphasis on maintaining high emplonyment through the manipulation of monetary and. especially, fiscal policy. The naive but widely espoused versions ignored the possibility of accelerating inflation under "Keynesian" economic management, something Keynes himiiself had recognized and acknowledged as a problem thirty years earlier. As inflation accelerated during the 1 970s, attention turne( increas- ingly to the "monetarist" approach to macroeconomic management, with its focus on some measure of the money supply and its relation to the price level. Monetar- ism came into vogue in the late I 970s. Like the Keynesian perspective. monetar- ism had its naive variants, especially when attempts were made to make it quantitatively operational, and these versions were discredited during the 1980s when postulated relationships between particular definitions of money supply and price level broke down in many countries. Other notions that were gaining currency among academic economlists and that found their way into macroeconomic policymaking in sonic countries were so-called rational expectations and the new classical economics. The latter empha- sized the high degree of perfection oft markets, not only for commodities and se- curities. but also for manufactured goo(ds and labor. The fomier made the iniportant observation that, in making their decisions, economiiic agents (house- holds and firms) are likely to take into account all the information that is available to them, and to anticipate the future consequences of their actions and those of oth- ers, rather than nmerely extrapolate past behavior. Unfortunately, when academic economists translate this common-sense observation into their economiiic models, it is introduced as perfect foresight except for truly randon) fluctuations. Perfect foresight is an analytically powerful and convenient assumption, but one that is extraordinarily naive when applied to actual econonmic decisionmaking. Nonetheless, the power of these intellectual currents was such that during the late 1 970s and I 980s the two sets of ideas led sonic policymakers in Britain, Chile, Ar- gentina, and the United States to believe that inflation could be reduced relatively painlessly if only the government showed sufficient resolution with respect to monetary control. and, in the case of Chile and Argentina, denionstrated that res- olution by fixing the exchange rate. The latter two experiments are discussed at length in chapter 7. In the industrialized countries, there was also a general philosophical reac- tion to big-and growing-government with the emergence of neoconservatism and neoliberalism, two schools of thought that were not t'ar apart on niatters of economic and social policy, as both contended that the efficacy of government 28 Booni, Crisis. and Adjustmenl action was questionable. even if well-intentioned. In addition, neoconservatives questioned how well-intentioned many such interventions were, pointing rather to the self-interest of politicians in their pandering to the public on issues of general concern while privately recognizing that proposed solutions could not solve the stated problems, and to the self-interest of bureaucrats in greater government in- tervention so as to enhance their own social status, decisionmaking power, and remuneration. These philosophical currents, reinforced by the public's disenchantment with inflation and the government's apparent inability to bring it under control, led to the election of a more conservative group of leaders in several major countries: Margaret Thatcher in Britain (1979), Joe Clark in Canada (1980), Ronald Reagan in the United States (1980), and Helmut Kohl in Gcrmany (1981). (In 1981, however, France's Fifth Republic elected its first socialist president, Franiois Mitterrand; it was not a good period for incumbents.) The strong political attack on big government as being both incompetent and oppressive was reinforced by the clear failure, by the 1 980s, of central planning in the U.S.S.R. and in other Communist countries. China in 1978 inaugurated major reforms to decentralize economic decisionmaking both in agriculture (where it was highly successful) and in industry (where success was more modest). Hun- gary and Poland moved more tentatively in a similar direction. And in 1985 the U.S.S.R. began a program of glasnost (openness of expression) as a necessary pre- lude to perestroika (restructuring of the economy). By the end of the decade, Po- land, Czechoslovakia, Hungary, and Mongolia had formally abandoned communism as a political system and central planning as the principal mechanism for allocating resources, in favor of open markets; East Gemiany had been unified with West Germany under the latter's principles of economic organization; and Bulgaria and Romania had taken steps to dismantie their systems of central plan- ning. In 1991 the U.S.S.R. fragmented into its constituent republics, each of which was struggling with economic and political refomi, but none seemed likely to re- turn to a system of central control over the allocation of resources. Indeed, the desire for less government control, more private enterprise, more autonomy for government-owned enterprises, and more reliance on competition (including import competition) as a regulator of resource allocation was world- wide, extended to many developing countries by the late I 980s and no doubt helps explain their growing interest in trade liberalization. By the end of our period, these philosophical currents had drastically changed the environment both for na- tional economic policymaking and for international negotiation on economic matters. Chapter 3 The Period of Cheap and Easy Credit, 1973-1979 Two notable features of the period from 1973 to 1979 were the new supply of in- temational credit at low interest rates and the dramatic rise in oil prices in 1974. These were large exogenous changes that produced important policy reactions in most of the eighteen countries under study here. As this chapter points out, the change in credit conditions had a more lasting effect than the change in oil prices. The new credit conditions were favorable for almost all these countries.) Meanwhile, the oil price increase had differential effects. For the oil exporters In- donesia and Nigeria, it was favorable. For countries that were roughly self-suffi- cient in oil, such as Colombia and Argentina, the shock was not too serious. For yet others, the shock was offset by increases in other commodity prices, as in Sri Lanka and C6te d'lvoire in 1974 and Morocco in 1974 and 1975. Since a change in the terms of trade has rather similar effects however produced, we shall con- sider it to be the relevant magnitude. Table 3-1 gives estimates of the size of the 1974 and 1975 terms-of-trade shock in relation to the gross domestic product (GDP) and exports of the previous year. The countries are arranged in three groups, in descending order of the size of the terms-of-trade shock in relation to GDP (combining 1974 and 1975). The first group consists of the seriously affected, with a total effect exceeding 3 percent of GDP. For the five countries in the second group, the terms-of-trade effect was very small in relation to GDP, but large in relation to exports, except in Colombia. The three countries in the third group gained-Nigeria and Indonesia enormously, and Morocco significantly.2 All the countries achieved positive growth in 1974, although barely so in the case of India and Chile. Their poor performance had little to do with the oil price rise, however. In most countries the growth was rather slower than in 1973. The year 1975 was again similar for most, the growth rate falling further in eleven cases, and recovering in the others. The exception was Chile, which 29 30 Boom. Crisis, and Adjustnment Table 3.1 Terms-of-Trade Shocks, 1974 and 1975 (percenl) Total Total Change efjrct on effect on in debt GDP,, Exports,- (PPG)/ GDP growith rate GNP, Country /974 1975 1974 1975 1973-75u 1973 1974 1975 1976 Chile -12.4 -5.I -48.2 -27.8 +32.0 -5.5 0.8 -13.2 3.6 Cameroon -3.8 -3.7 -20.3 -16.7 +0.6 5.5 10.7 -0.8 4.3 C6te d'lvoire -0.9 -6.4 -2.6 -16.1 +1.4 4.3 6.2 10.2 5.8 Kenya -4.1 -3.0 -13.4 -8.0 +2.5 5.8 3.6 1.3 2.2 CostaRica -5.1 -1.0 -22.6 -4.0 +7.2 7.8 5.4 2.0 5.4 Pakistan -3.1 -2.8 -21.4 -22.0 -18.9 7.1 3.4 4.1 5.3 Korea,Rep. -4.0 +0.9 -16.6 +4.0 +0.8 15.2 8.9 7.7 13.5 Sri Lanka -3.1 -0.6 -21.9 -3.8 -1.1 9.5 3.8 6.5 3.5 Thailand -0.8 -3.0 -5.3 -16.6 +0.7 9.8 4.3 4.8 9.4 Brazil -2.6 -0.5 -33.3 -7.0 +3.0 14.4 9.0 5.2 9.8 Mexico -0.9 -0.6 -22.5 -15.8 +1.5 8.2 6.1 5.7 4.2 Turkey -1.1 -0.3 - 18.1 -5.2 -5.1 4.2 8.6 8.9 8.8 Argentina -0.9 -0.3 -19.5 -7.7 +8.1 3.8 5.5 -0.5 -0.2 India -0.9 +0.0 -25.0 + 1.0 0.0 3.4 1.2 9.2 1.7 Colombia +0.9 -1.1 +7.6 -9.5 -1.6 6.7 5.7 2.1 4.8 Morocco +3.0 +1.3 +20.8 +5.9 +2.5 3.5 5.4 6.7 11.0 Indonesia +17.0 -3.0 +90.9 -11.1 -5.6 8.7 7.7 5.0 6.9 Nigeria +23.1 -2.6 +136.7 -9.8 -3.5 7.6 11.2 -3.2 9.2 a. Percentage points. Note: The effect on the terms of trade nmust be regarded as giving an order of magnitude only: there are considerable divergences in several cases between World Bank data and those given in the country studies. (But only in the case of Kenya were World Bank data clearly wrong.) Source: All World Bank data, except for Kenya, for which the data are from Bevan, Collier, and Gun- ning (unpublished). The debt figures are for public and public guaranteed debt only and are from World Debt Taibles 1980-81. experienced a catastrophic fall of 12 percent in real GDP, partly because of a fall in copper prices. Except in Chile, there were no very serious recessions. GDP fell in Nigeria, mainly because of a reduction in the quantity of oil produced, but real in- come, of course. rose with the rise in oil prices. In 1976 growth improved for most of the countries. This was the first year of the coffee boom, and among the noncoffee exporters that had sustained a serious shock in 1974, Korea, Pakistan, Thailand, and Turkey experienced a rapid rise in GDP. This rapid recovery is striking. The decline in growth following the 1974 shock was clearly over. All the countries that suffered a negative shock increased their borrowing, as was to be expected: but the increases in 1974 and 1975 were not excessive. Almost as many countries reduced the ratio of public and publicly guaranteed debt (PPG) /le Period oJ CCieap and Easy Creda. 1973-1979 31 to GNP as increased it (see table 3- 1). Only Chile experienced a very large rise, and this was due mainly to a fall in GNP rather than a large rise in borrowing. The varying effects of the 1974 shock and the subsequent growth of GDP can- not be understood without examining policy reactions in our countries. First, we consider what would have been optimal or rational reactions to the oil price rise. given the knowledge available at the time. For five of our countries, the coffee boom of 1976-78 was soon to overshadow the oil price rise, and therefore optimal reactions to this favorable shock are also considered. Next, we describe the actual policy reactions to the 1974 shock and the reactions of the coffee exporters to their windfall. Complicating circumstances make the evaluation difficult, even with hindsight, although the new ease of borrowing was clearly more influential than changes in the terms of trade, as indicated by the investment booms in almost all our countries.We argue that the great increases in borrowing were devoted mainly to investment. Optimal Policy Reactions to Exogenous Changes Policy reactions to the cheapening and increased ease of foreign borrowing and to the change in the terms of trade resulting from the oil price rise would have de- pended on whether authorities expected the changes to be temporary or pemia- nent, or, at least, long-lasting. In particular, a country's decision about whether to borrow and how much-that is, about the extent to which it should run a current account deficit-would have depended on a number of factors that might push in opposite directions. Another important consideration would have been whether its temis of trade had worsened (as in most cases) or improved. Consider, first, whether the greater ease and cheapness of borrowing was ex- pected to be permanent. Although commercial banks had already begun to in- crease their lending to developing countries before 1973. it was the oil price rise that caused real rates of interest to fall drastically and commercial bank loans to rise rapidly. beginning in 1974. The leading oil exporters could not absorb the huge increase in their eamings, and the large countries of the Organization for Economic Cooperation and Development, fearful of inflation, were unwilling to pursue expansionary policies. It was a buyers' market for "petro-dollars." Surely this state of affairs should not have been expected to last, even if the increase in the real price of oil was believed to be pemianent. The surpluses of the oil export- ers would undoubtedly be reduced as they leamed to spend. and the industrialized countries would become less wary of deficits. Long-temi real interest rates might have been expected to rise from the zero or negative levels of 1974 and 1975 to 3-4 percent, which seems to be a long-term norm. It was rational for a country to take advantage of a temporary period of low real interest rates by borrowing and investing more than it otherwise would in that 32 Boomn. Crisis, and Adjustment period. although the extent of the advantage would have been severely limited by the difficulty of raising the level of investment efficiently for a short period. Loans are contracted at nominal rates. The expected rate of inflation had be- come very uncertain, and so also had real interest rates. After 1976 debt was there- fore increasingly contracted at variable rates. Since borrowers could not be sure that the real interest rate on medium- or long-term loans of this type might not turn out to be high, borrowing should have become a less attractive proposition. Yet many countries began to borrow heavily for investment in 1974 and 1975, and these investment booms continued long after low interest rates were ensured. As for the oil price rise itself, there were good reasons to suppose that the rise would be permanent. or long-lasting, at any rate. Undoubtedly, the consensus was that the price rise had come to stay, although there were, of course, some dis- senters. It is rational for a country (or a person) to adapt immediately to a new cir- cumstance that is expected to be permanent. A permanent fall in real income should in principle be followed by a rapid reduction of consumption. Borrowing to maintain consumption would require a bigger adjustnient later. A fall in invest- ment should also occur unless the change in circumstances increased the real yield of investment or reduced the cost of foreign borrowing. In fact, the real yield of investment in oil substitutes and measures that would economize in the use of oil went up, while that in energy-using industries and activities went down. Brazil, for one, embarked on an extensive oil-substituting investment program. Although this turned out to be a poor investment and was probably ill-considered at the time, in principle, at least, a shift in the pattern of investment, both toward tradables (ex- ports and import-competing industries), to reduce the current account deficit, and toward oil-saving activities seemed rational. Another important factor to consider is the difficulty of making rapid adjust- ments in response to a current account deterioration. Such a deterioration could not be rectified overnight without a loss of domestic output. Temporary borrowing is therefore justified until the relative price changes made in order to restore exter- nal balance have the desired effect, for it permits the level of output to be main- tained during this period. Some expansionary fiscal or monetary measures might be necessary to maintain demand during the transition, since both real incomes and real cash balances would have fallen in the face of the rise in import prices. Another way of looking at the problem is to ask how a rise in borrowing (or use of reserves) could be avoided. In the short run, this could be achieved only by reducing the quantity of imports, generally by means of deflationary measures that would also reduce the demand for, and hence the output of, nontradables. It is true that a devaluation or import controls could switch the pattern of demand away from imports toward nontradables, hence maintaining demand for the latter. Nei- ther of these measures may produce much "switching" in the short run. Indeed, they may reduce domestic output further because of the higher domestic cost of imported inputs brought about by devaluation or by their physical shortage result- ing from controls. Thus a rapid reduction of demand, sufficient to improve the cur- rent account and so avoid borrowing or the use of reserves, even if accompanied The Period of Cheap and Easy Credit, 1973-1979 33 by devaluation or tighter import controls, could have a considerable deflationary effect.3 The upshot is that some rise in borrowing, as indeed occurred, was certainly rational for a short period, say two to three years, in the case of all of the countries that suffered the terms-of-trade shock of 1974. Thereafter, one should expect some adjustment, which would imply devoting a higher proportion of GDP to exports or import savings, with a fall in either consumption or investment (in relation to GDP). This switching would require a movement of relative prices in favor of trad- able goods, in other words, a real devaluation. The foregoing assumes that countries were borrowing an optimal amount when the terms-of-trade shock hit them. In reality, prior to 1974 borrowing on in- ternational markets was constrained. Thus some higher level of borrowing, to re- duce any fall in investment or raise its level, would be justified by the increased ease and cheapness of borrowing; and this consideration might justifiably post- pone the adjustment to worsened terms of trade beyond the two- to three-year pe- riod suggested. This would depend on the existence of sound investments that had previously been frustrated by the inability to borrow or by high interest rates on marginal borrowing. Remember, too, that however high the returns to investment, there is a prudential limit to borrowing abroad (see chapter 4). The oil price rise of 1973-74 came on top of a general rise in world prices. The reaction of countries was in some cases influenced by the fear of 'importing" inflation. It is questionable. however, whether fighting such a price rise-either by controls or by deflationary action on the domestic front-was a good idea. A jump in world prices such as that of the early 1 970s would tend to result in a once-and- for-all desirable adjustment of and rise in domestic prices.4 This is referred to as 'adjustment inflation" in chapter 6. Countries that benefit by an improvement in the terms of trade (expected to be permanent) could expect some rise in both consumption and investment. As long as real foreign interest rates were very low, they would favor domestic invest- ment. They would have difficulty achieving a rapid rise in domestic investment, however, without embarking on ill-chosen and very low-yielding projects. Fur- thermore, the price of nontraded capital goods. primarily construction, may be forced up, also limiting the rise in efficient investment. If the gain from the change in the temis of trade were large, then a period of investment in foreign assets would be optimal while the country organized itself to sustain a somewhat higher level of domestic investment with adequate social returns. In the case of our countries, it is important to remember not only the oil shock but also the coffee boom of 1976-78. For five of them-Cameroon, Colombia, Cote d'lvoire, Costa Rica, and Kenya-this boom dwarfed the oil shock that pre- ceded it. Yet the boom could not be expected to last and did not therefore cancel any need to adapt to the oil price rise that was expected to be permanent. This ap- plies in particular to Costa Rica, C6te d'lvoire, and Kenya. since the other two did not suffer as a result of the oil price fise. 34 Boom. Crisis. and Adjustment A temporary windfall should be devoted almost entirely to savings, to be matched by domestic or foreign investnment. As we have already emphasized. good domestic investments take time to prepare. and the increased expenditure may be delayed for several years. The best strategy is to buy toreign assets that can later be sold when nmore profitable donmestic investment expenditures are made. In this respect, the optimal reaction to a temporary windfall does not differ from a sudden improvenment in the temis of trade that is expected to last. Unlike oil production, coffee production is usually in the hands of small pro- ducers. The government may or may not permit the windfall to accrue to them. If it does, they too will normally want to save most of the windfall, but acquiring tor- eign assets is difficult for them, even if it is legal. Adequately attractive domliestic financial assets may also be unavailable. What would be optimal for a country and its citizens may thus be prevented by financial controls or by the un(derdeveloped state of domestic financial markets. It may even be difficult to invest" in durable goods. As a result. the windfall recipients may be (Iriven to consume nmore than they otherwise would or to make low-yielding direct investmiients in hotise or tarm improvenments. Reactions to exogenous events may also be affected by the initial state ot the economy, whether it is in good shape or is besieged with problems. Inflation was among the most important of such probleims notably in Argentina. Brazil, and Chile. but to a lesser extent in most other countrics (see chapters 6 and 7). Reac- tions may in addition be affected by exogenous events that are peculiar to the country in question, such as drotughts in Indiai. We now turn to actual policy reac- tions in the eighteen countries. The Policy Responses of the Countries Adversely Affected by the 1974 Terms-of-Trade Shock Three consequences of the terms-of-trade shock were of concern to policynmakers in the eighteen countries: the deterioration in the balance of paynments. an acceler- ation of inflation, and a fall in demand for donmestic output. We consider first the ten major losers from this point of view, beginning with the ftour that chose to (de- flate: Chile. Sri Lanka, Kenya, and Thailand. Chile's current balance in 1974 was virtually uncthanged (lespite a deteriora- tion in the terms of trade, since the volume of copper and other exports hdlid risen sharply. At the end of 1 974, however, the copper price fell f'rom $1 .50 per pound to $0.50 per pound. Since the Pinochet regime believed that the anticipated large current account deficit could not be financed, it initiated a massive fiscal and nmon- etary contraction. There was an across-tlhe-board reduction in public sector spend- ing of 15 percent, together with tax increases. The fiscal deficit of 5.5 percent of GDP in 1974 became a surplus of i .2 percent in 1975. an amazingly large turn- around in a short time. The public sector wage bill andl investment were drastically 7The Period of Cheap and Easy Credit, 19.73-1979 35 cut. GDP fell by about 12 percent, and real income by much more as a result of the deteriorating terms of trade. The external deficit was thereby contained. WVhile the dollar value of exports fell by 26 percent, that of imports fell by 20 percent, despite the rise in import prices. The result was a further rise in the current account deficit, from about $300 to $500 million. Of the ten countries. Chile was the only one to experience a recession, that is, an absolute fall in GDP. The others did no worse than suffer a fall in the rate of growth of GDP. Were the savage deflationary policies undertaken solely because of the belief that the projected deficit could not be financed? There were other disturbances in Chile. In 1974 the quarterly rate of inflation was nearly 50 percent, but the author- ities devalued faster than the rate of inflation until the second quarter of 1975 and thus did not appear to be unduly concerned about inflation. It was only in April 1975, when quarterly inflation reached 70 percent, that the authorities began to tackle inflation explicitly; the quarterly rate was quickly halved. Chile's efforts to control inflation are considered at length in chapter 7. Another factor that was at least concordant with the public expenditure cuts was a determination to reduce the role of the public sector. Sri Lanka was another country whose government did not believe it could fi- nance the deficit that would arise if no action was taken. It tightened already tight exchange restrictions and also took deflationary fiscal action, mainly by reducing food subsidies. Aid flows and borrowing rose from about I percent to nearly 4 per- cent of GDP, and it seems that the deflationary measures taken were probably nec- essary. They were not so severe as to cause a recession. Devaluation was not contemplated. Like Chile and Sri Lanka, Kenya suffered a large terms-of-trade shock. It was already fighting a balance of payments problem arising from an earlier public in- vestment boom. It borrowed further from the IMF and the World Bank, and also from some commercial sources. As in Sri Lanka, there was also some tightening of restrictive import and credit controls. Government investment was reduced, and other investment also fell, no doubt as a result of the credit squeeze. Government consumption rose, however, supported by foreign borrowing. Kenya was one of the few countries in which investment fell as a result of the termis of trade shock. GDP growth was very low in 1974 and 1975 (and fell on a per capita basis). There was a devaluation of 14 percent in 1975. The balance of payments was turned around by the coffee boom in 1976. and strong growth was resumed. Thailand experienced a fairly severe terms-of-trade shock in 1974 and was one of the few countries to take immediate deflationary action. The growth of pub- lic expenditure was moderated, while tax revenue proved to be buoyant. The con- solidated public sector balance changed from a deficit of 3.5 percent of GDP in 1973 to a surplus of 0.5 percent in 1974 (Warr and Nidhiprabha, forthcoming). The Bank of Thailand also adopted a mild deflationary policy. This appears to have been done more because of the inflation bubble that had begun in 1973 and reached 24 percent in 1974 than because an excessive current account deficit was feared. As it turned out, the current account deficit was actually well below its 36 Boom, Crisis, arnd Adjustmnent long-run average. Output suffered insofar as the rate of growth was only about 4.5 percent in 1974 and 1975. well below the average of more than 7 percent for the 1970s. Expansionary policies were resumed in 1975 when the inflation rate came back to 5 percent. There was no adjustment to the changed terms of trade, and def- icits continued into the 1980s at higher levels than in the previous decade. Our analysis of optimal policy might suggest that these four countries should not have taken deflationary action. It is not clear that political conditions or the ideological bent of economic policies would have permitted further borrowing in the case of Chile or Sri Lanka, and Chile's reactions were also much influenced (in the year of 1975) by the extremely high inflation inherited from the Allende period. The fairly mild deflationary action in Kenya and Thailand might perhaps have been avoided with somewhat greater recourse to foreign borrowing in 1974 and 1975. Brazil and five other countries suffered losses because of the shocks while avoiding deflation. Along with Brazil, the others-Costa Rica, Cote d'lvoire, Cameroon, Pakistan, and Korea-apparently expected a fall in demand because of the oil price shock. A less positive interpretation would be that these countries showed no concern for the balance of payments deterioration because they rightly believed that they could easily borrow. They also showed little concern for the jump in inflation, probably believing, in most cases correctly, that it was a world- wide phenomenon that would reverse itself (see chapter 6). Brazil's reaction was to tighten import controls somewhat and exercise sonle mild fiscal and monetary restraint in 1974, which was in any case justified by the fact that the economy was already probably overheated before the oil price rise. This policy of restraint was temporary, however. Before the end of the year, the government initiated a large new program of long-gestation import-substituting investment in the energy field. It made no other adjustment to the adverse terms- of-trade shock. Indeed, the oil price increase was not fully passed on to consumers or producers. The exchange rate policy (consisting of frequent small devaluations intended to achieve purchase power parity) was unchanged. High levels of bor- rowing continued throughout the 1970s, and inflation increased. In Costa Rica, there was a huge rise in the current account deficit and a burst of inflation. Although Costa Rica was accustomed to price stability, the authorities nevertheless permitted domestic credit to expand rapidly in order to avoid any re- duction in aggregate real expenditure. On top of this, they initiated a public invest- ment boom in 1975. The coffee boom of 1976 perniitted this exuberant neglect of adjustment to continue for a while. Cote d'lvoire started a large public investment program in 1974. The terms- of-trade shock in that year was negligible, since improved cocoa and timber prices had offset the oil price increase. Although the terms-of-trade shock in 1975 was severe and the current account deficit rose to about 10 percent, the public invest- ment plans were not modified. In 1976 they were supported by the beginning of the coffee boom, when borrowing was reduced, only to rise to very high levels in 1978 and after, as the terms of trade worsened again. There was, of course, no The Period of Chzeap and Easy Credii, 1973-s979 37 change in the nominal exchange rate, since Cote d'lvoire is a member of the Franc zone. Cameroon's exports were, in 1974, very similar to those of Cote d ' Ivoire. Not surprisingly, its terms of trade over 1974 and 1975 were also similar. Unlike Cote d'lvoire, Cameroon took no expansionary action in 1974, and its GDP fell margin- ally in 1975, in contrast to a strong rise in Cote d'lvoire. Thereafter, GDP grew rap- idly in both countries. Oil was discovered in Cameroon in 1973, and the investment booms of 1976 and later years was partly due to Cameroon's invest- ment in oil production. Pakistan had just started an ambitious program of public sector investment (in 1973) when the oil shock hit. The effects of this shock were compounded by a fer- tilizer price rise, serious floods, and the international textile recession. The current account deficit went from I percent to 10 percent of GDP, but this jump was easily financed by borrowing on favorable terms, mainly from the members of the Orga- nization of Petroleum Exporting Countries. Although inflation rose to 23 percent, this did not alarm the authorities and produced virtually no policy reaction. The government made some unsuccessful attempts to reduce current expenditure but planned no cuts in capital expenditures and made no change in the nominal ex- change rate. In short. Pakistan borrowed its way through the unfavorable exoge- nous shock. Korea was among the countries concerned with the loss of output that would stem from the terms-of-trade shock. Like Pakistan, Korea felt some repercussions from the world textile recession of 1974. The terms-of-trade shock was quite large, and the current account gap widened in 1974 to more than 10 percent of GNP. It was easily financed, however, mainly by the use of reserves and by borrowing from the IMF. The public sector deficit was allowed to increase, and the won was devalued by 21 percent in December 1974. The growth rate fell to about 8 percent in 1974 and 1975-almost a recession by Korean standards. By 1977 the current account deficit had been eliminated. Inflation rose moderately but became a matter of concern only later. The required adjustment was thus achieved with little or no loss of output. The exogenous shocks also had some adverse effects on Argentina, Colom- bia, Mexico, Turkey, and India. Although these countries felt only a small terms- of-trade shock in relation to GDP, it was large in relation to exports, except in Co- lombia. Since there was no shock in Colombia, no policy reaction was needed. Easy borrowing allowed Argentina, Mexico, and Turkey to ignore the balance of payments deterioration. They had all initiated public sector investment booms in 1973 or earlier, and these booms were allowed to continue. India is a special case because its policy response was extensive, although it responded more to inflation than to the balance of payments deterioration. The in- flation in turn was due far more to bad harvests than to the rise in import prices. The years 1971-72 and 1972-73 had brought drought and a decline in cereal pro- duction. Moreover, in the recovery year 1973-74 both cereal output and general agricultural production were still below trend.5 Largely for this reason, but also 38 Bonm. Crisis. and Adjusinhent because of expansionary fiscal and monetary developments, inflation accelerated. It rose from about 6 percent in 1971-72 to 10 percent, 20 percent. and 25 percent in the following three years. (Anything above 10 percent is regarded as critical in India.) Of course, the rise in import prices contributed to inflation in 1973-74 and 1974-75, but it did not play as large a role as in many countries, since import and export prices are small components of the costs of production and living in India. The fiscal laxity of the early 1970s, which was reversed only in 1973-74, was a contributory cause. This in turn can be at least partly explained by exogenous events-the bfief war with Pakistan in 1971. the influx of nearly 10 million Hindu refugees from Bangladesh in that year, and the relief requirements, including tood subsidies, arising from the drought in 1972-73. The policy response began quietly in 1973-74. Government expenditures were reduced (by 2.3 percent of GDP) and monetary policy was also tightened in mid- 1973. Nonetheless, inflation continued, and severe budgetary measures were taken in March and July 1974, when the emphasis was on reducing disposable in- comes via taxation and incomes policy, though public investment was again re- duced. Inflation actually went into reverse in the fall of 1974. The quite modest deficits were easily financed by the use of reserves and bor- rowing from the IM. They would, of course, have been larger without the defla- tionary measures described. The current account turnaround was dramatic, with a surplus of nearly 2 percent of GNP by 1976-77. A large part of the explanation is that inflation fell below the world rate for several years. with a consequent depre- ciation of the real exchange rate and a boom in exports. Large stocks of foreign exchange and cereals were accumulated. It could be (and was) argued that India overadjusted. Three Gainers from the 1974 Terms-of-Trade Shock: Indonesia, Nigeria, Morocco Two of the three countries that experienced a positive terms-of-trade shock were the oil exporters Indonesia and Nigeria. The shock was greater for Nigeria. By 1973 oil production was about 17 percent of GDP in Nigeria and 12 percent in In- donesia. Oil made up 85 percent and 50 percent of their total exports, respectively. Nigeria also experienced a large rise in the quantity produced from 1970-74 on. This was an exogenous event, but it was not strictly a shock for it was expect- ed. For the period 1974-78, Gelb (1988) estimates the windfall (counting both quantity and prices as windfall) at about 23 percent of nonmining GDP in the case of Nigeria and 16 percent in the case of Indonesia.6 In both countries, the doniestic windfall accrued in the first instance entirely to the government. Therefore the do- mestic consequences depended on what the government did with its new revenues. If, for instance, it used it all to buy foreign assets, there would have been no do- mestic consequences at all. The Period of Chleacp and Easy Credil, 1973-1979 39 In 1974 both countries had a large turnaround in the current account, about 5 percent of GNP in Indonesia and 16 percent in Nigeria. From 1975 through 1978. both reverted to current account deficits, owing to massive increases in investment as a proportion of (a rapidly rising) GNP. Between the first half of the 1970s and the second half, the average investment share in Nigeria rose from 17 percent of GNP to 25 percent, and in Indonesia from 20 percent to 25 percent.7 In both countries the shares of consumption fell. This drop was even more pronounced in the case of private consumption.8 The main reason for this reaction was probably that the government had wanted a higher level of investment but could not previously achieve it without unpopular measures. The government was able to keep all or most of the windfall for investment or public consumption with- out imposing an actual burden on the people. Moreover, it might have been quite difficult to transfer most of the windfall to the private sector without disturbing re- ductions in taxation, and in Nigeria a total elimination of nonoil taxes would not have been enough to transfer the whole of the windfall. The choice between in- vesting at home or abroad went heavily in favor of domestic. mainly public, in- vestment. In both countries this had the expected effect of bringing about a real appreciation. that is. a rise in the price of nontradables in relation to nonoil tradables. In the early 1980s, Nigeria's GDP fell heavily while Indonesia continued to progress and avoided any debt rescheduling (chapter 4). Their different perfor- mances in the 1980s can be traced back to differences in the treatment of their 1974 windfalls, particularly Indonesia's better choice of new investments. In con- trast to Nigeria, it devoted a much higher proportion of public development and capital expenditure to agriculture and rural development. This move would have helped to offset the depressing effect on agriculture of the real exchange rate ap- preciation. Furthernore, in November 1978 Indonesia devalued the rupiah from 415 per U.S. dollar to 625. This was done not for any balance of payments reason. but mainly to reverse the real appreciation and hence stimulate agricultural and other traditional outputs and exports. The different treatment of agriculture had important consequences. Nigerian exports, other than oil, virtually vanished, while Indonesian nonoil exports rose from 25 percent of the total in 1975 to 43 percent in 1979. The third country to benefit from the terms of trade in 1974 was Morocco, whose gain from the quintupling of phosphate prices far outweighed the loss from the oil price increase. Even before the phosphate boom, it had stepped up public investment, in 1973, and although it had done so largely for internal political rea- sons, the increasing ease of borrowing that was already evident in 1973 may have had some influence. In 1976 the price of phosphate fell 50 percent, but the govern- ment kept to its investment plans. The current account, which had been in surplus in 1974, deteriorated to a deficit of 17 percent in 1977. Investment rose from 17 percent in 1973 to 35 percent in 1977, while consumption approximately main- tained its share ot GNP. False expectations and an inability to retreat quickly when expectations proved to be false led Morocco into deep trouble. 40) Boo(In, Crisis. and A/ldjusinent The Coffee Boom Unlike the oil price shock, the coffee boom of 1976-78 should certainly have been perceived as temporary. The boom had a large impact on five countries in our study: Cameroon, Colonibia, Costa Rica, C(te d'lvoire. and Kenya. 9 AlthoLigh Brazil is also a mlajor coffee producer, and frost in Brazil was the cause of the boom, it is excluded from this survey because Brazilian exports are not dominated by coffee. The average price of coffee in 1977 was three times the 1975 average. Table 3-2 compares the terms of trade for these countries between the period 1973-75, which catches the oil price shock. and 1975-77. which catches the coffee shock. For all five countries, the coffee boom was more powerful than the oil price shock. so all had better terms of trade in 1977 than 1973. Then the coffee boonm died away in the late 1970s, leaving Cameroon, Costa Rica, and Kenya with worse tenris of trade than before the oil price shock. Colombia had not suffered an oil shock, and its terms of trade in 1979 were much better than in 1973. Ce5te (IFvoire, less de- pendent on oil inmports than Costa Rica or Kenya, also enjoyed better terms of trade in 1979 than in 1973. The countries differ greatly in the extent to which the windfall accrued to the producers or to the government. In Costa Rica and Kenya. the whole price rise ac- crued to producers. Colombia had an export tax, and also a coffee fund, to help stabilize the price producers received. About 75 percent of the rise from 1975 to 1977 was passed on to producers (but the amount withheld was not ranked as gov- ernment revenue). The West African countries used governmental commodity sta- bilization funds not only to stabilize the receipts of famiers but also to tax them heavily. In Canieroon, producer prices rose about 60 percent when world prices rose 200 percent. Producers in C6te d'lvoire received about half the world price. less when it was high and nmore when it was low. Despite these differences, government revenues in four of the five countries roughly doubled from 1975 to 1978. In Costa Rica and Kenya, the rise was only an indirect consequence of the boom, but no less rapid. Only in C6te d'lvoire did revenues rise niuch higher-close to 170 percent-owing to the surplus of the Table 3.2 Terms-of-Trade Index for Five Coffee Exporters, Selected Years Country 19.73 1975 1977 1979 Canieroon 100 69 131 91 Colombia 100 1 (X) 196 144 Costa Rica 1(0 76 109 87 Coted'lvoire 100 85 152 123 Kenya 100 81 124 92 Source: World Bank data except for Kenya, in which case see Bevan, and others tunpublished). Thle Period oJ Cheap and Easy Credit, 1973-/ 979 41 stabilization fund. It did not take long for government expenditures to catch up with, and overtake, revenue. Only Colombia ran a budget surplus over the period of 1976 through 1978. Cote d 'Ivoire. with its huge rise in public revenue, achieved a small public sector surplus in 1976 and 1977, but this turned into huge deficits in 1978 and later years. Government reactions differed in the two West African countries. CUte d'lvoire had already started increasing public investment in 1974. The coffee (and cocoa) boom supported this policy and may have magnified it. When coffee and cocoa prices started to fall in 1978, public investment probably stopped rising as a proportion of GNP, but remained very high for several years. Borrowing exceed- ed 15 percent of GNP. Cameroon experienced a more modest investment boom, which was related to the exploitation of its newly found oil reserves. Fiscal policy was much more conservative, and 1978 saw a surplus, although oil revenues were as yet a trickle. Of the two Latin American coffee exporters, Colombia had somewhat the same experience as Cameroon. and Costa Rica's was like that of Cote d'lvoire. Al- though the proceeds of the coffee price rise accrued mostly to the private sector in Colombia, the boom was moderated by appropriate fiscal and monetary policy. Both the budget and the current accounts were in surplus through the period 1976- 78. Colombia was the only coffee boom country in which domestic investment as a proportion of GNP did not rise (or fall), although reserves rose by about $2 bil- lion. By contrast, Costa Rica was already experiencing a surge in government-led investment when coffee prices rose and helped support the surge. Despite higher revenues from coffee, the budget deficit increased, and the current account deficit, although reduced in 1976 and 1977, remained very high (about 8 percent of GNP). As coffee prices fell. the deficits became enormous, as in C6te d'lvoire. In both countries. the adverse effects of the oil price shock reasserted themselves when the coffee high died away. Kenya also experienced an investment boom starting in 1976. This is the only case in which the investment boom was clearly a consequence of the coffee boon. The windfall accrued initially to the producers. Bevan and others (unpublished) reck- on that 60 percent of the rise in income was saved, a clear indication that the peasant producers understood the price rise would not last. The investment boom was more private than public. While public investment also rose. the increase in public con- sumption was greater and proved hard to compress when coffee prices retreated. Were government and private reactions to the coffee boom rational or opti- mal? Certainly, a rise in savings was a rational reaction. The Kenyan experience might suggest that more of the windfall would have been saved had more re- mained in private hands or been passed on through reduced tax rates. Another in- teresting question is how much ot' the savings should have been (levoted to domestic investment and how much to the acquisition of foreign assets. It would seem best to have devoted a large proportion to foreign assets, including reserves. A sudden burst of real domestic investment that may last for only a very few years is most unlikely to be efficient, unless there is a shelf of already planned and 42 Boom, Crisis. and Adjuistment appraised projects, which is seldom or never the case. Furthermore, investments always have a considerable local component (particularly in construction) that cannot usually be expanded quickly. Any attempt to do so will withdraw resources from traded goods sectors through higher prices of nontradeables. Considerable price and resource movements in response to a temporary situation are to be avoided. Except for Colombia, the coffee boom countries did not organize or per- mit any build-up of foreign assets. Perhaps they were influenced by a view prev- alent twenty years earlier-namely. that reserves are a waste of development potential. The Investment Booms in Sixteen Countries, 1974-81 We have argued that raising the proportion of GNP devoted to investment would have been a rational reaction to both the easier credit conditions and the coffee boom. The same may not be true for the supposedly permanent deterioration of the terms of trade arising from the rise in oil prices. Higher oil prices would tend to raise profitability and hence investment in energy production and energy sav- ing, but reduce investment in those industries that are heavy users of energy. In such situations the terms-of-trade deterioration should be countered by a real de- preciation that raises profitability and investment in tradeable goods production but reduces it in nontradeables. Thus the outcome is ambiguous. In fact, in every one of the countries except Brazil and India a big investment boom began between 1973 and 1978. In Brazil there was a boom from 1970 to 1975, but the level of investment in relation to GNP was the same in 1979 as in 1973. In India there was a slowly rising trend of investment from 1968 to 1985, but no surges. In nearly all of the other countries the investment boom was predominantly public. The only clear exceptions were Chile and Kenya, and possibly Came- roon. 10 Changes in the level of public investment would have been made as a mat- ter of policy, while the level of private investment would have been determined by profit expectations, possibly tempered by credit or other controls. In some of our countries, public investment was partly offset by a fall in private investment; this was true of Colombia, Mexico's first boom, Pakistan, and Thailand. In most cases private investment also rose, though less than public investment. Table 3-3 indi- cates the dates and sizes of the booms. Most started about the time of the oil price shock or a little later. In Colombia. Kenya. Mexico (second boom), and Sri l anka, the boom began in 1977 or 1978. The Oil and Phosphate Gainers As already mentioned, the rising price of oil sparked an investment boom in both Indonesia and Nigeria. Since the windfall accrued to their governments, the Ihe Period of Ulealp enzd Flo (s Credit. 197.i-1979 43 Table 3.3 Investment Booms lnv .we w el/ el U ( e it/ 0/ ;/c/a Counirv Period P,,blic Pritiae To.cl Argentina 1973-77 8.4 13.4 1 3.3 10.7 2 .7 24.1 Cameroon 1974-79 4.5 4.6 11.1 17.4 15.6 22.0 Chile (F) 1976-81 5.1 4.2 7.7 16.8 12.8 21.0 Colombia (F) 1978-83 5.5 9.1 9.9 8 1 15.4 17.2 Costa Rica (F) 1975-79 7.0 8.9 15.0 16.4 22.0 25.3 C6te dilvoire 1974-78 11.3 21.0 8.1 8.7 19 4 29.7 Indonesia 1974-8I 8.0 13.2 8.6 16.7 16.6 29.9 Kenya (F) 1977-8(0 9.0 1(.7 9.1 1 3.0 1X.1 23.7 Korea, Rep. 1976-79 5.5 7.5 18.8 25.S 24.3 33.3 Mexico (I) 197 1-75 4.7 8.9 13.3 12.5 18.0 21.4 Mexico (2) 1977-81 7.7 11.7 11.9 14.0 19.6 25.7 Morocco 1973-77 4.7 20.7 12.2 13.5 16.9 34.2 Nigeria 1974-76 4.8 17.3 11.9 14.1 16.8 31.4 Pakistan 1973-77 7.) 1 5.3 7.1 5.9 14.2 1.2 Thailand (F) 1974-81 3.7 9.2 19.7 16.5 23.4 25.7 Sri Lanka 1977-82 6.5 16.7 7.3 15.27 13.s 31.9 Turkey 1973-77 8.5 12.5 9.6 10 .1 18.1 22.5 NVon F indicates gross fixed capital fonination. Source Country studies for this volum. (cxcCpCI fr Korea). The figures for total investment diller from thlose derived fromii thc World Bank data hase (which are expressed as a percentage of ('. 1 not (CIV) gnien in the appendix tables at the end of this chapter. But there is no serious conillict. The tigires lor Korca are from ServXn and Solimano ( 1993). econonmic consequences depended on the regime's preferences and its ability to impose them. Nigeria's military governmiient was inexperienced in formulating economiiic policy and thus left this task to the bureaucracy. which it protected froni the poli- ticians In consequence of the rise in nmilitary expenditure during the civil war, the military already had more than enough resources. Political pressures on the bu- reaucracy were thus weak, and it couli pursue its own objectives. These itcluded Africanization and industrialization in the capital-intensive inmport-substituting manner that was then still in line with development thinking in niost developing countries, whether radical or nationalist. This philosophy and the great haste with whicil investment expenditure was undertaken resulted in enormous waste. In Indonesia. the windfall and the investmlent boom were of niore modest pro- portions. Sonic of the oil windfall was devoted to what tnight be considered a non- inflationary form of investing abroad--namely. patyinig otf the debts of Indonesia's state oil fimi Pertamina (see chapters I0 and 1 2 for accounts of the Pertanmina af- fair). The Pertamiina scandal weakened the influence of the advisers and officials who were most keen on capital-intensive industrial investments while it strengthened 44 Boomn, Crisis, and Adjuisrneent the position of the economic team popularly known as the "Berkeley Mafia" (they had received their economic training at the University of California, Berkeley). Above all, it sent out an early warning about the dangers of short-term borrowing. Thus, public investment in Indonesia rose less and mnore slowly than in Nigeria, and was more devoted to agriculture and rural development. Although Indonesia was also an autocracy, its governmental decisions were influenced by a greater va- riety of interests than decisions in Nigeria. Those who have studied both countries are quite clear that Indonesia's investment was much more productive than that of Nigeria. ' ' In contrast. the investment boom in Morocco was not a consequence of im- proved terms of trade. Rather, it had been initiated in the Five-Year Plan for 1973- 77, before the phosphate boom of 1974 (and before it could hiave been anticipa- ted). The plan owed much to the king's difficulties. The amiy had become mur- derously untrustworthy, and the king sought new allies within the middle class (managers, directors, bureaucrats), which therefore needed to be strengthened. At the time, Morocco accounted for one-third of the world's phosphate ex- ports (and had nearly three-quarters of the world's known reserves). No cartel could be formed, but for a while Morocco was a successful price leader. When the price quintupled, the government seized on the false expectation that the high price could be sustained, especially in view of the similar expectation for oil pri- ces. The already expansionary Five-Year Plan was therefore revised upward. Al- though the reasons for the boom were originally exogenous (from an economic point of view), it was greatly magnified as a response to a favorable external shock (the excess of the windfall gain from phosphate over thie windfall oil loss) that was expected to persist. According to Claassen (unpublished), the chosen investments focused too much on irrigation that benefited larger landowners and their export crops for thie European market. Although it could hardly have been anticipated in 1973, the prospects for such exports grew dim when Portugal, Spain, and Greece joined the European Economic Community. There was also a large capital-intensive invest- ment in phosphate derivatives, which may or may' not have been very productive. The Coffee Gainers The investment surge among the coffee gainers was not a result of the coffee wind- fall, except in Kenya. As noted earlier, Colombia succeeded in stabilizing the windfall and experienced no rise in investment during the coffee boom. Its later public investment program was planned to counter the deflationary effects of the subsequent fall in coffee prices. Costa Rica seemed to have difficulty containing the income demands of dif- ferent sections of the population and thus experienced some breakdown of the dis- tributional equilibrium that had prevailed earlier.12 The increase in public investment and central government expenditures preceded the coffee boom but was soon supported by it. Costa Rica's rather minor public investment boom Thie Period oJ Chleap and EasY C'redii 1973-1 979 45 therefore seems to have been a mixed case of an economically exogenous increase in response to political pressures and an increase induced by the coffee boom, which could not be resisted because of political econonmy pressures. In C6te d'Ivoire. it was perceived that the economy could no longer rely on the source of the outstanding growth of the 1 960s. agricultural development. Fur- thermore, there were large and growing inequalities between the North and the South, the latter having been the main beneficiary of growth. These factors evi- dently convinced President Houphouet-Boigny of the need for a vigorous govern- ment impetus, and he initiated the Programme du Nord at the end of 1974. This was the first time that C6te d'lvoire had experimented with massive public invest- ment expenditures. More than $415 million was to be spent on one sugar-growing and processing project (SODESUCRE). The program was accelerated as revenues rose with the cocoa and coffee boom, but the new strategy of growth (to be led by public sector investment) had been decided before coffee and cocoa prices rose. Cameroon's investment surge began in 1974, largely in response to the need to exploit its new oil discoveries. Because of the coffee boom. this could be ac- complished without excessive current account deficits and foreign borrowing. Ac- cording to table 3-3, the boom was mainly private, but in Cameroon's case parastatal investment is counted as private. Kenya's brief investment boom from 1976 to 1978 occurred mainly in the pri- vate sector and was clearly a result of the rise in incomes. Although the windfall accrued directly to producers, government revenue also rose substantially (be- cause of general taxation, also because of some relaxation of import restrictions, which brought a rise in tariff revenues). A large part of the growing public revenue was spent on consumption, although public investment also rose. The greatest in- crease in investment in this period occurred in the private sector. The way in which government macroeconomic policy affected private savings and the efficiency of this private investment are particularly interesting. 1 3 Owing to exchange controls, private savings could not be invested abroad. Import quotas were in force but were relaxed, so that there was a surge in imports of durable consumption goods, partly, no doubt, because it could be anticipated that quotas would soon become less relaxed again, and capital gains would be made. Such imports count as consumption, of course, although they were really a form of personal investment in this case. Furthermore, the policy of financial re- pression with low controlled interest rates implied that the acquisition of financial assets was an unattractive form of savings. Real investment, especially in con- struction, therefore received an unwarranted impetus. The upshot was that the pri- vate sector received strong incentives to acquire real assets immediately. With freer markets, the use of the windfall would have been spread over a longer period, and the resulting investment would presumably have been more efficient. 46 Boom, Crisis, and Adjustment The Eight Losers Consider now the situation in the eight countries that werc adversely affected by the 1974 terms-of-trade shock and that did not benefit from the coffee boom. In five of these, investment started picking up either well before the terms of trade shock (in Argentina, Turkey, and Pakistan, and in Mexico during the first boom) or was more or less contemporaneous with it (in Thailand). Note that in every case the boom began for essentially political reasons and was not interrupted by the ad- verse terms-of-trade shock, which was quite large in relation to exports. The ease of borrowing permitted this. Mexico had two booms in the 1970s. The first (from 1971 to 1975) had en- tirely internal-political, institutional, and personal-origins and dates back at least to the student revolt of 1968. It led to increasing concern about the inequality of income distribution, and this inspired leftist elements within the governing po- litical party, helping them to gain influence. During the first year of Echeverria's presidency (1971), the Treasury maintained its traditionally powerful role, but Echeverria soon became convinced that policy in 1971 had been too restrictive, and departments were ordered to double the spending levels of the 1971 budget. He personally initiated the investment boom and was responsible for the erosion of the conservative countervailing powers of the Treasury. This erosion was com- pleted by the succession to that office of the next president, Lopez Portillo. The boom and rising public deficits were sustained by foreign borrowing (and a rise in the inflation tax) until 1976, when there was a devaluation and moderate correc- tion of the deficit. Huge new oil deposits had been discovered and by 1977 oil exports amounted to $1 billion. This was still only a trickle compared with the flood that was to come. The flood could be anticipated, however, and the availability of foreign fi- nance seemed to be unlimited. Therefore, although the public deficit was very high by historical standards (3.3 percent of GDP), the second public investment boom (1977-81) was initiated. The second boom had its origins both in the political and institutional changes associated with the first boom (which had after all not ended in disaster), and in favorable exogenous events, both internal and external. In Argentina, the public investment boom began with the Peronist govern- ment of 1973-75. Initial conditions were favorable, with high reserves and a cur- rent account surplus in 1973 resulting from high prices for wheat and meat. It was evidently part of a rather typical program designed to restrain inflation by price and wage agreements within the framework of a 'social pact" and to promote real growth through increased investment and fiscal deficits. The new investments were understandably concentrated in the energy and defense sectors. The invest- ment boom continued under the military government that succeeded in 1975, de- spite a large current account deficit in that year. It continued through the Martinez de Hoz period, until early 1981. The major investments were undertaken by public enterprises, many of which were under military control. Their expenditures were beyond the control, and probably even the knowledge, of the Finance Ministry. Thze Periud of Cheap and Easy Credit, 1973-/979 47 They were the main reason for the public sector deficits that undermined the Mar- tinez de Hoz attempt to conquer inflation in Argentina (see chapter 7). In Turkey. a party with an explicit social democratic ideology (the Republican People's Party) took the lead in the 1973 elections, obtaining a plurality of seats rather than a majority. The growing strength and aspirations of distributional coa- litions implied, at least in the eyes of the government, that these could be con- tained and satisfied only by rapid growth. Also in 1973, there was a surge in remittances from Turkish workers, mostly in Germany, and this peaked in 1974. The public sector expansion was planned before the oil price shock of 1974, which, together with the Cyprus war, put the current account back into deficit. The new opportunities of borrowing permitted the public sector-induced boom to con- tinue for a while. The political economy explanation of the boom is very similar to that given for Costa Rica. Several factors lay behind the public investment boom in Pakistan, which was embarked on in 1974 at virtually the same time as the oil shock. Although the shock was quite severe, it was largely offset by a rise in remittances from Pakistani workers in the Middle East. Furthermore, instant cheap loans were available from Islamic oil-producing countries. Thus, despite increases in the price of oil and fer- tilizer, external circumstances permitted the boom. In Thailand, the rise in total investment from 1974 to 1981 was quite small, but it was not matched by any rise in savings and therefore added to the current account deficits. The increase in public investment, mainly for power and irriga- tion, was large but was partly offset by a fall in private investment. In Chile, Korea, and Sri Lanka, the investment boom began well after the terms of trade shock, which affected all three severely. Chile and Sri Lanka were among the few countries that took deflationary action in 1974. Chile's subsequent investment boom was in effect a recovery from a deep recession. The ratio of in- vestment to GDP did not rise above the normal levels for the years before the dis- turbances of the Allende socialist government in 1970-73. Nevertheless, it was remarkable in several respects. It was wholly private and arose out of a major lib- eralization of domestic capital markets that produced a huge increase in financial transactions and a rampant stock market boom. (The financial boom and subse- quent crisis are discussed further in chapter I0.) The confidence in the future en- gendered by the liberal reforms of the Pinochet regime is evident from the surge of domestic borrowing, often at very high real interest rates. The boom lasted into the 1980s and was accompanied in its later stages by massive foreign borrowing. The story of the collapse is recounted in chapter 4. Sri Lanka suffered greatly from the changes in international prices in 1973 and 1974. In response. its increasingly autocratic United Front government im- posed extreme austerity, associated with yet further import repression. There was some relief in 1976 and 1977 as tea prices rose (a blip in Sri Lanka's almost ever- declining terms of trade), but this was too late for the United Front. The United National party under J. R. Jayawardana won an overwhelming victory in the 1977 elections. This was the first time any single party had obtained a majority. 48 Born. Crisis, and Adjustnieni In addition. external circumstances (in the fornm of rising tea prices) and the austerity of the previous government had helped Sri Lanka accuniulate substantial reserves, totaling as much as ten months of imports. The new government imme- diately embarked on extensive economic liberalization somewhat akin to that in Chile under Pinochet and that in Turkey in 1980. Aid donors responded enthusi- astically and underwrote the changes by large increases in aid. There was, perhaps, some tension between the (relatively) free-market liberalization policy and the government's effort to spearhead growth by a massive increase in public invest- ment. The program was to some extent populist (the huge Mahaweli power and irrigation project, and the housing program, for example, were expected to benefit large numbers of people). It was also probably felt that this was the only way to absorb quickly the large amounts of aid that were on offer. The notable feature of Sri Lanka's investment splurge is that it was associated with a major change in economic policy and with foreign support. It resembles Turkey in 19890-1 in these respects. ' 4 Korea's investment boom of the mid-1970s originated in a decision made in 1972 to transform the structure of the national economy in the direction of heavy and chemicals industries (HCI). One factor influencing this decision seems to have been President Park's perception, based on a (mis)reading of the so-ca1led Nixon Doctrine, that Korea needed to beconie more self-reliant in nianpower and in fire- power for the sake of its national defense and therefore needed to build up its steel, shipbuilding, machinery, and associated industries. Another factor was the per- ception that Korea's wages were moving out of the "'cheap labor" category and that the country would gradually have to yield its strong labor-intensive export products to those with cheaper labor. With an eye on the model ot Japan. some of its officials believed that a strong public initiative was required to shift the struc- ture of production toward the more capital-intensive products that Korea could plausibly hope to export profitably, after a settling-in period. To this end. Korea in 1973 launched an ambitious investment plan that was overwhelmingly private but with government direction, encouragement, and cred- it and tax advantages. It was derailed almost imniediately by the first oil shock but was put back on track in 1976 after a relatively rapid adjustment to that shock (aid- ed by strong export performance, including income from overseas construction, and energy conservation measures). By 1978 the economy was clearly overheated, and in March 1979 a major stabilization program was introduced to combat infla- tion and the loss of export competitiveness as domestic prices rose in the presence of a fixed exchange rate (unchanged against thc dollar from December 1974 to January 1980). The stabilization program was largely planned before the second oil shock, although President Park's decision to scale back the HCI program (some of its inefficiencies had become manifest by this time) may have been influenced by the early effects of the oil shock. The Korean ratio of investment to GNP rose from 25 percent in 1973 to a peak of 36 percent in 1979 before being scaled back to3 1 percent in 1981. T,e Period of Cheap and Eas v C(red/l 1973-1979 49 Thie Causes oqflte Inzvestnment Boonms In only three cases-in Indonesia, Kenya, and Nigeria. can the investment booms in our countries be traced to a favorable external exogenous shock. The second boom in Mexico was partly caused by the internal exogenous shock of new oil dis- coveries. In fourothercases (Cameroon. Costa Rica, Cote d'lvoire. and Morocco), a rise in commodity prices supported, and in at least one case magnified, a public investment boom that was already under way. In Colombia. and perhaps Pakistan. the boom was motivated by an lnfa or- a-ble change in economic circumstances that was expected to depress domestic output. In short, it was instituted for standard Keynesian reasons-a countervail- ing policy pennitted by substantial reserves or ease of borrowin. Intemal political reasons seem to have played a large role in the booms of Ar- gentina. Costa Rica, Cote d'lvoire, Mexico, Morocco. and Turkey. Apparently these countries felt that increased government investment, and no doubt the induced rise in output, would relieve internal tensions. In Turkey and Sri Lanka. a change of gov- ernment was associated with a radical changc in economic philosophy. The Korean boom. although mainly private. began as a result of the structur- alist theory that thc economy required a big shove by the government to move to the more capital- and skill-intensive phase of developnient that was becomino ap- propriate. Chile was exceptional in that its boom was whiolly private and started fronm a very low level. The only common element in all the countries was the greater ease and cheap- ness of foreign borrowing. Even those in which the boom was cause(d by a favor- able shock did not take long to start borrowing. The Uses of Borrowing In view of the debt crisis that ensued, the next important question to ask is, What uses were madc of the borrowed funds? In principle, if a country borrows to in- crease investment there should be no debt problem. This statement, however, car- ries two important provisos. The first is that thle investments have a real cconomic return that is at lcast equal to the real rate of interest. Since the borrowing is pre- sumably in foreign currency. the required equal rate of return must also be ex- pressed in foreign currency. This does not mean that investments should iot go into nontraded good sectors. They, too, may have important indirect earnings or savings of foreign exchange. Indeed, the value of every input and output of any investment project in the final analysis depends on its estimated direct and indirect use, savings. or earnings of foreign exchange, and the required methods of esti- mating that value are prescribed in one of the standard systems of cost-benefit analysis. 1 The second proviso is that repaynients should not be scheduled so as 50 Boom. Crisis. and Adjugstment Table 3.4 Investment, Consumption, and Net Borrowing (percenlage oj(,DP) Growth of National Net real in Lestment Consumption borrowing (consufmption Country 1970-73 74-79 1970-73 74-79 197(-73 74-79 pet head Argentina 20.3 24.5 79.5 74.3 1.1 -1.5 0.6 Brazil 20.5 23.2 80.5 80.2 1.6 3.8 9.4 Cameroon 18.5 20.9 91.4 89.7 3.2 2.5 3.3 Chile 13.5 16.9 90.0 86.9 3.0 4.6 9.4 Colombia 19.0 18.6 84.3 80.6 2.8 -0.5 3.3 Costa Rica 20.7 22.5 86.6 87.2 6.1 9.1 6.7 C6te d'lvoire 22.0 27.0 79.1 79.2 4.6 7.4 3.4 India 17.8 21.1 83.3 79.6 0.7 -0.4 1.0 Indonesia 18.4 23.3 81.5 73.7 2.1 0.0 4.5 Kenya 24.8 23.5 81.5 84.0 4.3 6.3 1.7 Korea, Rep. 23.2 29.8 83.3 76.5 4.8 4.6 10.3 Mexico 19.8 21.9 85.5 83.0 1.6 2.3 3.4 Morocco 17.1 26.6 86.1 88.1 0.2 9.0 2.3 Nigeria 16.0 22.4 86.2 76.4 0.9 -2.0 -2.2 Pakistan 14.6 17.0 91.( 93.8 3.7 5.6 2.4 Sri Lanka 17.0 17.8 86.4 87.8 1.9 1.8 7.3 Thailand 2 3.9 26.1 77.9 78.0 ().9 3.6 3.4 Turkey 19.1 22.1 83.9 85.6 -1.5 3.6 6.5 ,VNie: Last column is average annual rate of growth of real consumption per head (including public consumption). 1 970-79. Sourcce See the tables in the appendix toi this chapter to run ahead of the benefits. Usually. however. creditors can be prevailed upon to reschedule payments if the ultimate soundness of the loan is not in doubt. Table 3-4 shows the average ratios of consuniption and investment (public and private combined) to GNP for 197(-73 and 1974-79. National investnment is here defined to exclude the usually small part that was foreign financed in the fonr of direct and portfolio investment and thus includes only investment financed out of donmestic savings and out of foreign borrowing or the use of reserves. Columnns 5 and 6 show the ratio of "net borrowing" abroad to GNP, that is. the current ac- count deficit less inflows of direct and portfolio investment.16 To what extent were the magnified foreign deficits and "net borrowing" of the period 1973-79 associated with a rise in investnient (rather than consumption ),? 17 The story of the investment boooms suggests a close relationship. Every country except Colombia and Kenya raised its investnment ratio. Of these sixteen, nine also raised the level of net borrowing. Six countries managed to raise investment significantly while reducing "net borrowing." These were the two oil exporters, Indonesia and Nigeria. and also Argentina, Ctnneroon (which began to benefit trom oil only in 1979), India, and Korea. Ten countries in all The Period of Cheap and Easy Credit 1973-1979 51 borrowed a higher proportion of GNP. All of these except Kenya increased the in- vestment ratio, and most raised the investment ratio more than they raised the bor- rowing ratio. Thus, Kenya is the only clear case of a country that borrowed primarily to support consumption. Indeed, consumption fell as a proportion of GNP in the majority of countries, and only in Kenya and Pakistan did it rise by more than 2 percent of GNP. This does not, of course, imply that real consumption fell. According to the figures in column 7 of table 3-4, the annual rate of growth of real consumption per head (including public consumption) from 1970-79 was high in several countries, most notably Brazil, Chile, Costa Rica, Korea, Sri Lanka, and Turkey. These fig- ures are suspect, however. Total current price consumption is deflated by the cost- of-living index, which is not appropriate for much public consumption. and is also known to be biased downward in several countries. By and large, from the viewpoint of 1980, and on the basis of only macroeco- nomic information, there was little reason to worry about the debt. The debt prob- lem could have been serious only if (I) the raised levels of investment yielded little or nothing, or little or nothing that could be transformed into foreign ex- change, or (2) if the increased public debt was incurred to finance the private ac- quisition of foreign assets rather than current account deficits. Summing Up the Period 1973-79 Most of the oil-importing countries managed a reasonably high growth rate from 1974 to 1979, despite the oil price shock (table 3-5, columns I and 2). Argentina and Chile were the exceptions. In most cases, however, the rate was lower than in the years 1970-73, which are generally regarded as a golden age. Even so, seven countries managed to achieve a higher growth rate-Cameroon. Chile, India, Mo- rocco, Pakistan, Sri Lanka, and Thailand. Although most countries raised the ratio of investment to GNP, the returns can have contributed little to growth in the period. Much of the new investment was in long-gestation capital-intensive projects, which, even if well chosen, would have had little impact by 1979. Moreover, there is evidence, albeit mostly anec- dotal, that some, and possibly a good deal, of the investment can now be judged, with the benefit of hindsight, to have been ill-chosen (see chapter II). The invest- ment booms and associated foreign borrowing would have contributed to growth in another way. The increased demand for domestic labor ensured that any slack in the economy was taken up. Thus, the fairly high growth rates of the 1974-79 period were probably a Keynesian phenomenon in the main, and it is unlikely that this kind of growth could have lasted much longer. Column 9 of table 3-5 indicates a deterioration in the terms of trade for all the countries except two oil exporters (Indonesia and Nigeria) and two coffee export- ers (C6te d'lvoire and Colombia). The Jeterioration was severe (greater than 20 52 Boon. Crisis. aind Adjustment Table 3.5 Some Key Indicators, 1970-79 (percent) 7ernzs GN!A"P grotr DeNbt"(G,VP Debt int"GNP CA d/efIGNP trade CotIIry 1970-73 /9'4_79 1973 1979 19,3 /979 /973 /979 1973/79 Chile 1.7 2.8 31.1 37.3 0.6 2.9 2.7 5.9 51 Cameroon 2.7 8.6 14.8 33.0 0.6 1.3 1.0 2.3 91 Coted'lvoire 6.4 5.8 26.8 47.0 1.2 3.2 9.6 16.9 123 Kenya 9.7 5.6 30.3 38.5 1.2 2.1 5.3 8.3 92 Costa Rica 7.4 5.2 27.0 43.7 1.6 3.0 7.5 14.4 87 Pakistan 4.7 4.8 64.4 40.7 1.3 1.1 1.3 4.2 63 Korea, Rep. 9.1 9.6 29.2 24.5 1.9 1.8 2.3 6.5 8X Sri Lanka 3.1 5.2 17.0 30.3 0.5 0.83 1.2 6.8 90 Thailand 7.0 7.3 8.4 14.5 0.5 1.2 0.4 7.7 76 Brazil 11.9 6.1 16.5 26.4 1.0 2.4 2.8 4.8 64 Mexico 8.5 5.8 15.7 25.1 0.9 2.4 2.5 4.0 61 Turkcy 6.3 5.3 14.4 7.0 0).4 1.1 -3.2 2.1 82 Areentina 3.6 2.4 8.9 10.0 1.07 1.07 - 1.8 1.0 64 India 2.4 3.4 13.2 12.2 0.3 0.3 0.5 0.3 73 Colombia 7.2 5.3 23.0 13.9 1.0 0.9 0.5 -1.6 144 Morocco 3.9 5.6 16.9 48.2 (0.7 2.9 -1.6 9.8 94 Indonesia 8.5 6.6 38.7 31.3 0.7 2.0 2.8 -1.9 250 Nigeria 9.8 3.9 6.3 5.1 0.2 0.3 0.0 -2.2 330 Nore: Deht and interest are long- and nicediuii-terTii only. Sho(rt-term debt figures are available for Tuost countries only from 1977. Debt figures are for end (f year. Source: World Bank, except for Kenya's terimis of trade which are taken from Bevan and others, (unpublished). percent) for seven: Chile. Pakistan, Thailand. Brazil, Mexico. Argentina. and India. Table 3-5 also shows that all the countries with worsened termns of trade, ex- cept India, increased the size of their current account deficits (or turned a surplus into a deficit, in the case of Turkey, Argentina, and Morocco). The current account deficit became very large (greater than 5 percent Of GNP) in Chile, Cote d'lvoire, Kenva. Costa Rica, Korea, Sri Lanka, Thailand. and Morocco. The definition of a sustainable current account deficit is discussed in cliaptcr 4. It is. of course, related to the optimum level of borrowing. To anticipate. we can say that a deficit of niore than 2-3 percent of GNP is unsustainable in the long run. The higher or more burdensome the existing debt, the nmore urgent it becomes to adjust, in the sense of changing policies so as to reduce the current deficit. The burden of debt, as judged by interest in relation to GNP, Was still nowhere extremely high in 1979, and had reached 3 percent only in Cote d'lvoire and Costa Rica. Some countries with high current account deficit ratios also ha(d high-a debt ratios-notably Chile, C6te d'lvoire, Kenya, Costa Rica, and Morocco. Here the need to adjust was becoming urgent. The Period oJ Chreap and Easy Credit. 1973-1979 53 As explained in chapter 1, most of our eighteen countries would have required both "switching" and "absorption" policies to correct an unsustainable balance of payment deficit. The classic switching policy is a change in the nominal exchange rate, but for various reasons, good and bad. many governments were reluctant to make this change. Import and export taxes could also have been changed, but, be- ing developing countries, most preferred to try to switch demand away from im- ported goods and toward import substitutes through controls, and to switch production toward exports through some form of subsidy. There was little use in switching policies in the period 1974-79, in compari- son with what was to come later. The high inflation countries-Argentina, Brazil, Chile, and Colombia-resorted to frequent nominal devaluations (until Argentina and Chile experimented with fixing the rate). This was also true of Turkey after 1975. The purpose of these devaluations, however, was to prevent relative domes- tic and world prices from getting too far out of line rather than to effect a change. There was no policy change as a result of the oil price shock. Early in 1974 Costa Rica unified its exchange rates, devaluing the official rate by 29 percent. It is not clear how far this was a response to the deteriorating bal- ance of payments, or how large the effective change was. In December 1974, Ko- rea devalued by 20 percent, in response to the terms-of-trade shock and the large rise in the current account deficit. Kenya also devalued, by a more modest 16 per- cent in 1975. In 1976 Mexico ran into a balance of payments crisis and devalued by a massive 60 percent: the previous boom and associated inflation had clearly resulted in a large overvaluation of the peso. At the end of 1 977, Sri Lanka also effected a large devaluation of 87 percent against the dollar; this was part of a ma- jor change of economic policy under a new government, which in addition re- moved most import and exchange controls as well as export incentive schemes. The primary purpose was to permit a more open economy (in this respect the de- valuation rather resembles that of India in 1966). The most interesting devaluation (of 51 percent) was that of Indonesia in 1978. This came out of the blue: there was no pressing balance of payments problem; the objective, which was achieved, was to improve the viability of the nonoil tradable sectors, which were suffering from appreciation of the real exchange rate. These changes in exchange rates, their mo- tivation, and their effects, are discussed in chapter 8. Some countries used controls on and off to help switch production and expen- ditures. For instance, Brazil, India, Kenya. and Sri Lanka tightened import con- trols somewhat in 1974. Some of the coffee-boom countries relaxed and tightened import controls as the value of exports waxed and waned (see chapter 9). Export subsidies were also used, for example, in Sri Lanka. As for our countries' absorption policies-fiscal and monetary-the terms- of-trade shock of 1974 was naturally deflationary. both because domestic incomes were squeezed and because the associated imported inflation caused the real mon- ey supply to shrink. Some of the suffering countries took no action, allowing al- ready expansionary policies to continue. Others initially took mild deflationary fiscal and monetary action but quickly opted for borrowing and expansion. Only 54 Boom, Crisis, and Adjustnment in Chile was the reaction so severe as to cause a major recession. In most of the countries, GDP grew more slowly in 1974 and 1975, but then 1973 had been an ex- ceptional year. Fiscal policy was the main instrument, and, within fiscal policy, expenditure (including subsidies). Few countries significantly increased their tax rates-Chile, India, and Korea were exceptions. Some countries used monetary or credit policy, however. Open market operations were nowhere significant, so that the monetary base could not be influenced independently of fiscal and payments balances. Cred- it controls were possible, however, and were used in several countries, notably in India. In some other countries, credit was more or less out of control as parastatal organizations were authorized to borrow directly from the central bank. In yet oth- ers, central bank losses were also important. (For more details on the uses of fiscal and monetary policy see chapter 10.) No country, excepting India, made a sustained attempt to adjust to the wors- ened terms of trade. A few countries initially took some action to ameliorate the deterioration in their external payments situation, but this sooner or later gave way to expansionary policies supported by borrowing. Although in some cases the combination of high debt and very large current account deficits was threatening, on the whole the debt situation was not regarded as a serious problem at the time, largely because countries were borrowing mainly to increase the ratio of invest- ment to GNP. Appendix The appendix tables to this chapter contain columns for investment (Inv). divided into direct and portfolio investment (DFI + P) and national investment (NI); con- sumption (Con); the current account (CA); remittances (R); and error. The relationship between these concepts may be explained by the following identities. In the absence of "remittances" (public and private unrequited transfers, in the jar- gon of the IMF's International Financial Statistics), (3.1) GDP = Consuniption (C) + Investment (I) + Exports - Imports. Adding in net factor income (F), we have (3.2) GNP = C + I + CA (current account). Remittances (R) contribute to the current account but not to GNP. Given their ex- istence, we therefore have The Period oj'Cheap and Easy Credit, 1973-1979 55 (3.3) GNP=C+I+CA-R. Some investment consists of direct foreign investment (DFI) and portfolio invest- ment (P). This investment (DFI + P) belongs to foreigners. We therefore write (3.4) GNP = C + NI + (DFI + P) + CA - R where NI stands for national investment. (DFI + P) goes to finance a balance of payments deficit without corresponding borrowing or the use of reserves. In the following country tables, these right-hand side magnitudes are expressed as per- centages of GNP. They should, in principle, add to 100. In practice they do not, and the tables therefore include an error term, which is positive when the other terms exceed 100. In table 3-4, we used the concept "net borrowing" (B), which is -CA - DFI - P. In this table NI + CON - B = 100 + R + error. All magnitudes are ex- pressed as percentages of GNP; therefore the error is CON + INV + CA - R - 100. 56 Boom, Crisis, and Adjustment Table 3A.1 Argentina Year Inv Dl+PI NJ CON CA R Error 1970 21.8 0.4 21.4 79.3 -0.7 -0.0 0.4 1971 21.0 0.5 20.5 79.0 -1.6 -0.0 -1.6 1972 21.1 0.1 21.0 79.4 -0.9 -0.0 -0.4 1973 18.2 -0.2 18.4 80.1 1.8 0.0 0.1 1974 19.5 -0.1 19.6 80.3 0.2 0.0 0.0 1975 26.1 -0.1 26.2 75.2 -3.4 0.0 -2.1 1976 27.2 -0.1 27.3 69.7 1.7 0.0 -1.4 1977 27.5 0.3 27.2 70.6 2.7 0.1 0.8 1978 24.7 0.7 24.0 72.5 4.4 0.2 1.4- 1979 22.9 0.4 22.5 77.8 - 1.0 0.1 -0.4 1980 22.4 0.7 21.7 81.0 -8.5 0.0 -5.1 1981 19.3 1.6 17.7 84.2 -8.4 -0.0 -4.9 1982 17.3 1.1 16.2 88.5 -4.5 0.1 1.2 1983 18.8 1.4 17.4 85.0 -4.1 0.0 -0.3 1984 12.2 0.9 11.3 91.1 -3.4 0.0 -0.1 1985 9.3 0.5 8.8 92.3 -1.6 0.0 -0.0 1986 9.4 0.0 9.4 94.2 -3.8 0.0 -0.3 1987 17.4 -0.8 18.2 88.2 -5.5 -0.0 0.1 1988 17.3 0.3 17.0 84.5 -1.8 0.0 0.0 1989 13.2 - - 88.7 -2.4 0.0 -0.5 - Not available. Source: World Bank Date and IMF, International Financial Statistics (various years). Tlte Period of C/leap and EaJsy Credit, 1973-1979 57 Table 3A.2 Brazil Year Inv Dl+PI Ni CON CA R Error 1970 20.7 1.0 19.7 80.6 -2.0 0.1 -0.8 1971 21.3 1.1 20.2 81.4 -3.4 0.0 -0.7 1972 21.4 1.0 20.4 81.2 -2.9 0.0 -0.3 1973 23.5 1.7 21.8 78.7 -2.7 0.0 -0.5 1974 25.6 1.2 24.4 81.2 -7.3 0.0 -0.5 1975 27.2 1.0 26.5 78.2 -5.7 0.0 -0.3 1976 23.5 0.9 22.6 80.5 -4.4 0.0 -0.4 1977 22.4 1.0 21.4 79.9 -3.0 (.0 -0.7 1978 23.5 1.1 22.4 80.1 -3.6 0.0 -0.0 1979 23.4 1.5 21.9 81.5 -4.8 0.0 0.1 1980 24.1 0.8 23.3 81.6 -5.6 (0.1 -0.0 1981 24.0 0.9 23.1 80.7 -4.7 ).1 -0.1 1982 22.1 1.0 21.1 83.9 -6.1 -0.0 -0.1 1983 17.5 0.6 16.9 86.0 -3.6 (. 1 -0.2 1984 16.2 0.6 15.6 83.8 0.0 0.1 -0.1 1985 17.9 0.5 17.4 82.3 -0.1 0.1 0.0 1986 20.1 -0.1 20.2 82.0 -2.1 (.0 0.0 1987 22.9 0.2 22.7 77.6 -0.5 0.0 0.0 1988 22.6 - - 76.1 1.3 (.0 0.0 1989 23.3 - - 78.0 0.2 0.0 1.5 - Not available. Source: World Bank data and IMF, International Financ lal Siats;iuts (various years). 58 Boom. Crisis, and Adjustment Table 3A.3 Cameroon Year Inv Dl+PI NI CON CA R Error 1970 16.7 1.5 15.2 86.0 -2.7 0.9 -0.9 1971 17.9 0.2 17.7 94.2 -3.9 0.8 7.4 1972 19.8 0.2 19.6 95.1 -7.0 0.5 7.4 1973 21.6 -0.0 21.6 90.4 -1.0 -0.4 11.4 1974 18.6 1.5 17.1 87.4 -0.8 0.1 5.1 1975 21.7 1.0 20.7 90.0 -6.0 0.9 4.8 1976 19.0 0.3 18.7 94.3 -3.2 1.3 8.8 1977 23.5 0.1 23.4 87.2 -3.0 1.0 6.7 1978 24.2 0.8 23.4 87.1 -4.5 0.0 6.8 1979 23.4 1.2 22.2 92.3 -2.3 0.0 13.4 1980 20.7 2.0 18.7 92.6 -5.8 0.0 7.5 198] 27.1 2.0 25.1 85.4 -5.8 0.1 6.6 1982 25.0 1.6 23.4 82.0 -4.8 -0.2 2.4 1983 26.1 3.0 23.1 76.0 -0.7 -0.0 1.4 1984 22.3 0.2 22.0 71.9 2.7 -0.1 -3.0 1985 26.6 3.8 22.8 68.5 4.3 -0.4 -0.2 1986 24.4 0.0 24.4 80.9 -6.0 -0.6 -0.1 1987 21.1 0.0 21.1 87.6 -10.2 -1.0 -0.5 1988 18.3 - - 87.6 -7.5 -1.2 -0.4 1989 13.0 - - 90.4 -1.9 -0.6 2.1 - Not available. Source: World Bank data and IMF, Inmernational Financial Stalistics (various years). Thte Period oJ Cheap and Easy Credit, 1973-1979 59 Table 3A.4 Chile Year Inv D1+PI Ni CON CA R Error 1970 16.9 -1.1 18.0 85.0 -1.1 0.1 0.7 1971 14.7 -0.7 15.4 87.6 -2.0 0.1 0.2 1972 12.3 -0.1 12.47 92.4 -4.0 0.1 0.6 1973 8.0 -0.1 8.1 95.0 -2.7 0.1 0.2 1974 21.5 -5.2 26.7 79.4 -2.7 0.1 -1.9 1975 13.6 0.6 13.0 92.5 -7.1 0.2 -1.2 1976 13.2 -0.1 13.3 85.7 1.6 0.5 -0.0 1977 14.7 0.1 14.6 89.2 -4.2 0.7 - 1.0 1978 18.2 1.2 17.0 87.5 -7.2 0.6 -2.1 1979 18.3 1.4 16.9 87.2 -5.9 0.5 -0.9 1980 21.6 0.6 21.0 85.7 -7.4 0.0 -0.1 1981 23.7 1.2 22.5 91.4 -15.1 0.0 -0.0 1982 12.2 1.7 10.5 97.7 -10.2 -0.1 -0.2 1983 10.7 0.7 10.0 95.2 -6.2 -0.0 -0.3 1984 15.1 0.4 14.7 96.8 -12.2 -0.0 -0.3 1985 15.4 0.8 14.6 93.9 -9.9 -0.2 -0.4 1986 16.5 2.1 14.4 91.9 -8.0 -0.4 0.8 1987 18.4 5.3 13.1 86.1 -4.7 -0.7 0.5 1988 18.4 5.0 13.0 82.3 -0.8 -0.7 0.6 1989 22.1 - - 82.7 -3.3 -0.3 1.8 - Not available. Source: World Bank data and IMF, Iniernational Finaneial Statistii s (various years). 60 Boom, Crisis, and Adjustment Table 3A.5 Colombia Year Inv Dl+PI NJ CON CA R Error 1970 20.8 0.5 20.3 83.7 -4.2 0.5 -0.2 1971 19.9 0.5 19.4 86.6 -5.9 0.4 0.2 1972 18.5 0.2 12.4 84.3 -2.3 0.4 0.1 1973 18.7 0.6 18.1 82.5 -0.5 0.3 0.4 1974 21.8 0.3 21.5 80.9 -2.9 0.4 -0.6 1975 17.3 0.2 17.1 82.9 -1.3 0.4 -1.5 1976 17.9 0.1 17.8 81.0 1.1 0.3 -0.3 1977 19.0 0.2 18.8 78.4 1.9 0.2 -0.9 1978 18.4 0.3 18.1 79.6 1.1 0.3 -1.2 1979 18.3 0.3 18.0 80.6 1.6 0.4 0.1 1980 19.1 0.2 18.9 80.6 -0.6 0.5 -1.4 1981 20.7 0.6 20.1 83.4 -5.5 0.7 -2.1 1982 20.8 0.9 19.9 85.1 -8.0 0.4 -2.5 1983 20.3 1.4 18.9 84.6 -8.0 0.4 -3.5 1984 19.5 1.5 18.0 83.8 -3.8 0.8 -1.3 1985 19.6 3.0 16.6 82.0 -5.4 1.4 -5.2 1986 18.7 2.0 16.7 77.9 1.1 2.3 -4.6 1987 21.1 1.0 20.1 81.4 1.0 2.9 0.6 1988 23.4 0.5 22.9 81.2 -0.6 2.7 1.3 1989 21.0 - - 81.5 -0.5 2.8 -0.8 - Not available. Source: World Bank data and IMF, International Financial Sialislit s (various years). Tlre Period oj Clreap and Easy Credit. 1973-1979 61 Table 3A.6 Costa Rica Year Inv Dl+PI 'I CON CA R Error 1970 20.8 2.7 18.1 87.4 -7.6 0.6 0.0 1971 24.7 2.1 22.6 87.3 -10.8 0.7 0.5 1972 22.7 2.8 19.9 87.1 -8.3 0.5 1.0 1973 24.7 2.5 22.2 84.5 -7.5 0.5 1.2 1974 27.4 2.9 24.5 90.3 -16.4 0.6 0.7 1975 22.3 3.6 18.7 89.6 -11.5 0.5 -0.1 1976 24.4 2.7 21.7 84.8 -8.6 0.6 (.0 1977 24.9 -2.2 22.7 83.2 -7.5 0.5 0.1 1978 24.2 2.0 22.2 86.9 -10.6 0.5 -0.0 1979 26.3 1.1 25.2 88.2 -14.4 0.3 -0.2 1980 27.9 3.7 24.2 88.0 -14.4 0.3 1.2 1981 32.7 2.7 30.0 85.5 -17.6 1.2 -0.6 1982 29.6 1.1 28.5 86.7 -12.3 1.6 2.4 1983 27.0 1.9 25.1 85.6 -9.9 2.5 0.2 1984 24.8 1.6 23.2 84.1 -4.5 4.2 0.2 1985 27.4 1.4 26.0 82.2 -3.5 6.0 0.1 1986 26.9 1.3 25.6 78.7 -1.9 3.7 0.9 1987 29.0 1.8 27.2 82.4 -6.1 5.3 0.0 1988 25.7 1.6 24.1 84.3 -4.2 6.0 -0.2 1989 26.0 - - 84.7 -8.6 3.3 -1.2 - Not available. Source: World Bank data and IMF, Iniernalional Financial Statirstcs (various years). 62 Boom, Crisis, and Adjustment Table 3A.7 C6te d'Ivoire Year Inv DI+PI NI CON CA R Error 1970 23.8 2.4 21.4 74.9 -2.7 -1.5 -2.5 1971 23.4 0.9 22.5 79.7 -3.9 -1.8 1.0 1972 22.4 1.1 21.3 80.2 -7.0 -1.6 -2.8 1973 25.4 2.5 22.9 81.5 -1.0 -3.0 8.9 1974 23.9 0.8 23.1 76.8 -0.8 -3.3 3.2 1975 24.4 1.9 22.5 84.2 -10.6 -4.0 2.0 1976 25.4 1.0 24.4 79.1 -5.9 -6.1 4.7 1977 29.9 0.1 29.8 72.6 -3.1 -5.2 4.6 1978 32.9 1.1 31.8 78.8 -11.7 -5.9 5.9 1979 31.2 0.9 30.3 83.8 -16.9 -7.0 5.9 1980 29.8 1.0 28.8 82.3 -18.4 -7.1 0.8 1981 27.6 0.4 27.2 86.5 -17.8 -6.1 2.4 1982 24.9 0.7 24.2 85.4 -14.4 -5.1 1.0 1983 22.3 0.6 21.7 87.7 -14.8 -4.7 -0.1 1984 11.8 0.0 11.8 83.6 -1.2 -4.3 -1.5 1985 13.9 0.4 13.5 82.2 1.1 -4.0 1.2 1986 12.0 0.8 11.2 83.3 -3.4 -4.1 -4.1 1987 12.6 - - 89.8 -10.2 -4.3 -3.5 1988 15.7 - - 86.5 -12.0 -4.2 -5.6 1989 11.3 - - 95.6 -14.5 -3.8 -3.8 - Not available. Source: World Bank data and IMF, International Financial Statistics (various years). The Period oJ Cheap and Easy Credil, 1973-1979 63 Table 3A.8 India Year Inv Dl+PI Ni CON CA R Error 1970 17.2 0.0 17.2 84.0 -0.7 0.5 -0.0 1971 18.6 0.0 18.6 82.8 -0.6 0.8 -0.0 1972 17.2 0.0 17.2 83.7 -0.5 0.3 0.1 1973 18.3 0.0 18.3 82.5 -0.5 0.3 -0.0 1974 19.8 0.0 19.8 81.5 -0.9 0.4 0.0 1975 20.9 0.0 20.9 79.7 0.3 0.9 0.0 1976 21.0 0.0 21.0 78.4 1.7 1.I 0.0 1977 19.8 0.0 19.8 79.8 1.8 1.3 0.1 1978 22.3 0.0 22.3 78.9 0.1 1.3 (.0 1979 22.8 0.0 22.8 79.2 -0.3 1.7 -0.0 1980 22.8 0.0 22.8 80.3 -1.3 2.0 -0.2 1981 25.7 0.0 25.7 77.5 -1.7 1.6 -0.1 1982 23.6 0.0 23.6 79.6 -1.4 1.6 0.2 1983 22.4 0.0 22.4 80.5 -1.3 1.5 -0.1 1984 22.6 0.0 22.6 80.6 -1.6 1.6 -0.2 1985 25.6 0.0 25.6 78.3 -2.7 1.3 -0.1 1986 24.5 0.0 24.5 79.1 -2.5 1.2 -0.1 1987 23.1 0.0 23.1 80.5 -2.4 1.2 -0.0 1988 24.7 0.0 24.7 79.8 -3.1 1.3 0.1 1989 23.9 0.0 23.9 80.3 -2.8 1.2 0.0 Source: World Bank data and IMF, international Financ ial Statistic s (various years). 64 Boom, Crisis, and Adjustment Table 3A.9 Indonesia Year Inv, Dl+P/ A'l CON CA R Error 1970 15.8 0.9 14.9 85.8 -3.2 0.7 -2.3 1971 18.4 1.4 17.0 83.1 -3.8 0.5 -2.8 1972 22.1 1.8 20.3 78.3 -2.9 0.4 -2.9 1973 21.2 0.1 21.2 78.9 -2.8 0.3 -3.0 1974 20.1 -0.2 19.9 74.2 2.3 0.2 -3.6 1975 24.3 1.5 22.8 76.1 -3.5 0.1 -3.2 1976 24.4 0.9 23.5 74.6 -2.3 0.0 -3.3 1977 23.8 0.5 23.3 73.0 -0.1 0.1 -3.4 1978 24.4 1.3 23.1 75.1 -2.7 0.0 -3.2 1979 27.8 0.5 27.3 69.4 1.9 0.1 - 1.0 1980 25.4 0.3 25.1 65.5 4.0 0.3 -5.4 1981 30.6 0.2 30.4 68.6 -0.6 0.3 -1.7 1982 28.9 0.6 28.3 75.7 -5.9 0.1 -1.4 1983 30.0 0.8 28.2 74.2 -7.7 0.1 -3.6 1984 27.5 0.3 27.2 73.7 -2.2 0.2 -1.2 1985 29.2 0.3 28.9 73.2 -2.3 0.1 0.0 1986 29.4 0.7 28.7 75.8 -5.1 0.3 -0.2 1987 32.9 0.5 32.5 70.5 -2.9 0.4 0.1 1988 33.1 0.5 32.6 69.4 -1.7 0.3 0.5 1989 36.5 - - 66.0 -1.2 1.0 1.0 - Not available. Source: World Bank data and IMF, Interneujonal Financial Statistics (various years). The Period of Chzeap and Easv Credir, 1973-1979 65 Table 3A.10 Kenya Year Inv Dl+PI Nil CON CA R Error 1970 25.3 0.9 24.4 79.3 -3.2 1.7 -0.3 1971 24.7 0.3 24.4 85.2 -6.5 3.4 -0.0 1972 23.0 -0.1 23.1 82.2 -3.3 1.9 -0.0 1973 27.2 -0.1 27.3 79.4 -5.3 1.3 0.0 1974 26.8 -0.0 26.8 84.9 -10.8 1.1 -0.2 1975 18.9 0.4 18.5 90.0 -7.0 1.6 0.3 1976 21.2 1.1 20.1 83.0 -3.8 0.4 -0.0 1977 24.7 1.3 23.4 76.2 0.6 1.5 -0.0 1978 31.1 0.6 30.5 83.7 -13.0 1.8 0.0 1979 23.1 1.3 21.8 86.7 -8.3 1.5 0.0 1980 30.2 1.2 29.0 84.5 -12.6 2.1 0.0 1981 28.6 0.1 28.5 83.0 -8.4 3.3 -0.1 1982 22.7 0.1 22.6 85.3 -4.8 2.2 1.0 1983 21.5 0.2 21.3 82.3 -0.8 3.2 -0.2 1984 21.5 0.1 21.4 83.4 -2.1 3.0 -0.2 1985 26.5 0.2 26.3 78.4 -1.9 3.3 -0.3 1986 22.6 0.4 22.2 80.9 -0.5 3.0 0.0 1987 25.4 0.5 24.9 83.9 -6.5 2.8 0.0 1988 26.5 0.1 26.4 83.5 -5.6 4.3 -0.0 1989 26.6 - - 83.9 -7.3 4.8 -1.6 - Not available. Source: World Bank data and IMF, Iniernalional Financial Slatisuic s (various years). 66 Boon7, Crisis, and Adjustment Table 3A.11 Republic of Korea Year Inmv Dl+PI NI COA' CA4 R Error 1970 24.6 0.7 23.9 84.5 -7.0 2.0 (). 1 1971 25.1 0.4 24.7 85.3 -8.6 1.7 0.1 1972 20.9 0.6 20.3 84.2 -3.5 1.6 -(.() 1973 24.7 0.7 24.0 79.0 -2.3 1.4 -0.0 1974 31.8 0.6 31.2 80.1 -I0.8 1.2 -(0.1 1975 27.5 0.3 27.2 82.8 -9.1 1.1 0.1 1976 25.7 0.5 25.2 76.9 -1.1 1.2 0.3 1977 27.7 0.4 27.3 73.6 0.0 0.6 0.7 1978 31.9 0.2 31.7 72.5 -2.2 1.0 1.2 1979 36.0 0.0 36.0 72.9 -6.5 0.7 1.7 1980 32.8 0.1 32.7 78.4 -8.8 0.7 1.7 1981 30.7 0.2 30.5 78.8 -6.9 0.7 1.9 1982 29.8 -0.1 29.9 77.2 -3.7 0.7 2.6 1983 29.7 0.2 29.5 74.2 -2.0 0.7 1.2 1984 30.9 0.5 30.4 72.6 -1.6 0.6 1.3 1985 30.3 1.3 29.0 71.9 -1.0 0.6 0.6 1986 29.7 0.6 29.1 67.2 4.5 1.0 0.4 1987 29.9 0.2 29.7 64.1 7.7 0.9 0.8 1988 30.2 0.1 30.1 62.5 8.4 0.9 0.2 1989 34.8 - - 63.2 2.4 0.1 0.3 - Not available. Source: World Bank data and IMF, International Financial Statistic. (various years). 7The Period of Chieap and Easy Credit, 1973-1979 67 Table 3A.12 Mexico Year In v Dl+PI NI CON CA R Error 1970 22.1 0.8 21.3 84.5 -2.9 0.1 3.6 1971 19.7 0.8 18.9 86.2 -2.1 0.1 3.7 1972 19.8 0.8 19.0 86.0 -2.0 0.1 3.7 1973 20.8 0.9 19.9 85.4 -2.5 0.1 3.6 1974 22.6 0.8 21.8 84.3 -3.9 0.2 2.8 1975 23.1 0.8 22.3 84.0 -4.4 0.2 2.5 1976 21.9 1.2 20.7 84.7 -3.7 0.2 2.7 1977 22.5 2.3 20.2 82.4 -2.2 0.2 2.5 1978 23.2 1.5 21.7 82.3 -3.0 0.2 2.3 1979 25.6 0.7 24.9 80.5 -4.0 0.2 1.9 1980 28.0 1.2 26.8 77.3 -5.7 0.2 -0.6 1981 28.4 1.7 26.7 78.0 -6.7 0.1 -0.4 1982 24.3 1.6 22.7 76.4 -3.9 0.2 -3.4 1983 22.1 -0.1 22.2 74.0 3.9 0.2 -0.2 1984 21.0 -0.2 21.2 76.5 2.5 0.2 -0.2 1985 23.0 -0.3 23.3 76.8 0.6 0.6 -0.2 1986 19.4 0.3 19.1 81.6 -1.4 0.4 -0.8 1987 20.3 1.1 19.2 77.9 3.0 0.5 0.7 1988 21.7 1.4 20.3 81.2 -1.5 0.3 1.1 1989 18.6 - - 87.9 -2.0 0.4 4.1 - Not available. Source: World Bank data and IMF, International Finanmial Stafisni s (various years). 68 Boom, Crisis, and Adjustment Table 3A.13 Morocco Year Inv Dl+PI NI CON CA R Error 1970 18.7 0.5 18.2 86.4 -3.2 1.9 0.0 1971 18.2 0.5 17.7 85.8 -1.4 2.5 0.1 1972 15.5 0.3 15.2 86.5 1.0 2.8 0.2 1973 17.1 -0.0 17.1 85.5 1.6 4.0 0.2 1974 20.8 -0.3 21.1 80.7 3.0 4.3 0.2 1975 25.4 -0.0 25.4 86.5 -5.8 5.8 0.3 1976 28.5 0.4 28.1 92.6 -15.0 5.5 0.6 1977 34.8 0.5 34.3 87.7 -16.9 5.2 0.4 1978 26.1 0.4 25.7 90.4 -10.2 5.9 0.4 1979 25.2 0.3 24.9 90.9 -9.8 6.0 0.3 1980 25.0 0.5 24.5 89.1 -7.8 6.1 0.2 1981 27.4 0.4 27.0 92.9 -12.6 7.5 0.2 1982 29.5 0.5 29.0 90.1 -12.7 6.8 0.1 1983 25.1 0.4 24.7 88.8 -6.7 7.4 -0.2 1984 26.5 0.4 26.1 89.4 -8.1 7.7 0.1 1985 28.8 0.2 28.6 87.1 -7.3 8.9 -0.3 1986 25.5 0.0 25.5 85.4 -1.3 9.6 0.0 1987 23.6 0.3 23.3 85.3 1.0 9.8 0.1 1988 24.9 0.4 24.5 80.6 2.2 7.7 0.0 1989 25.1 - - 84.6 -3.7 7.5 -1.5 - Not available. Source: World Bank data and IMF, International Financial Statistics (various years). The Period oJ Cheap and Easy Credit, 1973-1979 69 Table 3A.14 Nigeria Year Inv Dl+PI Ni CON CA R Error 1970 13.4 1.5 11.5 90.3 -3.0 0.5 0.2 1971 17.5 1.9 15.5 89.2 -3.0 0.0 3.7 1972 19.7 1.8 17.9 85.5 -2.2 -0.1 3.1 1973 20.7 2.0 18.8 81.1 -0.0 -0.3 2.1 1974 15.1 0.8 14.3 71.8 16.3 -0.3 3.5 1975 22.2 1.0 21.2 79.0 0.1 -0.3 1.6 1976 27.7 0.7 27.0 74.6 -0.8 -0.3 1.8 1977 27.3 0.8 26.6 75.8 -2.0 -0.3 1.4 1978 25.3 0.4 25.0 80.5 -6.8 -0.4 -0.6 1979 20.6 0.4 20.2 76.4 2.4 -0.5 -0.1 1980 21.2 -0.7 22.0 73.1 5.7 -0.6 0.6 1981 21.9 0.6 21.4 84.1 -7.3 -0.6 -0.7 1982 15.6 0.5 15.1 92.1 -9.4 -0.5 -1.2 1983 11.6 0.4 11.2 93.4 -5.6 -0.4 -0.2 1984 6.1 0.2 5.9 93.7 0.1 -0.4 0.3 1985 7.7 0.6 7.3 91.3 3.3 -0.3 2.6 1986 9.9 0.3 9.9 94.6 0.9 -0.2 5.5 1987 12.1 0.3 12.5 88.1 -0.3 -0.1 0.0 1988 13.2 3.1 10.5 91.0 -0.7 -0.0 3.5 1989 13.5 - - 85.0 3.8 0.3 2.0 - Nt available. Source: World Bank data and IMF, International Financial Siatistics (various years). 70 Boom, Crisis, and Adjustment Table 3A.15 Pakistan Year Inv Dl+PI NI CON CA R Error 1970 15.8 0.2 15.6 91.0 -6.7 1.2 -1.1 1971 15.7 0.0 15.7 91.5 -4.6 1.7 0.9 1972 14.1 0.3 13.7 90.6 -2.6 1.9 0.2 1973 13.1 -0.1 13.2 91.1 -1.3 3.0 -0.1 1974 13.5 0.0 13.5 94.4 -5.7 2.3 -0.1 1975 16.4 0.2 16.2 95.9 -9.5 3.0 -0.2 1976 17.4 0.1 17.3 93.1 -6.3 3.6 0.6 1977 19.5 0.1 19.4 91.5 -6.1 4.9 -0.0 1978 18.0 0.2 17.8 92.3 -2.8 7.6 -0.1 1979 18.1 0.3 17.8 95.3 -4.2 9.2 -0.0 1980 18.7 0.3 18.4 94.3 -3.7 9.2 0.1 1981 18.9 0.4 18.5 91.6 -2.7 9.0 -1.2 1982 19.5 0.2 19.3 92.6 -3.7 9.3 -0.9 1983 19.1 0.l 19.0 92.9 -0.6 12.1 -0.7 1984 18.5 0.2 18.3 93.6 -2.1 10.9 -0.9 1985 18.6 0.9 17.7 95.3 -3.9 1 (. I -0.1 1986 19.1 0.6 18.5 90.9 -2.3 10.6 -2.9 1987 19.5 0.8 18.7 88.0 -1.0 9.0 -2.5 1988 18.4 0.8 17.6 89.5 -2.9 7.4 -2.4 1989 18.0 - - 90.7 -3.3 6.8 -1.4 - Not available. Souirce: World Bank data and IMF, Iniernalional Finanmial Sa1islils (various years). The Period of Cheap and Easy Credit. 1973-1979 71 Table 3A.16 Sri Lanka Year Inv Dl+PI NI CON CA R Error 1970 19.3 0.0 19.3 85.6 -2.6 0.6 1.7 1971 17.3 0.0 17.3 86.1 -1.6 0.7 1.1 1972 17.5 0.0 17.5 85.3 -1.3 0.6 0.9 1973 13.9 0.0 13.9 88.4 -0.9 0.6 0.8 1974 15.8 0.0 15.8 92.5 -3.8 1.5 3.0 1975 15.7 0.3 15.4 92.6 -2.9 2.7 2.7 1976 16.4 0.0 16.4 86.9 -0.2 2.4 0.7 1977 14.5 0.0 14.5 82.5 3.5 2.7 -2.2 1978 20.2 0.1 20.1 85.2 -2.4 2.9 0.1 1979 25.9 1.4 24.5 86.6 -6.8 5.7 0.0 1980 34.0 1.1 32.9 89.4 -16.4 6.9 0.1 1981 28.4 0.1 28.3 90.3 -10.3 8.4 -0.0 1982 30.4 0.3 30.1 90.2 -11.4 8.8 0.4 1983 29.0 0.7 28.3 88.8 -9.1 8.7 0.0 1984 26.6 0.6 26.0 81.8 0.0 8.2 0.2 1985 23.9 0.4 23.5 90.2 -7.0 7.4 -0.3 1986 23.8 0.5 23.5 90.1 -6.5 7.4 -0.0 1987 23.4 0.9 22.6 89.3 -4.9 7.4 0.4 1988 22.8 0.4 22.2 90.3 -5.7 7.5 -0.1 1989 21.9 - - 90.1 -6.0 6.8 -0.8 - Not available. Source: World Bank data and IMF, Iniernational Financial Statistics (various years). 72 Boom,j. Crisis. and Adjuisinent Table 3A.17 Thailand Year /ni Dl+PI Nl CON CA R Error 1970 25.5 0.8 24.7 78.7 -3.5 0.7 0.0 1971 24.2 0.6 23.6 78.7 -2.4 0.6 -0.1 1972 21.8 1.0 20.8 79.6 -0.6 0.7 -0.1 1973 27.1 0.8 26.3 74.7 -0.4 1.3 0.1 1974 26.7 1.5 25.2 75.7 -0.6 1.8 0.0 1975 26.7 0.2 26.5 77.9 -4.2 0.5 -0.1 1976 24.0 0.5 23.5 78.7 -2.6 0.3 -0.2 1977 27.0 0.5 26.5 78.8 -5.6 0.2 -0.0 1978 28.4 0.5 27.9 76.6 -4.8 0.2 -0.0 1979 27.5 0.9 26.6 80.4 -7.7 0.2 -0.0 1980 26.6 0.9 25.7 80.5 -6.5 0.7 -0.1 1981 26.7 1.0 25.7 81.3 -7.5 0.5 -0.0 1982 23.5 0.7 22.8 79.9 -2.9 0.5 0.0 1983 26.1 1.2 24.9 81.9 -7.3 0.7 0.0 1984 25.2 1.4 23.8 80.4 -5.2 0.4 -0.0 1985 24.5 2.9 21.6 80.2 -4.2 0.5 0.0 1986 22.5 0.6 21.9 77.4 0.6 0.6 -0.1 1987 26.3 1.1 25.2 75.3 -0.8 0.5 0.3 1988 29.3 2.8 26.5 73.9 -2.8 0.4 -0.0 1989 31.5 - - 72.2 -3.7 0.4 0.2 - Not available. Source: World Bank data and IMF. International Financial Statistics (various years). The Period of Chieal, and Easy Credit, 19.73-1979 73 Table 3A.18 Tbrkey Year Inv Dl+PI NI CON CA R Error 1970 19.9 0.5 19.4 83.1 -0.3 2.6 (. 1 1971 17.9 0.4 17.5 86.3 0.3 4.6 -0.1 1972 21.1 0.3 20.8 82.6 1.3 4.9 0.1 1973 19.1 0.4 18.7 83.7 3.2 6.0 0.0 1974 21.7 0.2 21.5 85.3 -1.9 5.1 0.0 1975 23.3 0.3 23.0 85.4 -4.6 4.0 0.1 1976 25.3 0.0 25.3 82.3 -4.9 2.7 0.0 1977 25.4 0.1 25.3 83.5 -6.6 2.3 0.0 1978 18.9 0.1 18.8 85.6 -2.4 2.1 0.0 1979 18.9 0.1 18.8 85.8 -2.1 2.6 0.0 1980 22.3 0.0 22.3 87.7 -6.1 3.9 0.0 1981 22.5 0.2 22.3 85.5 -3.4 4.5 0.1 1982 21.2 0.1 21.1 85.1 -1.8 4.4 0.0 1983 20.2 0.1 20.1 87.2 -3.9 3.5 0.0 1984 20.1 0.2 19.9 87.2 -2.9 4.4 0.0 1985 21.5 0.2 21.3 84.3 -2.0 3.9 -0.1 1986 25.2 0.2 25.0 80.8 -2.6 3.4 0.0 1987 26.1 0.1 26.0 78.7 -1.2 3.6 -0.0 1988 24.6 0.5 24.1 76.3 2.3 3.1 0.1 1989 22.9 - - 80.5 1.2 4.6 0.0 - Not available. Source: World Bank data and IMF, International Financial Statisti(s (various years). Chapter 4 Heading for Crisis: 1979-1982 The period from 1979 to 1982 began with the second oil shock and ended with Mexico's debt moratorium. That moratorium marked a critical change in the avail- ability of intemnational credit that affected most, but not all, of our eighteen coun- tries. During these four years, and for some time after, most of these countries found their temis of trade deteriorating, and most of them increased their debt, some to extremely high levels. The ensuing crises brought home the dangers of heavy foreign borrowing. The Situation in 1979 As pointed out in chapter 3, our countries made little adjustment to the oil price rise of 1973-4. All the net oil importers except India increased their current ac- count deficits in the 1970s, and most increased their debt. Furthermore, most countries were significantly less well placed to meet an external shock in 1979 than they were in 1973 (see table 3-5). Table 4-1 shows how the situation wors- ened from 1979 to 1982. (Note that the debt and interest figures in table 4-1 in- clude short-term debt, which is excluded from table 3-5 because short-tern debt figures are not available for 1973.) In 1979, several of the countries were running unsustainable current account deficits.' A current account deficit becomes unsustainable when the ratio of a country's deficit to its gross national product (GNP) exceeds the rate of growth of GNP multiplied by the debt/GNP ratio-in other words, when the debt/GNP ratio ris- es (this ignores inward equity investment, which was nowhere of quantitative im- portance in the eighteen countries). An unsustainable deficit is not necessarily undesirable. There is no reason to eschew an increase in the debt ratio if it is well below some critical level. Indeed, it is sound policy to let the ratio rise as long as the increased borrowing is used to 74 Heading /or Crisis: 1979-1982 75 Table 4.1 Debt and Current Account Ratios, 1979 and 1982 (Percentage) D)ebu Current 70ar ilebt Debrl Interes,' accounti servicc/ Debr; GNP GNI' GNP expsorts es porls Couxntry 1979 1/982 19'9 1982 19'9 1982 /979 /982 /979 /982 Argentina 15 84 1.9 6.9 1.0 4.5 23 50 211 447 Brazil 31 36 2.1 4.5 4.7 6.1 63 8X1 336 395 Cameroon 37 37 1.2 2.6 2.2 4.8 10 19 122 133 Chile 45 77 2.8 10.6 5.9 10.2 39 71 190 336 Colombia 21 27 0.9 2.8 --1.6 8.0 13 30 68 204 Costa Rica 53 167 2.9 5.4 14.4 12.3 34 21 182 317 Cote d'lvoire 58 111 2.8 10.0 16.9 14.4 25 46 173 277 India 15 13 0.3 0.6 0.3 1.4 1(0 14 151 191 Indonesia 35 29 2.0 2.1 -1.9 5.9 20 18 85 124 Kenya 46 57 2.1 4.1 8.3 4.8 17 33 164 217 Korea 36 52 1.8 5.8 6.5 3.7 14 22 114 132 Mex-ico 31 52 2.4 6.8 4.0 3.9 68 57 252 312 Morocco 53 84 2.9 5.3 9.8 12.7 38 43 347 327 Nigeria 8 14 0.3 1.4 -2.2 9.4 2 16 32 10(X) Pakistan 43 38 1.1 1.4 4.2 3.7 20 16 324 215 Sri Lanka 34 55 1.6 2.5 6.8 11.4 9 15 96 160 Thailand 23 35 2.4 3.1 7.7 2.9 15 21 74 130 Turkey 22 38 1.1 3.2 2.1 1.8 41 30 513 196 Note: Countries in italics are those whose deht was rescheduled in the peTiod 1985-88. A currcnt ac- count deficit is shown as positive. Debt incltides public and pn vate, long- and short-term. Source The figures for 1982 arc fromn World Debt 7ab/es (I 990-91 ) those for 1979 are froint worl Debt Tab/es (1980-81) and national account data base. Current Accunlt(;Np ligures are froiri the tp- pendix to chapter 3. finance investments with a real social return greater than the marginal real rate of interest paid on the increased borrowing. There is no objectively definable upper limit to the debt/GNP ratio. It should be limited either by the inability to find promising enough investments or by risk. There are several distinguishable risks. A change in circumstances may reduce the yield on the chosen investments or even lurn them into liabilities. Interest rates on outstanding debt may be higher thian expected because of a change in world capital markets. Also, GNP growth may be less than expected. so servicing the debt mlay become difficult. For one reason or another, whether as a result of bad luck or bad management, the country may become uncreditworthy and the expected capital inflow may dry up. The necessary adjustment mioht create severe internal prob- lems and loss of output. Suppose, for the sake of illustration, that a country should take action to sta- bilize the debt/GNP ratio when it reachies 40 percent. If it is considered imprudent -6 Boom71, Crisis. and Adjustment to expect GNP to grow at a rate of more than 5 percent, then the current account deficit should not exceed 2 percent of GNP (.05 x .4 x 10 0). Foreign lenders tend to look more at the levels of debt in relation to exports. They do this because amortization and interest on foreign debt are reckoned in dollars. and a country may have difficulty finding the dollars if there is a fall in export receipts (or surge in imports), even though the payments are modest in re- lation to GNP. Figures for total debt service (aniortization and interest) and for total debt in relation to exports (table 4-1) show that countries with low ratios of exports to GNP niay have high ratios of debt to exports and of total debt service to exports, even though the debt in relation to GNP is moidest. This was the situation in Brazil and Turkey in 1979. For a given debt/export ratio, the lower the interest rate and the longer the maturity of the debt, the lower the total ratio of debt service to ex- ports. The given debt/export ratio is then less risky. Bearing this in mind, suppose further that a country should be taking steps to limit the debt/export ratio when it reaches 2. By analogous argument to that of the preceding paragraph, the current account deficit should not exceed 10 percent of exports if the expected growth rate of the dollar value of exports is 5 percent a year. In recent years (1973-79), Mo- rocco and Turkey experienced a growth rate of the dollar value of exports of less than 5 percent a year: but their debt/export ratio was very high in 1979 (347 per- cent and 513 percent, respectively), and that of their current account to exports ex- ceeded 1O percent. Consider, too, what might happen when the growth rate of export value is less than the rate of interest paid on foreign borrowing. To see the significance of this, partition the current account deficit into its interest component and the noninterest component. termed the primary current account deficit. Now suppose the primary deficit is. and remains, zero. The debt will then grow at r percent per year where r is the rate of interest. If r exceeds the rate of growth of export value, the debt/ export ratio will grow indefinitely. A sufficient primary surplus is then needed to prevent this outcome.2 By 1979, many of our countries must have been paying a higher interest rate on new commitments than the growth rate of export value that could be reasonably expected. Almost all were running primary deficits. Chile, Costa Rica, Cote d'lvoire, Kenya, Morocco, and Pakistan had, by 1979, reached a debt/GNP ratio in excess of 40 percent. All had large current ac- count deficits in relation to GNP, ranging from 4.2 percent (Pakistan) to 16.9 per- cent (C6te d'lvoire). Except for Pakistan, because of its relatively low deficit and its ability to borrow at low interest rates from other Islamic countries, these coun- tries were running dangerously unsustainable current account deficits. The 1979-81 Shocks The first step in discussing the shocks of 1979-8 1 is to distinguish them from un- favorable exogenous events. If an event is expected. it can hardly be described as Heading for Crisis: 1979-1982 77 a shock. In 1979 there was a dramatic increase in oil prices, triggered by the fall of the Shah of Iran. The average price rose from $14.7 per barrel in 1978 to $31.3 in 1979. It rose somewhat further in 1980 and 1981, to $34.1, before falling slowly until the collapse of 1986.3 These price movements were certainly shocking. There were other commodity price movements, the most important for our countries being the fall in the price of coffee (though copper was also important for Chile, and phosphates for Morocco). Since coffee is subject to sudden periodic booms (when Brazil freezes, coffee boils) followed by longer declines, the fall in coffee prices after 1978 can hardly be described as a shock, although it contributed substantially to the worsening terms of trade for the coffee exporters. In table 4-2 we have simply calculated the total terms-of-trade effect that allows for all com- modity price changes, whether or not these could properly be described as shocks.4 A third unfavorable event was the rise in interest rates. Nominal rates began to rise in 1977, when the London interbank offered rate (LIBOR) three-month dol- lar rate averaged 6 percent. They then rose almost continuously through 1981, when the same rate averaged 16.5 percent; but it had already reached 15 percent in the last quarter of 1979. Thus, the heavy new borrowing in the period under re- view was made at interest rates that were known to be high, and it would be mis- leading to include the whole of the rise in interest payments as an adverse shock. In table 4-2 we therefore show how much interest payments would have risen in each of the recorded years if no fresh debt had been incurred. This does not show the increase in interest payments, but only that part due to changes that were not in the country's power to control.5 Yet another unfavorable change resulted from the lower growth experienced by the countries of the Organization for Economic Cooperation and Developn-mcnt (OECD). From 1976 through 1979, the GDP of OECD countries grew an average 3.8 percent per year. In contrast, from 1980 through 1983, it was only 1.2 percent, with a slight fall in 1982. This decline had some effect on the volunme of exports from developing countries. The volume of imports into OECD countries fell in the years 1980-82 by about 0.5 percent a year. We have not quantified this effect.6 It is worth noting, however, that for ten of the eighteen countries the volume of exports to the developed world was higher in 1982 than in 1979, despite the re- cession. The losers were Argentina (- 17 percent). Colombia (- 1 3 percent), Costa Rica (-5 percent), Cote d'lvoire (-7 percent), India (-9 percent), Indonesia (-9 per- cent), Kenya (-24 percent), and Nigeria (-43 percent). The rise in the price of oil, together with the recession, naturally reduced the world demand for oil. but Nige- ria's huge loss had other reasons, as is suggested by the relatively small fall in In- donesia's exports.7 Several highlights can be seen in table 4-2: * The interest rate shock was small, particularly in relation to the terms-of- trade effect. * Nigeria and Indonesia gained greatly. Mexico also gained from the terms- of-trade effect, but this was offset by the rise in interest rates. Note, 78 Boom. Crisis, and Adjustment Table 4.2 Terms of Trade and Interest Rate Effects (percentage of GDP and merchandise exports) Terms-of-trade Interest effect rate effect Total effect Country Year GDP, 1 Exports,,1 GDP,-l Exports,, GDP,-l Exports,, C6te d'Ivoire 1979 -0.66 -2.25 -0.26 -0.88 -0.92 -3.13 1980 -5.28 -19.20 -1.75 -6.35 -7.03 -25.55 198] -4.38 -14.72 -0.97 -3.25 -5.35 -17.97 -13.30 -46.65 Sri Lanka 1979 -2.42 -7.83 -0.40 -1.28 -2.82 -9.11 1980 -3.81 -13.03 -0.04 -0.13 -3.85 -13.16 1981 -2.63 -9.94 -0.10 -0.36 -2.73 -10.30 -9.40 -32.57 Chile 1980 -1.82 -9.72 -2.03 -10.83 -3.85 -20.55 1981 -2.21 -13.05 -0.82 -4.82 -3.03 -17.87 1982 -1.01 -8.41 -1.30 -10.90 -2.31 -19.31 -9.19 -57.73 Korea, Republic 1979 -0.68 -2.69 -0.13 -0.50 -0.81 -3.19 of 1980 -3.17 -13.60 -2.21 -9.47 -5.38 -23.07 1981 0.93 1.54 -1.05 -3.78 -0.12 -2.24 -6.31 -28.50 Thailand 1979 -0.90 -5.30 -0.18 -1.04 -1.08 -6.34 1980 -1.88 -9.70 0.13 0.69 -1.75 -9.01 1981 -2.78 -13.76 -0.45 -2.23 -3.23 -15.99 -6.06 -31.34 Cameroon 1979 -3.03 -17.61 -0.03 -0.17 -3.06 -17.78 1980 -0.89 -4.65 -1.15 -5.47 -2.04 -10.12 1981 -0.27 -1.43 -0.24 -1.31 -0.51 -2.74 -5.61 -30.64 Brazil 1979 -0.79 -12.53 -0.61 -9.73 -1.40 -22.26 1980 -1.41 -21.39 -0.99 -15.02 -2.40 -36.41 1981 -0.81 -9.77 -0.58 -6.97 -1.39 -16.74 -5.19 -75.41 Kenya 1980 -1.04 -5.83 -1.38 -7.69 -2.42 -13.52 1981 -1.44 -8.19 -0.24 -1.35 -1.68 -9.54 1982 -0.42 -2.50 0.17 1.02 -0.25 -1.48 -4.35 -24.54 Heading fri Crisis: 1979-1982 79 Terms-of-trade Interest effect rate effect Total efflct Counlry Year GDP,_l Exports,1 GDP,. Exports,i GDP,_, Exports,1 Colombia 1979 -0.55 -4.23 -0.12 -0.90 -0.67 -5.13 1980 -1.63 -13.75 -1.39 -11.83 -3.02 -25.58 1981 -0.92 -7.79 0.36 3.03 -0.56 -4.76 -4.25 -35.47 Costa Rica 1979 -0.44 -1.80 -0.31 -1.25 -0.75 -3.05 1980 -2.23 -9.65 -0.56 -2.43 -2.79 -12.08 1981 -1.67 -8.07 1.47 7.09 -0.20 -0.98 -3.74 -16.11 Morocco 1979 -0.12 -1.07 -0.34 -3.03 -0.46 -4.10 1980 -0.72 -6.12 -1.37 -11.67 -2.09 -17.79 1981 -0.57 -4.33 0.04 0.32 -0.53 -4.01 -3.08 -25.90 Turkey 1979 -0.11 -2.48 0.39 9.09 0.28 6.61 1980 -0.63 -19.69 0.09 2.84 -0.54 -16.85 1981 -0.59 -11.95 -1.01 -20.36 -1.60 -32.31 -1.86 -42.55 Argentina 1980 -0.44 -6.16 -0.99 -13.94 -1.43 -20.10 1981 -0.12 -2.32 -0.27 -4.77 -0.39 -7.09 1982 -0.46 -7.47 0.42 6.89 0.04 -0.58 -1.78 -27.77 Pakistan 1979 -0.82 -9.94 -0.09 -1.04 -0.91 10.98 1980 -0.35 -3.31 -0.50 -4.76 -0.85 -8.07 1981 -0.25 -2.29 0.23 2.12 -0.02 -0.17 -1.78 -19.22 India 1979 -0.29 -5.59 -0.04 -0.84 -0.33 -6.43 1980 -0.39 -7.04 -0.07 -1.25 -0.46 -8.29 1981 0.26 5.31 -0.03 -0.62 0.23 4.69 -0.56 - 10.03 Mexico 1979 0.18 3.32 -0.58 -10.64 -0.40 -7.32 1980 1.34 21.32 -1.08 -17.21 0.26 4.11 1981 0.65 8.13 -0.77 -9.64 -0.12 -1.51 -0.26 -4.72 I The wahh- ......n.. ... the /.il,i, ,,g p,,oge' 80 Bomon, Crisis, and Adjustmnent Table 4.2 (continued) Terms-of-trade Interest effect rate effect Total effect Country Year GDP,-1 Exports1, GDP_11 FXports,, GDP, - Exports,, Indonesia 1979 4.75 22.60 -0.55 -2.63 4.20 19.97 1980 5.63 19.81 -0.50 -1.74 5.13 18.07 1981 1.55 5.51 -0.17 -0.61 1.38 4.90 10.71 42.94 Nigeria 1979 4.57 28.81 -0.28 -1.77 4.29 27.04 1980 8.25 37.86 -0.69 -3.16 7.56 34.70 1981 1.50 5.99 0.08 0.32 1.58 6.31 13.43 68.05 Note: The countries are arranged in order of highest to 5.6% in 1979 (see Table 4.1) Big shock-total negative effecvGDP > -4.37 in 1979 (see Table 4.2). Inaction-see text. Lack of fiscal control-see text. Recession-actual fall in annual GDP. Real exchange rate appreciation- peTcentage appreciation of the real exchange rate from 1979(l) to 1982(2) > 15%. a. These countries all had periods of rapid real appreciation. In Argentina. there was a huge apprecia- tion from 1978(1) t( 1981(1). followed by a fall back to the levelsof 1978. In Brazil the real exchange rate fell from 1978(1) to 1980(1), but then rose by 45% to 1982(3). In Costa Rica, the real exchange rate appreciated front 1978(1) to 1980(4). before falling back to 1978 levels. b. The lack of real appreciation in the period 1979-82 does not imply that the currency was not over- valued during that period. In the case of Morocco our author argues that the dirhamo was overvalued relative to 1970. taken to be an equilibrium year for the exchange rate. c. In Camero(n the temis-of-trade shock was offset by a rising volume of oil exports. Source: World Bank data. helped with standbys, and Kenya did not default or demand rescheduling. It took pride in meeting its commitments, a high proportion of which were to official lenders. 98 Boom, Crisis, and Adjusimeni In the case of Sri Lanka. the current account deficit was enormous. Although the debt/GNP ratio was also high, the terms were favorable and debt service quite low. Above all, aid donors and the World Bank were happy with tihe liberal re- forms and were prepared to give much support. The remaining seven "untroubled" countries require little comment. In 1982, their current account deficits were very modest, except for Cameroon and Indone- sia, where the debt figures were not alarming. They remained creditworthy. Inaction and Fiscal Control Whether or not the countries identified as "troubled," 'intermiediate," or "untrou- bled" in table 4-4 could be characterized as having suffered a "bad start," "big bad shock," "inaction," "lack of fiscal control," "currency overvaluation," or "reces- sion" is indicated by a Yes (Y) or No (N) in the table. The criteria for this assess- ment are given in the note to table 4-4. The categories "inaction" and 'lack of fiscal control" need some discussion. since it is a matter of judgment whether a country has these loosely defined char- acteristics, and we could be accused of taking a peep into the future before decid- ing. "Inaction" means a failure to try to reduce absorption by fiscal or monetary action. We believe our ascriptions are well supported by the country studies on which this volume is based, although it should be noted that "inaction" may in- clude obviously inadequate or very delayed action. Kenya is a borderline case. It was already experiencing a serious problem in 1979. but fiscal action was delayed until 1981-82. Nonetheless, the public deficit was halved from 1980-81 to 1982- 83. Chile is a special case in that inaction refers to the failure to devalue, for Chile was running a public sector surplus. Of course, if no action was required, there is no point in recording inaction. In fact, all the countries for which table 4-4 records No (N) for inaction did take some deflationary fiscal or monetary action in the period. except possibly Indonesia. Lack of fiscal control means that the Finance Ministry was unable to control public expenditure, usually because parastatal institutions or state governments were able to borrow, either from the central bank or abroad. without the sanction or even knowledge of the Finance Ministry. It could also be because political con- ditions made the Finance Ministry too weak to curb other central government min- istries. This lack of control is ascirbed only if our country studies refer to it explicitly. A No (N) does not mean, however, that fiscal discipline was as good as may be desirable. It is clear from table 4-4 that fiscal and monetary inaction, often accompanied by lack of fiscal control, is by far the best discriminant of whether a country was in deep trouble by the end of 1982. Indeed. table 4-4 strongly suggests that the ini- tial conditions have little significant independent explanatory value. Heading fi r Crisis: 1979-1982 99 Real Exchange Rate Appreciation The y sign in table 4-4 indicates a real effective exchange appreciation in excess of 15 percent between the first quarter of 1979 and the second quarter of 1982. Ap- preciation does not necessarily imply that the currency was overvalued, but the country studies suggest that this was the case. At first glance, it might seem that there was no relation between overvaluation and the debt crisis in the countries that experienced the appreciation, but the footnotes to table 4-4 indicate that Ar- gentina. Brazil, and Costa Rica, had large real appreciations during part of the pe- riod. The Moroccan country study for this volume (Claassen unpublished) also suggests that the dirham was overvalued in the period 1979-82. This evidence for overvaluation in turn suggests a relationship with the debt crisis, as might be expected. When the exchange rate becomes incredible, and the authorities delay devaluation, large capital outflows are probable. Capital flight may be moderated by high real interest rates, but they would have to be extremely high, and disturbing for the internal financial system and for domestic investment, if a maxidevaluation is widely expected. Exchange controls may be used but are unlikely to prevent major outflows where the incentive to evade them is strong. In the early 1980s, huge flows of capital poured out of Argentina, Mexico, and Nige- ria. and, to a lesser extent, from Brazil and Chile. Indonesia-which has no ex- change controls-recognized the need to devalue in time, and avoided the problem. Exchange controls and capital flight are further discussed in chapter 8. Since the debt crisis and recession are closely associated, as table 4-4 shows, an association of overvaluation and recession follows. Korea and Turkey are ex- ceptions: they experienced a recession but no real currency appreciation. The re- cession in Korea was caused wholly or mainly by drought, while Turkey's recession of 1980 was a hangover from the troubles of the late 1970s, soon to be replaced by recovery. There are only three cases of probable overvaluation without recession: India, Sri Lanka, and Thailand. In India, the exchange rate was irrelevant for imports be- cause of extensive controls, while exports were far too small in relation to GDP for their sluggish behavior to have caused a recession in this period. In Sri Lanka. the overvaluation was caused by the high capital inflow that supported the boom, the investment boom caused a real appreciation, without the latter causing a recession. To a lesser extent, the same applied to Thailand, where the real appreciation was, in any case, quite modest. Recessions, 1980-83 All the countries in the first group of table 4-4 experienced a recession in the pe- riod 1980-83, as well as serious trouble on the external front. The reasons for the recession varied, and included natural disaster, falling export earnings and private investment. and cuts in public expenditures to combat inflation or improve the /00 Boonm. Crisis, and Adjustment balance of payments. The withdrawal of foreign credit was the immediate cause in only a minority of cases. In Argentina, the recession originated with the overvaluation of the currency resulting from the predetermined exchange rate scale-that is, the tablita. This was followed by the collapse of the tablita and capital flight. which led to very high interest rates, bank failures, and general uncertainty. Both public and private investment collapsed. In Brazil in 1981, monetary restrictions and increased reli- ance on bond financing in the face of inflation also resulted in very high interest rates and a fall in investment. In Chile, overvaluation of the currency, falling cop- per prices, rapidly rising interest payments, and bank failures combined to cause a collapse of investment, which more than halved from 1981 to 1983. As in 1975, Chile had the biggest recession of all in 1982, with a 15 percent fall in GDP. Costa Rica had its own debt crisis in 1981. As elsewhere in Latin America, investment fell sharply in 1981 and 1982. The currency had become highly overvalued. A de- layed large devaluation in 1981 added to the inflation that had made it necessary. This produced a severe monetary squeeze, in addition to which the government raised taxes to try to reduce the yawning budgetary deficit. A rise in net borrowing especially from official sources coincided. In C6te d'lvoire, the authorities under- took deflationary action in 1981, including large cuts in public investment, in the face of a huge current account deficit (18 percent of GNP). Net borrowing peaked in 1982 when the recession began. It was exacerbated in 1983 by a fall in agricul- tural production due to drought. In Mexico, the fall in borrowing in 1982 was com- bined with capital flight. The consequential and necessary massive correction of the current account deficit in 1982 and 1983 could not be achieved without defla- tion and extremely severe cuts in imports. Between 1981 and 1983 the current ac- count moved from a deficit of 6.7 percent of GNP to a surplus of 3.9 percent. Investment fell by about 45 percent, and the volume of imports by about 60 per- cent; GDP fell by about 5 percent. In Nigeria, the recession of 1981 through 1983 was accompanied by a large rise in net borrowing and inward transfer of resour- ces. Ihe fall in oil exports (quantity and price) and the widening of the deficit prompted a severe compression of imports, by means of controls. This, together with a burst of inflation and the consequential monetary squeeze, and the uncer- tainty caused by chaotic internal conditions, resulted in a collapse of investment (from 22 percent of GNP to 12 percent). Morocco's recession in 1981 was mainly due to drought. Investment continued to rise, and the recession was short-lived as agricultural output recovered in 1982. In both these respects, Morocco differs from the other reschedulers. It did have a crisis in 1983. however, as a result of the withdrawal of credit. There was a large fall in inward transfers, which nonetheless remained positive, and investment fell. The recession was slight and short-lived. Only a few recessions occurred in the nonrescheduling countries in the period 1980-83. Turkey's GDP fell in 1980; this was the tail end of a recession caused by the debt crisis of 1977. Korea, too, had a recession in 1980. but it was entirely due to agricultural failure. Indonesia's slight recession in 1982 was mainly due to bad weather. Heading for Crisis: 1979-1982 /1) Clearly, few of the recessions of the early 1980s can be attributed to a drying up of foreign credit. It was the immediate causc only in Mexico and Morocco (in 1983), and perhaps in Costa Rica and Turkey with their own prior debt crises. The recessions among the other reschedulers were, except for Morocco in 1981, a byproduct of trying belatedly to cope with high and rising current account deficits, and with inflation in some of the Latin American countries. Chapter 5 exanmines further the contribution of the fall in foreign credit and high debt service to the slow recovery from recession. The recessions experienced by all eight reschedulers. except for Morocco. ex- tended over several years, whereas the few recessions among the others were one- year affairs. The pre-recession annual level of output was exceeded only after three years in C6te d'lvoire, four years in Costa Rica and Mexico. tive years in Brazil, and six years in Chile. In Argentina and Mexico, the output level of 1988 was still below that of 1980. Except in Morocco. all these recessions were far deeper than anything experienced in the developed countries since 1945. From peak to trough, they ranged from about 4.5 percent in the case of C6te d'lvoire to about 14 percent in Chile. Five of these deep recessions were in Latin America. These varying recession episodes raise important issues, some ot which are taken up again later in this book (chapters 5, 7, and II), while some require more research to resolve. Most have in common a fall in real aggregate demand caused either by external events or by government intervention to correct an unviablc bal- ance of payments, or both. This fall in demand typically results in a Keynesian recession. In no country are prices and wages completely flexible downward, so there is no mystery about such a recession. The degrce of downward flexibility is likely to vary, however, but to be less in more urbanized or industrialized countries. In 1981 in Latin America, the proportion of the GDP arising in agriculture ranged from 7 percent in Chile to 23 percent in Costa Rica. In Nigeria, the proportion was 23 per- cent and in Cote d'lvoire, 27 percent. Our country studies show that during the 1980s real wages fell substantially in most Latin American countries. including Argentina, Brazil, and, above all. Mexico. This does not mcan, however, that nom- inal wages were instantaneously flexible downward when there was a decline in nominal demand. The declines in real wages were accompanied by inflation. In- flation in a depressed real economy led to a fall in real wages. In addition, in some countries, notably Mexico and Nigeria later, recessions induced by external shocks had a "supply-side" element. Imports had to be re- duced drastically, this being done quickly with quantitative import restrictions, and the reduced availability of imported inputs then led to reduced domestic pro- duction. This is "iimport starvation." Import restrictions, like a devaluation, might be expected to switch demand away from imports toward domestically produced goods, and so to moderate a recession, but this effect is likely to take some time. In the short run, the import starvation effect is usually stronger. Nominal devaluation should also switch expenditure toward homc-produced goods, at least provided that it leads to real devaluation for a reasonable length of 102 Btx)ni Crisis. and Adjusinient time (see chapter 8). This switching effect would certainly not be instantaneous. If there is a sharp fall in demand, some recession is inevitable. Recessions may not only be induced directly or indirectly by external shocks or by a correction of previous overexpansionary policies; they may also (notably in India) result from droughts-which is a domestic supply-side effect-or from inflation stabilization policies (chapter 7). A usual byproduct of such policies is a real appreciation, which makes the production of tradables uncompetitive. The experiences of Chile and Mexico are instructive in this regard. The Chil- ean recession was far greater. Chile's GDP fell 14 percent in 1982, compared with Mexico's decline of 4.2 percent in 1983. Both countries suffered severe terms-of- trade declines, but Chile more so, and the reduction in inward resource transfer be- tween 1980 and 1983 was about the same (although much greater for Chile in comparison with the boom year 1981). Since Chile had wage indexation and was also more urbanized, its economy was in all likelihood more rigid. Both devalued in 1982, although Chile was a little slower to do so, and its policymakers have been criticized on that ground. Chile's growth rate rapidly recovered after the re- cession, however, while Mexico's stayed low. Furthermore, Mexico continued to struggle with high inflation, while Chile settled at a moderate inflation rate (about 20 percent). The depth of the Chilean slump may have had sonie longer-term ben- efit in moderating inflation in later years. Chapter 5 A Slow Recovery for Most: 1983-89 A dominant feature of the 1980s was the reduction in resource transfers to devel- oping countries after 1982. The reason for this change was not that international capital had become more expensive. In real terms (adjusted by the U.S. gross do- mestic product [GDP} deflator), the LIBOR (London interbank offered rate) re- mained in the range of 6.5-7.0 percent from 1981 to 1984 and then fell to 4 percent in 1987. Transfers declined primarily because some countries, including those that had absorbed much capital in 1978-82, lost their creditworthiness. Almost all of our eighteen countries relied less on an inflow of resources from abroad (hereinafter referred to simply as transfers) after 1982 than before. The transfers are measured by the current account deficit less interest paid abroad plus remittances. Remittances are here defined as the sum of public and private unre- quited transfers as given in international financial statistics. They consist mainly of remittances from nationals working abroad and grants from official donor agen- cies. Appendix tables 5A- I to 5A- 18 give the figures country by country and year by year. In the case of some highly indebted countries, interest reached more than 10 percent of the GNP. Interest payments have been erratic, however, especially in countries that failed to pay and whose debt was rescheduled.' Table 5-1 therefore shows the average resource flows for the sexennia 1977-82 and 1983-88; it also shows the current account, interest, and remittance coniponents of the 1983-88 transfers separately, and the maximum fall in transfers from one year to the next. The countries are arranged in order of size of reduction in inward transfers (col- umn 3). The presence of the Republic of Korea in the top half of table 5-I is sufficient warning that it must be interpreted with care. The change in transfers is not always an exogenous event outside the country's control. Korea did not lose creditworthi- ness, but considered it desirable to reduce the foreign debt. Its large current ac- count deficits around 1980 were rapidly reduced and became large surpluses after 1986.- I03 104 Boom. Crisis, and Adjustment Table 5.1 Resource Transfers, Current Account Deficit, and Outward Interest Payments (percentage oJ GNP) Average Avlerage Reduction Alverage inward inwiard in current Average Av erage Maximnumn Year oJ resource resource inward account inierest remittance annual maximnm transler. transjrr resoi( uanagem?ent a nd Long -Run Grow th 355 with its concentration on macroeconomics, was not planned to help fill this gap, but we proceed to record whatever can be learned from the country studies and a few other sources concerning the quality of investment, especially public invest- ment. The related but somewhat different subject of rates of return on capital achieved in state-owned enterprises was considered in chapter I 0. In Brazil, incremental capital output ratios appear to have doubled (after al- lowing for estimated changes in capacity utilization) from about 2 to about 4 be- tween the late 1960s and early 1970s to the mid-1980s. As partial causes, Coes (forthcoming) suggests a widening of the divergence of interest rates, and an in- crease in the variation of real exchange rates. There was a rise in the proportion of investment in construction: investment in housing had increased, encouraged by a reduced trust in the inflation indexing of financial assets. Coes further remarks that public investment since the late 1970s was not guided by costs and benefits, and that highly productive infrastructural investment was sacrificed in favor of pro- grams with a demonstrably lower social rate of return. For instance, investment by Nuclebras trebled in the early 1980s, '"despite the fact that nuclear power was probably the highest cost source of electricity available to Brazil.' In Cameroon, macroeconomic estimation suggests a high rate of return (see also table I I - I), but this was probably due entirely to oil. Public investment in all other sectors of activity seems to have produced financial losses (see Connolly un- published). In Costa Rica, the decision in 1972 to create CODESA, the Costa Rican devel- opment corporation which was given direct access to Central Bank credit, was a disaster. It invested in most spheres of economic activity, including such capital- intensive products as fertilizers and aluminum. All its twelve leading subsidiaries had losses in every year from 1976 to 1983, losses exceeding 25 percent of sales. In a report on CODESA, Arthur D. Little stated that 'an examination of the feasi- bility studies for the projects showed serious deficiencies" (Gonzalez-Vega forthcoming). In Cote d'lvoire, a single sugar cultivation and processing project. SODESU- CRE, constituted 37 percent of all public investment in agriculture. Berthel6my and Bourguignon (forthcoming) take this as indicative of the constituents of the enor- mous rise in public investment in the 1 976-S8 plan. It was decided on the sole au- thority of the president. They write: '"This project would quickly prove-and probably appeared so to several observers at that time-economically unsound. This was the first time that such an enormous project had been launched. The lack of any serious evaluation before undertaking it has had severe negative effects upon the economy afterwards." In the case of India, Joshi and l1ittie (forthcoming) estimate a return on public investment of only about 6 percent for both the periods 1960/61 to 1975/76 and 1976/77 to 1986,/87. Although the decisionmaking process for public investment seemed sound on paper, the process described, which includes cost-benefit analy- sis, covered only about a third of public investment. The authors dub the cost- benefit methods used as rudimentary and do not believe that the procedures were 356 Boom. Crisis, and Adjustment sufficiently objective and had enough political backing to adequately counter the chronic Indian preference for self-sufficiency over comparative advantage. Indonesia gets relatively high marks for its choice of public investments from Woo and others (forthcoming) and other observers, at least for the period after the famous Pertamina crisis of 1975, if not before. As mentioned in chapter 3 and else- where, the crisis weakened the nationalist lobby that most favored highly capital- intensive import-substituting investments. As a result of this and the devaluation of 1978, Indonesia maintained rural and agricultural investment, in contrast to Ni- geria, with which it is often compared. Nevertheless, Indonesia did promote many large industrial investments, especially in "resource-based" industries. These, however, appear to have been better planned than elsewhere (Auty 1990). Note, too, that when crisis threatened as oil prices fell after 1983, the Indonesian gov- ernment acted quickly to shelve plans for further large-scale capital-intensive in- dustrial projects. Korea has the highest apparent productivity of investment among the eigh- teen countries. Debate goes on-as to whether this is because Korea's macroeco- nomic policies led to a framework of price incentives that guided investment (predominantly private investment, for Korea has a very low ratio of public invest- ment to total investment, less than 20 percent on average since 1970) in the most socially profitable directions (largely labor-intensive exports) or whether Korea's industrial policies were an important factor. It is common ground that credit was steered at subsidized interest rates toward sectors that the government favored, es- pecially after 1973 when President Park initiated a drive for heavy industry. Auty (1991) estimates low financial returns for steel, petrochemicals, and shipbuild- ing.22 It is unlikely that these ventures had the high economic returns that have driven the Korean economy at such a remarkable pace since the early 1960s.23 Note, however, that Korea's heavy industry projects are probably the most effi- cient in the developing world (with the possible exception of those in Taiwan). In most developing countries, the capital cost of a plant of the same capacity is 30- 100 percent greater than in the United States or Japan. Korea has often achieved lower capital costs, despite the higher cost of imported equipment, because of ex- ceptional speed and efficiency in site preparation, with low construction costs and short gestation periods. As in the case of Indonesia, the heavy industry program suffered rapid and substantial cutbacks when crisis threatened in the late 1970s. The great Nigerian investment boom of the ] 970s was accompanied by neg- ative long-run growth. The boom was initially concentrated on transport, especial- ly trunk roads, in addition to education. Feeder roads were apparently neglected. This was accompanied by administrative incompetence and corruption (so that some of the "investment" was probably consumption or capital flight). The new capital at Abuja was also planned, and work on it continues. In the late 1970s. the emphasis turned to industrial projects in fertilizers, refineries, petrochenmicals, and above all steel. The $6 billion steel project runs counter to all advice. Despite con- tinuing crisis, successive Nigerian governments have been obdurate in refusing to cancel or scale it down. The basic reasons for the failure of investment to procure Macroeconomic Management and Long-Run Growth 357 growth would seem to have been the import substitution syndrome combined with overoptimistic assessment of domestic demand; an often grossly overvalued ex- change rate, leading to manifold price distortions and uncertainty; and hasty plan- ning and poor implementation. As for Mexico, Gil Diaz (unpublished) writes of the Lopez Portillo adminis- tration from 1976 to 1982: The structural rigidities of the economy persisted and grew stronger as the State sector continued its expansion. The huge capital-intensive state enterprises which had been started in the former government, mostly in fertilizers and steel, continued now with incursions into pet- rochemicals. Mammoth investments into the development of new sea- ports were also initiated. It is very difficult to ascertain a posteriori if the huge waste in- volved in these projects was a result of the uncanny ability of the gov- ernment to select fields in which international prices were going to decline, such as silver, steel, tuna fishing and petrochemicals, or a lack of an adequate study of altematives when deciding to invest, in ports, for example. Or bad management. Or a bad selection of product lines. as was the case in steel. Perhaps it was a combination of all the factors enumerated above plus a few others which are the natural outcome of spending so much in such a short period. Regarding the situation in Morocco, Claassen (unpublished) writes, "The fan- tastic investment boom of 1973-77, largely financed by foreign borrowing and al- located mainly to irrigation and capital-intensive production of import substitutes, constitutes the first reason of the later balance of payment crisis since it did not generate the expected foreign exchange earnings which were necessary in order to service the increasing indebtedness." He also points out that the average invest- ment ratio was considerably higher from 1975 to 1985, while the growth of GDP was lower than in the late 1960s and early 1970s. Claassen criticizes the heavy in- vestment in irrigation on three counts: it was capital-intensive, it favored the elite landowners, and the expected returns were based on an increasing real value of sales of fruit and vegetables to European markets that did not materialize. Morocco is not the only country to have directed excessive investment into import-substituting capital-intensive industries. This criticism can be leveled at all eighteen countries except Korea for most of the period 1965-89. Morocco also embarked on resource-based export-oriented investment in phosphoric acid. We do not know whether this had good economic returns or not. Sri Lanka provides an example of the ways in which the efficiency of invest- ment may be diminished in a highly protected economy relying greatly on import controls (Athukorala and Jayasuriya forthcoming). Not only did Sri Lanka fail to exploit its comparative advantage, but the vulnerability of the economy was in- creased as all imports except capital goods became essential either for life or 358 Booom. Crisis, and Adjustrmenr domestic production. The resulting uncertainty and discontinuities in the avail- ability of imported capital goods bore heavily on investment efficiency. Some cuts in investment after the first oil shock may have been beneficial, however, since a number of negative value added industries, producing mainly intermediates, had been developed in the public sector. After 1977, Sri Lanka became absorbed with the construction of the Mahawe- Ii irrigation and power project. This, together with a large housing development project, accounted for much of the huge rise in public investment from 1977 to 1980. Initial cost-benefit analysis apparently suggested a yield of I I percent, but subsequent analysis of the agricultural components of the project has suggested that this was a large overestimate. Athukorala and Jayasuriya (forthcoming) re- mark that "it is known that alternative less glamorous projects were assessed to have much higher rates of return." Whatever the projected returns, it would seem in any case to have been imprudent to put so many eggs into one basket, but Ma- haweli was a pet project of the prime minister (later president), J. R. Jayawardana, whose electoral victory in 1977 and dramatic change of policies won the strong support of foreign capital suppliers. Macroeconomic Policy and Savings Given that the use of foreign savings is limited in the manner described in chapter 4, it follows that the ratio of savings to GNP is a constraint on the ratio of invest- ment to GNP (notwithstanding the possibility that investment may to some extent create savings). A rise in private savings permits higher total investment unless such a rise merely compensates for a fall in public savings as the public sector re- lies more on borrowing and less on taxation.24 Whether or not higher interest rates cause a rise in savings has been the subject of much debate and econometric in- vestigation. The evidence on balance seems to support a positive effect (see Fry 1988, chap. 6). Further econometric evidence from our country studies, although limited, lends sonie support to this view. Athukorala and Jayasuriya (forthcoming) found that the nominal interest rate on deposits (inflation was included as a separate regressor) was significant for pri- vate savings in Sri Lanka. They also found that the expansion of bank branches was significant. Onis and Riedel (I1993) found that the real deposit rate was highly significant for private savings in Turkey. and that a one percentage point increase raised the savings/disposable income ratio by one percentage point. Joshi and Lit- tle (forthcoming) suggest that a rise in real deposit rates from negative to positive was a factor in the substantial rise in household savings/GDP during the 1970s in India. As in Sri Lanka, the fall in population per bank branch was also significant.25 Korea is one of the eighteen countries, but no country study was commis- sioned there. Collins (forthcoming), however, found that the real interest rate was significant in a regression similar to that of Onis and Riedel for Turkey (both Macroeconomic Management and Long-Run Growth 359 include permanent and temporary income as regressors). The leverage was much less, requiring a doubling of real interest rates from about 5 percent to 10 percent to effect a rise in the savings ratio of one percentage point. The other countries offer no useful evidence, mainly because they did not venture into financial liberalization to any extent until recently. Those that did try some earlier financial liberalization (for example, Argentina and Chile) ended up with very high inflation and financial chaos, which would have made any relation- ship between savings and its conjectural determinants fragile, to say the least. Summary and Conclusions The investment ratio is significantly related to the long-run (1970-89) rate of growth of GNP per head: but it explains only 29 percent of the variance of the in- tercountry growth rates. Instability of the investment ratio (and of the annual growth rate of GNP) is negatively related to long-run growth, largely because the poor performers ran into acute balance of payments and debt crises in the early 1980s. This led to se- vere falls in investment, and to recession, followed only by weak recovery in most cases. It is notable that there is no relation between the severity of the shocks of 1979-82 and long-run growth. Policies matter more than adverse shocks, or windfalls. The investment booms of the 1970s, financed by foreign borrowing, were part of the reason for the crises (though a few countries managed to have booms with- out crises). These booms did not compensate for the subsequent collapse. While instability of investment goes some way toward explaining the huge variations in the apparent efficiency of investment (growth rate per head/invest- ment ratio), much remains unclear. Among the many possible determinants of overall investment efficiency, we have drawn attention to the choice of projects in the public sector. We have found some reason to believe that decisionmaking pro- cesses and criteria were often idiosyncratic and imprudent, and seldom calculated to yield high economic or social returns. This, however, is an area in which more research, including ex post cost-benefit analysis, is surely desirable. Our policy conclusions concerning long-run growth are simple indeed: * The objective of stability should be given much weight in the design and implementation of macroeconomic policy. * A sound system of cost-benefit analysis should underpin the selection of all large public sector investments. Chapter 12 The Political Economy of Stabilization and Adjustment According to the conventional economic criteria of growth, inflation, and stabil- ity of growth, some of our eighteen countries performed well and some per- formed badly over the years from 1965 to 1990. As already emphasized, these differences cannot be explained by the frequency and the magnitude of external shocks to which they have been subjected. Their explanation lies in other directions. First, key policymakers may not actually seek these economic objectives, de- spite the almost universal rhetorical commitment to them. Rather, their foremost concern may be the nation's political stability, security against external or internal aggression, substantial redistribution of income toward one or another favored group of the population, political longevity for themselves, or financial reward for themselves, their relatives, or their loyal supporters. Second, although policymakers may wish to attain the national economic ob- jectives mentioned above, they cannot do so because officials are unwilling or un- able to implement the required policies, or the public will not endure the policies long enough for them to work. Third, despite well-meaning decisions and implementation, the economies in question may be structured in such a way that the conventional and widely recom- mended actions to achieve growth and stability with low inflation will not work, as was argued for many years by the so-called structuralists; or, conversely, well- intentioned decisions and implementation following heterodox lines may fail to work because the economy in question is so structured that the conventional rem- edies would be more appropriate. Fourth, we must allow for the logical possibility that everything was done more or less appropriately, but bad luck, for example, in domestic harvests or ex- ternal terms of trade, prevented the country from achieving the desired results. (By the same token, it is possible that policymakers made a series of mistakes in fram- 360 The Political Economy of Stabilization and Adjustment 361 ing or executing their plans, but the performance of the country did not suffer be- cause of unrelated good luck.) This chapter deals with the first two of these explanations: political factors that inhibit or prevent the attainment of generally acclaimed economic objectives. It also touches briefly on the fourth. In their work, policy-oriented economists characteristically proceed by adopting the intellectual construct of a unitary governmental decisionmaking pro- cess, which involves defining national economic (and other) objectives and then pursuing them in a determined way. Their advice is designed to help clarify the objectives, and in particular to sharpen the need for choice among conflicting ob- jectives; and then to help policymakers mobilize the instruments needed to attain the specified objectives with maximum efficiency. In short, their purpose is to in- troduce both consistency and efficiency into the pursuit of economic policy. This construct is always useful, sometimes even necessary, but it is totally inadequate for interpreting the economic perfomiance of countries during a historical period, since, as noted above, the policymakers may have given predominant weight to noneconomic objectives; or there may have been no coherent policymaking process, but rather a collection of competing interests, all jockeying to manipulate the instru- ments in the hands of government for their diverse and typically conflicting aims. This chapter therefore attempts in a sketchy way to place our countries' re- sponse to disturbances in a political setting, and to suggest which political settings are more or less conducive to framing and executing a national economic policy oriented to growth and stability. By way of background, note that many developing countries have a relatively short history as nation-states, which dates from decolonization in the late 1940s for most of our Asian countries, and in the early 1 960s for our African countries. The Latin American countries differ from the others in this respect, since they have been nation-states for well over a century, as has Thailand. Modem Turkey dates from 1920. Furthermore, almost all our countries have experienced periods of serious civil disorder within the past thirty years, since independence. There have been threatened coups (Cameroon, Kenya, Morocco), actual coups (Brazil, Korea. Thailand. Turkey), virtual civil war (Argentina, Chile, Colombia, India), or actual civil war (Indonesia, Nigeria, Pakistan, Sri Lanka). Moreover, some (Ar- gentina, India. Morocco. Pakistan) were involved in international conflicts, and others (Kenya, Chile, Korea, Thailand) at times were deeply concemed about their extemal security. Among our countries, only Costa Rica, Cote d'lvoire, and Mex- ico have avoided serious civil disorder throughout the past quarter century.' By comparison, the rich industrialized democracies have been politically calm, peaceful, and orderly during this period. Despite these disadvantages, the period 1960-73 was an outstanding one for economic development, with unprecedented growth in a number of low and mid- dle-income countries. as discussed in chapter 2. The world's communist countries were also growing rapidly. The climate of opinion was that the state should play a pivotal role in development, not merely or even mainly as a provider of a stable 362 Boonm, Crisis, and Adjusiment framework for private decisions, but as an entrepreneur, investor, and general manager of the pace and direction of economic development. A formal process of development planning came into vogue, encouraged by the apparent postwar suc- cess of the Soviet Union, with its five-year plans for determining investment and allocating key resources within the economy. The vision of those who favored an activist state extended beyond the nation to the international economic order, which was alleged in the late 1960s to be bi- ased against low-income countries in general and against the producers of primary products in particular. Foreign ministers and even heads of government from de- veloping countries regularly attended international conferences of the Nonaligned Countries, the Group of Seventy-Seven, the Organization of African Unity, or the Association of South-East Asian Nations during which they framed, endorsed, or rallied around various proposals for a new international economic order, as de- scribed briefly in chapter 2. At various stages, India, Mexico. and Nigeria, among our countries, played an active and initiating role in these deliberations, which both reflected and reinforced the statist zeitgeist of the 1970s. The shock of the first oil price increase in 1974, although damaging to all oil-importing countries, was paradoxically wvelconmed by a number of leaders in developing countries out- side the Organization for Petroleum Exporting Countries, who saw it as an eco- nomic weapon that could be used to force the rich countries to agree to the pro- posed changes in the international economic order. Thus, political considerations sometimes overrode economic interests, and it would not have been consistent with this expressed view to complain too much about, or to respond too vigorously to, the oil price shock. Against this background, our countries launched their numerous public in- vestment booms, made possible in part by an increased flow of development as- sistance from the rich countries, but even more by the rapid growth of the international money and capital market, to which developing countries had in- creasing access (see chapters 2 and 3). The possible reasons for their diverse per- formance can be found in each country's form of government, democratic or authoritarian, in the initial conditions inherited from the past (their traditions, convic- tions, and institutions); and in the role of nongovernmental actors-interest groups within the country, and external influences-in the formation of economic policy. Form of Government It has sometimes been suggested that authoritarian governments are better able to manage national economies in developing countries than are democratic govern- ments since the former can quash opposition to occasional economic retrench- ment, with its inevitable squeeze on some segments of society, often urban wage- earners. Moreover, over the longer term they are allegedly better able to establish and carry out a coherent program for economic development, to maintain fiscal The Political Econorny oJ Stabilizaiion and Adjusinient 363 discipline, and to direct resources-the limited surpluses that can be extracted from the public in poor countries, plus external borrowing-to the most produc- tive ends. Democracies, in contrast, have difficulty maintaining a coherent policy over time and must constantly defer to special interests whose well-being is not always most conducive to longer-run growth. A cursory examination of our eighteen countries does not support this fre- quently expressed view. Neither the form of government nor the degree of politi- cal freedom seems to have had a significant bearing on the adaptability of our countries to external shocks and their subsequent performance. Four of our coun- tries-Costa Rica, Colombia, India, and Sri Lanka-were democracies (D) during the 1970s and 1980s; three (Brazil, Indonesia, and Korea) were military or quasi- military autocracies (MA), although both Brazil and Korea moved to elected gov- ernments in the period 1985-87; five (Cameroon, C6te d'lvoire, Kenya, Mexico, and Morocco) were civilian autocracies (CA), although Mexico's was notably dif- ferent in character from the others; and six experienced changes in type of govern- ment (CG). Since Chile and Pakistan were military autocracies during most of the period (both had democracies in the early 1970s and restored democracy in the late 1980s), that leaves Argentina, Nigeria, Thailand, and Turkey as the countries that underwent significant change for our purposes. Broadly speaking, these last four can be considered politically unstable during the 1970s and early 1980s, along with perhaps the borderline cases of India (because of Mrs. Indira Gandhi's national emergency in 1975) and Sri Lanka, with its radical change in government in 1977 and emerging civil war in the 1980s. The remaining countries were polit- ically stable. Table 12-1 lists the countries' political leaders and changes in their form of government. The political dimension can be approached in a somewhiat different way. The organization Freedom House has ranked countries since 1973 according to their degree of political rights and civil liberties (Gastil 1987). The greater the freedom, it might be thought, the greater the influence of special interest groups on economic policy making. Averaging Freedom House scores over the period 1973-85 pro- duces a list that runs from Costa Rica, the most liberal, to Caineroon, the least. They can be somewhat arbitrarily divided into two groups, the more free and the less free, ranked from the highest to the lowest degree of freedom: More Free Less Free Costa Rica (D) Nigeria (CG, 1979. 1983) Colombia (D) Morocco (CA) India (D) Kenya (CA) Sri Lanka (D) Indonesia (MA) Mexico (CA) Pakistan (CG/MA, 1973,1977,1988) Turkey (CG, 1980, 1983) Korea (South) (MAC(G, 1987) Brazil (MA/CG, 1985) Chile (CG/MA, 1973. 1989) Argentina (CG, 1973, 1976, 1983) C6te d'lvoire (CA) Thailand (CG, 1979, 1991) Cameroon (CA) T'able 12.1 Political Leaders, 1965-90 Cou,n,ry /965 1966 1967 1968 1969 /970 1971 /972 1973 1974 1975 1976 /977 Ar2enlina Illia Organia Leving.sion Lanorse Campora Peron 1. Peron Videla 13raizil Branco dcl Costa e Silva Medici Gekjel Cameroon Ahidilo Chile Frei Allende Pinochel: Colombia Valencia Restrepo Pastrana Lopez Costa Rica Bolmarich Trejos Figueres Oduber Cite d'lvoire Houphouet-Boigny Indiai Shasiri I. Gandhi De%ai lndone,ia Sukarno Suharto Kenyva Kenvatta Korea Park Mex ico Ordaz E-heverria Lopez-Portillo Morocco Hassan 11 Nigeria Azikiwe IronsiuGowon Ramat Obasanlo Pakistan Arub Khan Yahva Khan Bhuttob Isaq Khana Sri Lanka Senanayake Bandaranaike Jayawardene Thailand Thanom Sanya Seni/ Seni/ Kraingsak Kukrit Thanin Turkey Demirel Erind Melen Ecevitb Demirel Argentina Viola Gallieri Alfonsinb Menem Brazil Figueriredo Sarneyb Collor Cameroon Biya Chile Alwinb Colombia Turbay Betancur Barco Gaviria Costa Rica Carazo Monge Arias Calderon C6ie d'lvoire India C. Singh 1. Gandhi R. Gandhi V.P. Singh Indonesia Kenya Moi Korea Choi C. Park Chun Rohb Mexico de la Madrid Salinas Morocco Nigeria Shagarib Buharid Babangida Pakistan Zia UI-Haq B. Bhuttob Sri Lanka Premadasa Thailand Premb Chatchai Turkey Ecevit Demirel Evrena Ozalt a. Indicates a coup. b. Indicates a restoration of democracy. Source: Compiled by authors. 366 Boom, Crisis, and Adjustment The four most free countries are the democracies, and the least free are civil- ian autocracies, preceded by the military autocracies. The question that needs to be asked is whether there is any discernible rela- tionship between the various political attributes of these countries-their form of government, political stability, ordegree of political freedom-and theireconomic performance. The issue can be formalized somewhat by dividing our countries into those that performed relatively well during the 1980s, following the shocks early in the decade, and those that performed relatively poorly. The main criterion will be economic growth, with some admixture of external debt problems and in- flation. By these standards, the countries that performed badly during the 1980s are Argentina, Brazil, Cameroon (which performed well in the first half of the de- cade, but poorly thereafter), Chile, Colombia, Costa Rica, Cbte d'lvoire, Mexico, and Nigeria; those that performed relatively well were India, Indonesia, Korea, Morocco, Pakistan, Sri Lanka, Thailand, and Turkey. In terms of growth, Kenya and Sri Lanka are on the borderline, but because of Kenya's extraordinary growth in population it experienced little change in per capita income. so should bc grouped with the poor performers, whereas Sri Lanka's growth in per capita in- come was 2.6 percent a year. Turkey, although a high-inflation country, saw its per capita income grow 2.4 percent a year during the 1 980s, so we include it among the good performers. Chile's growth was impressive in the last few years of the decade, but not over the period as a whole. Moreover, its price level increased by a factor of five over the decade, in comparison with a doubling in Morocco, the country with the lowest per capita growth rate among the good performers. Co- lonibia, a democracy, was the only one of our Latin American countries that did not reschedule its external debt. These classifications can be summarized as shown in table 12-2. Here we have called those with dramatic changes in government "unstable" and all others "stable," although, as noted above, India and Sri Lanka might be considered bor- derline cases; Chile had a dramatic change to democracy in 1989, and Brazil and Korea introduced elected governments, both favored by the preceding military leaders, in 1985 and 1987, respectively.2 No clear pattern emerges in table 12-2. A roughly equal number of stable gov- ernments performed well and poorly, as was the case for unstable governienvi. Countries with a greater degree of freedom can be found in all four categories. De- mocracies and authoritarian governments alike can have poor-or good- economic performance. Simple generalizations about the effectiveness of various political systems in dealing with adverse-or favorable-external economic shocks do not seem to hold up.3 It is true that if we move India and Sri Lanka into the northeast, politically unstable, corner, then all the countries in the northwest corner (that is, those that are politically stable with good economic performiancc) will be civilian or military autocracies, all of which fall in the lower half of the Freedom House list. Among these countries, however, Korea and Pakistan had free democratic elections in the late 1 980s. And dcmocratic Colombia's perfotrrance. classified as poor here, was not markedly inferior to authoritarian Morocco's. Thze Politic al Ecoonoa, oJ Stabilization and Adjustment 367 Table 12.2 Political Regime and Economic Growth Econonic peIfornzance Stable Unstable Good Indiaa 3.0 Indonesia 3.3 Korea 7.2 Pakistan 2.9 Thailanda 5.3 Sri Lankaa 2.6 Turkeya 2.9 Poor Brazila 0.2 Cameroon -0.8 Costa Ricaa 0.6 C6te d'lvoire -3.2 Kenya 0.4 Argentinaa -1.5 MCxicoa -1.0 Nigeria -1.3 a. Countries in upper half of l reedonm House list. Now- Trend annual growth rate in GDP per capita over the period 1980-90 follows each country. Source Authors' compilation. Perhaps an autiloritarian government has some edge when it comes to adopting difficult but desirable economic policies. Clearly, however, many authoritarian governments are not able or willing to do so, and the cases of India and Sri Lanka suggest that in sonic circumstances democratic governments in developing coun- tries can also successfully implement policies oftmacroeconomic adjustment in re- sponse to adverse external shocks, which were admittedly modest in relation to GDP in the case of India, but were substantial for Sri Lanka. The classifications used here no doubt could be refined. It has been suggested that a distinction needs to be made between "weak" authoritarian states and strong" ones (Haggard and Kaufman, in Nelson 1989). Leaders of weak author- itarian states are insecure in tenure or not in complete command of the executive agencies of yovernment, with the result that they may be unwilling to promulgate policies that are unpopular with the general public or with particular constituen- cies. or they may be unable to ensure that their policies are actually implemented. When applied to economic policy, this distinction runs the risk of being tautolo- goLsS, with weak authoritarian states being defined as those that are unable to framc and carry out a coherent and effective macroeconomic policy. Nonetheless, sonic authoritarian governments clearly are weak in the respects mentioned above, and indeed should perhaps not be called "authoritarian" except for their low tolerance for civil and political liberty on the part of actual or feared opponents. Among our countries, Argentina, Brazil. Kenya. and Nigeria offer examples of weak authori- tarian states during munch of the 1 970s or early 1 980s, whereas Chile. Korea, and 368 Boom. Crisis. and Adjustment Mexico were strong authoritarian states, with C6te d'lvoire, Indonesia, and Paki- stan being moderately strong. Even "strong" authoritarian states must be concerned with their legitimacy at home and abroad and must pay attention to public opinion. Chile's Pinochet de- rived his security not only from the army's absolute control, but also from the fear of the alternative among many middle-class members of Chile's polarized society, who had already experienced it briefly under President Salvadore Allende in the early 1970s. In Brazil, Indonesia, Korea, and Turkey, military leaders attempted to legitimize their rule by founding political parties and converting to a civilian form of government. In doing so, they created forums (notably parliaments) where some opposition could be expressed, even if parliamentary power was limited. Even having a strong authoritarian government does not safeguard against policy errors. Chile, for example, fixed its exchange rate in 1979 without deindexing wage contracts and deregulated banking without providing for adequate regula- tion and supervision; and C6te d'lvoire in the mid-1970s mistook a transitory in- crease in coffee and cocoa prices for a permanent one and budgeted accordingly.4 The examples of Colombia and India demonstrate that democratic countries can have a reasonably disciplined fiscal policy and a conservative fiscal tradition. Democratic countries can put together and implement a coherent macroeconomic policy. Incumbent governments in democratic countries are periodically con- cerned about the impact of their policies and performance on the polls, and up- coming elections may dictate the timing of macroeconomic policies. When President Jose Sarney of Brazil deferred the fiscal tightening necessary to make his Cruzado Plan work until after the constituent assembly elections of November 1986, that deferral spelled the collapse of his bold, if heterodox, effort to quash Brazil's inflation.5 For this reason, democratic governments are likely to be less expansionist immediately after an election than they are immediately before, and thus an economic cycle sometimes develops in association with the timing of elections. This problem is not peculiar to democratic countries. The most striking exam- ple of this phenomenon has been Mexico, a peculiar hybrid between authoritari- anism and democracy. Mexico has been ruled by one party, the Party of Revolutionary Institutions (PRI), since 1929, and during most of this period its tol- erance for serious political opposition has been low. At the same time, the party operates within a constitutional framework that restricts presidents to a six-year term and prohibits self-succession. For reasons best known to the PRI, it strives to win these elections by large majorities, perhaps to show that serious political op- position is really redundant, given its overwhelming popularity. Toward that end, it apparently increases government expenditures substantially in the last eighteen months before the end of each presidential term. During its first year in office, each incoming government, therefore, has to devote much of its political energy to re- establishing fiscal equilibrium.6 This pattern is the opposite of one sometimes associated with Latin America: the so-called populist electoral cycle, whereby relatively poor and uninformed Tlte Political Economy oJ Stabilizoaion and Adjustment 369 electorates encourage candidates to promise all kinds of improvements. These politicians are elected and attempt to deliver on their promises by greatly increas- ing spending on public programs for health, education, foods subsidies, roads. and so on. It soon becomes clear that these programs cannot be conventionally fi- nanced on the scale on which they have been launched, so increased central bank financing is used, which helps speed up inflation. After a while, pressure from do- mestic groups dissatisfied or alarmed by the inflation or the deterioration in the country's international payments position leads authorities to recognize that mac- roeconomic policy needs to promote greater austerity. By this time, if an election is in prospect, the incumbent is likely to be removed in favor of a new politician who promises to deliver more (Dornbusch and Edwards 1989). Or a coup may oc- cur before the cycle is complete. This pattern, or at least part of it, is recognizable in Salvador Allende's elec- tion in Chile in 1970, and in Juan Peron's return to Argentina in 1973 (as well as in Alan Garcia's 1985 election in Peru. outside our sample of countries). Still, electorates are not always so undiscerning as the above model implies. Allende was elected by a minority, because the opposition was split. Peron was asked back to Argentina after an absence of nearly two decades in part because of a perception that only he could reduce the polarization in Argentina. That gamble did not work, but perhaps will be achieved by Peron's distant successor, Carlos Menem, elected in 1989. Insofar as political incumbents shy away from taking constrictive fiscal or monetary action because they fear they will be chucked out of office, electoral re- sults during the 1980s do not in general bear out this concern. Incumbents or their favored successors were returned to office in Sri Lanka (1982), Turkey (1983 and again in 1987), Costa Rica (1986), Korea (1987), and Thailand (1989), despite the fact that in each of these cases (except Sri Lanka) stringent fiscal policies had been in place earlier.7 Incumbents or their preferred successors were removed by the electorate in Argentina (1983 and again in 1989), Colombia (1986), Pakistan (1988), and Chile (1989). Mexico (1989) might also be added to the list, for al- though the PRI presidential candidate Carlos Salinas, to no one's surprise, won in 1988, the regional elections of 1989 were considered a referendum and the PRI ex- perienced its largest ever political losses. A number of these countries also had austerity programs. The main difference between the two lists is that economic performance, on the standards we invoked earlier in this chapter, were generally good in those countries in which incumbents were returned (Costa Rica being the main excep- tion), whereas they were generally poor in those countries in which the incumbent was dismissed (Pakistan being the main exception).8 The lesson here, insofar as there is a lesson, is that electorates focus on end results, not on the means; if tight fiscal discipline is associated with good overall economic performance. the elec- torate is not likely to object. New governments, whether democratic or authoritarian, are more likely to make drastic changes in economic policy-macroeconomic or structural-than 370 Boom, Crisis, and Adjustment are incumbent governments. Such changes were introduced among democratic governments following elections in Sri Lanka (1977), Costa Rica (1982), and Ar- gentina (1989); and among authoritarian governments in Korea (1961-64), Indo- nesia (1966-69), Chile (1973-74), and Nigeria (1986). New governments can more easily break with the past and take the steps deemed to be necessary in order to correct the "chaos" left by the preceding regime. In all the authoritarian cases, gross mismanagement by the preceding government was a primary reason for the military coup, although in each case it took the new government some time to frame its new economic policy, as military leaders became apprised of the com- plexities of economic policy and engaged economic advisers or officials in whom they had confidence. Turkey (1980) provides an exceptional case, since the eco- nomic stabilization was actually begun under the democratically elected Demirel government, but had not yet been completed at the time of the military takeover. The military leadership not only continued but strengthened the economic re- forms, and promoted the previous government's chief economic adviser Turgut Ozal to the position of deputy prime minister in order to continue the macroeco- nomic and structural reforms. In contrast, other countries (Colombia, India, Thailand and since 1964 Ko- rea), and Cameroon (until 1988, among our eighteen) have demonstrated basic continuity in their policies, whereas still others (C6te d'lvoire, Kenya, Mexico, and Morocco) managed to change policies gradually despite continuity in govern- ment, largely required by an adverse change in the external environment. "Basic continuity" does not exclude important changes in emphasis, as in Korea in 1982 and in Colombia in 1984. It has been suggested that the governments experiencing the greatest difficulty in introducing or even maintaining tight macroeconomic policies are those in "democratic transition"-countries in which an authoritarian government has yielded to a democratic form, but the latter is not yet well established. There have been many examples of this transformation since 1975: among our countries, Thailand (1979), Nigeria (1979), Argentina (1983), Turkey (1983), Brazil (1985), Korea (1987), Pakistan (1988), and Chile (1989).9 Political scientists Haggard and Kaufman (in Nelson 1989, pp. 59-60) suggest that democratic transitions are likely to lead to expansionist economic policies for three reasons: * First, political transitions typically reflect an increased level of political mobilization and conflict. It is usually because such conflict cannot be overcome through repression that authoritarian regimes weaken and give way to constitutional ones. Because political mobilization generally in- creases in the last phases of authoritarian rule, it confronts new democratic leaders with previously repressed demands, heightened social and eco- nomic expectations, and strong pressures to reward supporters and incom- ing groups. e Pressures from below are coupled with uncertainties at the top among new political elites. In the immediate post-transition period, the possibility ex- The Politial Economy of Stabilizaoion and Adjusimen, 3'1 ists that authoritarian forces will reenter politics. Short-run macroecononi- ic policies thus not only have coalitional consequences; they may also affect the survival of the new regime itself. These uncertainties shorten the time horizons over which politicians calculate the costs of policy choice. Difficult economic policy actions that create resistance or unrest-and that might provide an excuse for reversal of the democratization process-are likely to be avoided. Finally, democratization is likely to involve more substantial turnover in technical personnel and changes in decisionmaking institutions than is the case with changes of government in established democracies. With in- creased social demands, the uncertainties facing new political leaders, and the technocrats' own interest in supporting the democratic experinment, in- coming economic teams are more likely to pursue expansionist programs that meet expectations and reduce social conflict in the short run. By way of empirical support for their hypothesis, Haggard and Kaufman point out that during seven democratic transitions in the early 1980s increases in government expenditure were on average greater, budget deficits were higher, and central bank credit expansion was higher than in a control group of authoritarian countries and one of stable democratic countries. Furthermore, compliance with IMF programs was lower (Haggard and Kaufman, in Nelson 1989, tables I and 2). Countries undergoing a democratic transition do differ significantly, however, with some-Thailand, Turkey, Korea, among our countries-maintaining much continuity with the previous regime, especially among the technocrats. In all three cases, the new democratic leadership also reflected some continuity with the out- going regime (although, ironically, Ozal was not the military's favored candidate in Turkey's 1983 elections). In other cases-Nigeria, Argentina, Brazil, among our countries, along with Peru-the transition to democracy reopened extensive populist or (in Nigeria's case) ethnic claims on government largess that had been suppressed by the previ- ous regime (less so in Brazil than in the others), and rekindled debates on the basic thrust of economic policy. The new governments thus had to decide both on un- derlying principles of policy and on detailed implementation in ways that would build rather than erode support for democracy, in general, and for the incumbents, in particular. Moreover, in Argentina President Raul Alfonsin was preoccupied with establishing a system of justice and of administration that would endure fu- ture changes in government and that would discourage another military coup. Consequently, economic policy was at first given lower priority. In Nigeria, Pres- ident Shehu Shagari was politically successful in his extended largess and patron- age, in that he won a second term election in 1983; but the fiscal situation had deteriorated so extensively, and corruption was so widespread, that another mili- tary coup aborted his second term a few months after inauguration. Even in Korea, where former general Roh Tae Woo as head of the party sup- ported by the outgoing regime was elected president (but with less than half the 3'2 Buooti, Crisis. and Adjustmrent popular vote. due to a split opposition) and where most technocrats continued in the administration. new freedoms (combined with an exceptionally strong export boom) penmitted extensive labor unrest followed by exceptionlal wage increases in 1988 and 1989. Public expenditure became more expansionary in response to popular deniand. In comparison with other countries, hlowever. Korea niaintained a high degree of fiscal control. (Governments in democratic transition are not the only ones to use public ex- penditures to strengthen national cohesion or to build political coalitions. In a sense, democratic governments are constantly engaged in these processes, espe- cially the latter. Democratic leadership specializes, it might be said, in reconciling conflicting claims on public resources by various interest groups with the resourc- es that are available. or that can be extracted from the public-or fronm abroad. Aniong our countries, the most dramatic single exaniple is the pursuit by the new Jayawardana administration in Sri Lanka of the huge Mahaweli irrigation and wa- ter control project, designed in part to create employmiient and in part to bring pros- perity to the countryside and to rural Sinhalese who, although a majority, felt disadvantaged next to the minority Tamils. This niassive thirty-yeair project had been on the drawing boards for many years. but then was nmobilized anLl acceler- ated to six years with the help of foreign donors who were eaoer to show support for the more liberal economic policies of the new admninistration in 1977. despite the fact that dispassionate econonmic analysis suggested the project didl not otter an attractive rate of return. Indeed. as pointed out in chapter II. the World Bank and other donors seemi to have decided to support the project in principle even be- fore the detailed economic analysis was undertaken. Unfortunately, even vith ex- tensive foreign assistance (amounting to the extraordinary figure of nearly 10 percent of GDP in 1982), substantial local resources were also required to under- take the project. Thus, expenditures on this project alone reached 22 percent of to- tal government expenditures in 1982. Once embarked upon, it was difficult to abandon, although it was eventually scaled back somewhat. Ot course, authoritarian regimiies also engage in tostering national colhesion and building coalitions of supporters. The public investmlent booms of the 1 970s in both NMorocco and C6te d'lvoire. among others. were motivated by such con- siderations. Morocco's King Hassan 11 taced down two attempted mlilitary coups. in 1971 and 1972. To build more support among the elite, in early 1973 he dispos- sessed foreign landowners/farmers of the 600,0()0 hectares they still held (down from one million in 1960). allocated sonie of it to actual and potential supporters. and revived a I 930s plan for greatly extending the irrigation network, with a view to producing sugar for the domestic market and citrus and vegetables tor export. Some thirty dams were built in the resulting investment booml (see Claassen un- published). Ample financing seemed to be available at the tinme the projects were launched, thanks to strong world markets for phosphates in 1973-74. President Felix H-ouphouit-Boigny of C6te dIvoire launched a major pro- gram ot rural development, focused on cotton and sugar. during the five-year plan period 1975-79. This program was designe(d partly to quiet and occupy the rest- The Political Economv oJ Stabilization and Adjusiment 373 less 'developmentalists" in his national party, partly to calm a serious feud within the politically important Coulibaly family in the north, and, most important, to tie central and northern ethnic groups more closely to the economically and political- ly dominant south (see Woods 1989). It fit nicely into the regime's continuing ef- forts to induce 1voirians to stay on the land, or even to return to the land. and it seemed economically attractive on the basis of the high cotton prices of 1973-74 and the extraordinary sugar prices of 1974-75. The sharp price declines that sub- sequently occurred do not seem to have been contemplated. The fortuitous large increase in world coffee and cocoa prices in 1975-77 provided ample financing for a few years. When world prices for these leading export products declined. C6te d'lvoire, like Morocco, continued with its projects, financing them largely with funds borrowed abroad and thereby laying the basis for its later debt problems. In 1973 Korea launched its heavy and chemical industries (HCI) investment program, which was to move the Korean economy into a modern industrial struc- ture. Although most of the investment was to be undertaken by private firms, these firms were "guided" by public policy and credit allocation. The financial require- ments for the entire decade-long program were huge and alarmed financial offi- cials at the time. Those concerned with economic development argued, however. that HCI was the right course, partly by analogy with the evolution of the Japanese economy. For his part, President Park Chung Hee was disturbed by what he (in- correctly) took to be the implications of the recently promulgated Nixon Doctrine, namely, that within the foreseeable future Korea would have to rely entirely on it- self for its security, in particular against another attack by the Dcmocratic People's Republic of Korea. materially supported by China or the U.S.S.R. He therefore wanted to build a strong foundation for a defense industry-steel, chemicals, and machinery-in Korea. As a result, Korea also participated in the general invest- ment boom of the I 970s, although investments were temporarily postponed dur- ing the first oil shock, and many were postponed indefinitely after the second oil shock. The 1973 HCI program therefore tumed out not to be an irrevocable one. The general point of this discussion is that expenditures to strengthen national cohesion, or to build political coalitions, may in the minds of political leaders take precedence over the maintenance or restoration of macroeconomic equilibrium- as long as the expenditures can be financed somehow, or until inflation imposes risks to cohesion or coalition that appear to outweigh the gains from the expendi- tures. At times, these leaders appear to undertake large projects when adequate fi- nance seems available without taking into account the possibility that the financial requirements may greatly exceed those initially postulated, or that the available fi- nancing may diminish because of world economic developments. Once launched, projects may be politically difficult or economically expensive to drop. although as Korea showed in the middle and late 1970s, ambitious investment programs can be curtailed or canceled if they threaten macroeconomic stability. Cote d'lvoire, too, built only six of the twelve sugar mills it had originally planned, because the costs were much greater than anticipated, and the revenues less. 374 Boom, Crisis. and Adjuestment A less elevated focus on objectives other than growth and stability occurs in what has been called the predatory state, or more recently the 'kleptocratic" state (by Whitehead 1990), in which individuals or groups of individuals more or less blatantly use the powers of the state to enrich themselves and their supporters. Ev- ery government has now and then tolerated this kind of behavior, although not al- ways from its national leaders. Where national leaders have behaved this way, macroeconomic stability would be fostered only insofar as it enlarged the possible take, or was deemed to prolong the period over which government largess would be available. Extemal threats, real or perceived, are also likely to take priority over macro- economic stability in the minds of most political leaders. Among our countries, Pakistan (1971), Argentina (1982), and Morocco (1977-90) were involved in ac- tual conflicts, and Chile, Kenya, Korea, and Thailand all felt the pressure of exter- nal threats, the last two throughout our period. In addition, Nigeria, Kenya, and Sri Lanka had serious internal threats to security, requiring or thought to require sub- stantial defense expenditures. Military expenditures have been discussed briefly in chapter 10 (see table 10-3). Curiously, several countries with actual or perceived extemal threats tended to maintain tighter budgetary discipline and less destabi- lizing fiscal policy than did countries with low military expenditures. Although in principle security considerations may dominate macroeconomic considerations in the minds of most political leaders, in fact the potential conflict between these two objectives seems to have been well managed in most of our countries. Tradition, Convictions, and Institutions Even if a political leader desires to establish a tightly managed fiscal policy, he needs to be able to implement it. For that, the institutional framework, the strength, competence, and authority of the public officials, and the general accept- ability of the policy are all relevant. Financial officials tend to be fiscally conservative in all countries. That atti- tude derives partly from their training, which in turn sometimes involves doctrine but even more, involves an acquaintance with balance sheets and the elementary proposition that every expenditure must somehow be financed. It derives also from the fact that their authority in government arises from the need for financial control. Countries-more precisely, the governing elite-have quite different his- tories and traditions, and these can strongly influence each country's approach to fiscal policy. Historical experience and tradition are reflected both in convictions about appropriate policies. and in institutions charged with implementing policy. Some countries have deeply ingrained conservative fiscal convictions. Britain bequeathed to its formier colonies both a Gladstonian tradition and an administra- tive setup conducive to "treasury control" (see Beer 1956). Both survive in India and Pakistan, although they seem to be weakening over time. They were gradually The Political Economy of Stabilization and Adjustment 375 undermined in Sri Lanka under the populist administrations of Mrs. S. Ban- daranaike during the early 1960s and early 1970s and could not easily be revived during the "foreign aid boom" of the late 1970s, despite the fact that aid donors typically favor good treasury control. The British legacy could also be found in Kenya and Nigeria. Unlike the former Asian colonies, however, these countries had no widely accepted elite, and both were plagued by deep regional and tribal rivalries and mutual suspicions. In Nigeria, these differences led even to civil war within five years of independence (most Nigerian oil was in the breakaway region of Biafra). A conservative fiscal tradition is eroded when governments are in constant search for supporters and potential supporters seek governmental favors. Interces- sion by financial officials in this kind of setting is likely to be interpreted narrowly, as one regional or tribal group attempting to assert its authority over others. The treasury control that survived these handicaps finally succumbed to the coffee boom in Kenya in 1975-77 and the oil boom in Nigeria during 1979-80, when funds were (temporarily, it turned out) so ample that treasury leverage disappeared and financial control seemed like an unnecessary nuisance. A tradition similar to the British, but with different institutional details, was established in the former French colonies-Morocco, Cameroon, and C6te d'l- voire. Indeed, as explained in chapters 8 and 10, the last two countries remain menmbers of multinational monetary unions in which French Treasury officials continue to play an important role. While budgets are under national control, gov- ernment debt to domestic banks by multinational agreement cannot exceed 20 per- cent of each nation's revenues in the preceding year. This puts a restraint on deficits that cannot be financed by borrowing abroad, which C6te d-lvoire did ex- tensively, and Cameroon more modestly. French Treasury officials must contend with the officials of other ministries in Paris-Commerce, Agriculture, Foreign Affairs-each of which for various reasons would sometimes urge that a more ex- pansionist stance be permitted in the African countries. Conservative financial traditions are not limited to former colonies. Thailand also has a "British" tradition of financial conservatism, said to stem from its desire in the nineteenth century to avoid giving Britain or France fiscal provocation to compromise its independence, as happened with a number of other countries (see Ingram 1954, pp. 170-74). More recently, Colombia, Korea, Indonesia, and Chile have all established a practice of fiscal conservatism, in reaction to a period of rel- ative profligacy and the "chaos"' that followed. Colombia had a vicious civil war in the early 1950s. The political truce that ended the war involved national power- sharing by the two leading parties for over fifteen years, 1958-74, combined with a resolve to put the economy on a sound basis and to avoid the turmoil of the past. Korea's Park Chung Hee was in part reacting to the fiscally undisciplined rule of Syngman Rhee before 1960; Indonesia's Suharto to the fiscal profligacy of Soekarno before 1965; and Chile's Pinochet to the unlimited spending (leading to inflation of 700 percent) of Salvador Allende in 1972-73. Each of these periods 376 Boom, Crisis, and Adjusiment was traumatic for the informed public and created an environment that cried out for a high degree of fiscal discipline. Convictions arise from such historical experiences, and they tend to be re- flected also in the formal rules governing fiscal policy. Thailand, for instance, can- not run a budget deficit in excess of 20 percent of expenditures and did not do so during our period; foreign borrowing is considered a financing item rather than a receipt, but special provision is made for replacing maturing external debt. (State- owned enterprises are not covered by this rule, but their foreign borrowing has re- quired central approval since 1977.) In Korea, the national assembly can reduce budget expenditures submitted by the president for its approval, but it cannot increase them. Moreover, the Korean government cannot borrow from the central bank (with limited exceptions) with- out getting the explicit approval of the national assembly, a process likely to pre- cipitate public debate and therefore to be avoided in the eyes of Korean officials. The Indonesian government, at Suharto's insistence, has submitted only bal- anced budgets since 1967, although foreign loans count as receipts, and borrowing from the central bank is permitted under some circumstances. The government even alludes from time to time to the constitutional requirement for a balanced budget, although no such provision can be found in the constitution (Woo and oth- ers forthcoming). Thus are traditions established. Chile cut government expenditures drastically in the mid-I 970s and by 1975 was in budgetary surplus, despite the world recession and the sharp drop in copper prices. Moreover, Chile introduced a truly independent central bank in 1989, such that it is not obliged to lend to the government at any time. Colombia made a sim- ilar move in 1991, and Argentina in the same year prohibited its central bank from making domestic currency loans to the government. The traditions get reflected in other ways as well. Presidents Park (1961-79) and Chun (1981-87) of Korea each took a strong personal interest in economic policy, even though they had no economic background; so did Prime Minister Prem (1980-88) of Thailand and, less so, President Suharto (1966-) of Indonesia. Korea and Indonesia created economic "superministers" who had responsibility for all facets of economic policy. Revenue forecasts have deliberately been con- servative (that is, below outturn) in Korea. in order to restrain planned spending in the budget. As higher-than-projected revenues materialize, a supplementary budget is usually submitted, to ensure that spending occurs only as financing be- comes available. Once a budget is approved, there is no history of overruns; that is, the administrative system maintains tight controls on outlays as well as on the budget. In Thailand, the discipline on actual spending is so tight that the outturn in our period was always below budgeted levels, sometimes by as much as 8 per- cent (Ramangkura and Nidhiprabha 1991, table 4). Argentina and Brazil have quite different traditions. Juan Peron was a popu- lar. charismatic leader during the 1940s, appealing especially to urban workers and denigrating the "stuffy" conservative European attitudes of other Argentini- ans. During his first period in office, the country enjoyed favorable exports and a The Politic-al Economny oj'Stabilizalion and Adjustment 377 buoyant income, after the bleakness of the Great Depression. He believed the state should play an active role and was known as a big spender, especially in the area of social programs and public employment. He was deposed in a military coup in 1955 and exiled (to Spain), but he remained a popular figure with significant seg- ments of the population, thus making life difficult for any non-Peronista govern- ment that did not systematically suppress popular discontent. In 1973 he returned to Argentina as president and immediately launched a major program of public spending, encouraged by the high world grain prices of 1973. He died after less than a year in office, but had insisted that his wife be his vice-president, so Isabel Peron continued his policies until she was deposed by a military coup in March 1976. Partly as a consequence, Peronista statist expansionism retained its popular- ity with significant segments of the population, particularly urban blue-collar workers and many state employees. Brazil as seen by Brazilians is a country with a large frontier and unlimited possibilities for development. Cheap, available credit was necessary for develop- ment. Historically, coffee growers were the dominant economic group, followed later by the business community in Sao Paulo, both of which liked easy credit. There has been no strong conservative financial tradition. Reflecting these views, Brazil did not create a central bank until 1964, and even that was achieved only by agreeing to open unlimited rediscount facilities, at a nominal I percent annual interest, for the Banco do Brasil, a leading commercial bank (partly government- owned) that had also been the government's banker and had strong ties to com- mercial borrowers. This facility was not eliminated until 1986. Within the govern- ment, the minister of finance not only did not control all government spending, he did not even know about all government spending. State-owned enterpfises. spe- cifically, were outside the control of the Ministry of Planning (the chief economic official), and sometimes had access to central bank financing, via Banco do Brasil. Mexico started on a conservative financial tradition in the 1920s, in the after- math of a long civil war. A quasi-independent central bank was established in 1926. The economic difficulties of the Great Depression of the 1930s compro- mised this independence, but established close working relations between the cen- tral bank and the (more expansionist) treasury. This team then succeeded in establishing and maintaining a relatively conservative financial tradition during the 1950s and 1960s. An implicit bargain seemed to exist within the ruling PRI: the president of the republic would defer to the secretary of the treasury on financial questions, and the secretary in turn would not become apolitical rival of the pres- ident or his chosen successor. This "bargain" was in effect broken by President Luis Echeverria in the 1970s, when he exiled the traditional treasury man Hugo Margain to the Mexican embassy in the United States and appointed a more pliable successor, Jose Lopez Portillo. Late in his administration he established a new, rival Ministry of Planning and Budget to absorb the budgeting functions of the treasury and to challenge it institutionally. Expenditure rose by 3 percent of GDP between 1971 (Echeverria's first year of office) and 1975, precipitating a financial crisis and in 1976 the first 378 Boom, Crisis, and Adjistrnent devaluation of the peso since 1954. A modest retrenchment occurred, but expen- diture increased further under President Lopez Portillo, Echeverria's chosen suc- cessor, rising by an astonishing 14 percent of GDP between 1977 and 1982. This great rise was made possible by the rapid increase in oil production that Mexico experienced in the latter half of the I 970s, by the sharp rise in oil prices in 1979- 80, and by the external borrowing that such promising oil revenues permitted. The 1981-82 fall in oil demand, combined with oil pricing mistakes by Mexico, un- dermined Mexico's financial position. and the debt crisis of August 1982, dis- cussed in chapter 2, was the consequence. In the meantime, the Ministry of Planning and Budget had been staffed by technically competent treasury or central bank officials, and the subsequent two presidents, Miguel de la Madrid (1982-88) and Carlos Salinas (1988-), were drawn from that group.'0 Economic booms leading to large increases in government revenues typically weaken treasury control. An early example among our countries was Pertamina, Indonesia's state-owned oil company, following the first large oil price increase in 1974. It was led by an exuberant and entrepreneurial general, Ibnu Sutowo, who used the large inflow of funds not only to increase Pertamina's investments in oil exploration and development, but also to expand greatly Pertamina's range of ac- tivities, into manufacturing, transport, tourism, and even rice. To do so, Sutowo borrowed extensively in the Euro-currency market, against Pertamina's reve- nues.11 Then, when oil demand slackened in 1975, Pertamina was found to be badly overextended. A committee of financial officials was established to oversee Pertamina and other large state enterprises, to straighten out its financial situation, and to prevent a repetition. In the Javanese fashion, General Sutowo was eased out of his position and replaced by a less exuberant, more financially minded general. In the end, the Pertamina crisis, which attracted widespread adverse public attention, probably strengthened the position of the financial technocrats and helped avoid overexten- sion during the next oil boom of the late 1970s. Mexico's state-owned oil firm, Pemex, went through a similar phase in 1980-81, greatly expanding its activities, investing generously, paying large wage increases to its employees, and borrowing heavily abroad to accomplish it all, in an environment in which banks were eager to lend to an oil-rich firm. Oil demand and prices dropped sharply in 1982: Pemex's revenues suffered also from a Mex- ican reluctance, as in Nigeria, to lower posted oil prices, so market share was lost. Pemex was overextended, and its director general Jorge Diaz Serrano was finally dismissed. Similarly, fiscal discipline was greatly weakened in Morocco, C6te d'lvoire, and Costa Rica during their commodity export booms (in phosphates, cocoa, and coffee, respectively) of the mid-I 970s. Once weakened, discipline was difficult to reestablish after commodity prices fell. Even more extreme was the loss of fiscal discipline, enhanced by ethnic, tribal, and regional rivalries and mutual suspi- cions, in Kenya during its coffee boom, and in Nigeria during the 1979-80 oil boom. Budgetary control virtually disappeared in these two countries for several The Political EconomnY of Stabilization and Adjustment 379 years, reinforced in the case of Nigeria by a newly established democratic govern- ment under President Shehu Shagari in need of building a supporting coalition both for his party and for democratic government in general. As noted above, he was deposed after his reelection in 1983, in large part because of the fiscal laxity leading to cronyism and corruption. The general point is that when funds are readily available, and known by all to be available, it requires exceptionally strong traditions and strong-willed finan- cial officials backed by their political leaders to maintain financial discipline in the interests of avoiding difficulties in the future. Treasury control usually depends on the leverage of a practical limit to revenues, which permits officials to impose con- straints on spending. Most governments, democratic and authoritarian alike, are preoccupied with the short run and find it hard to resist spending a windfall in revenues. Among our countries, Cameroon stands out as a notable exception, having used part of its un- expected increase in oil earnings in 1979-81 to prepay foreign debt, and part of it to increase (secret) reserves abroad. not taking them into ordinary government revenues. Even in that country, however, government spending rose by 7 percent of GDP between 1979 and 1983. Colombia maintained its tight stabilization pro- gram through the small coffee boom of 1986, and Korea moved into budgetary surplus and prepaid external debt extensively to help neutralize the expansionary effects of a large export surplus in 1986-88. thus illustrating that a boom in reve- nues does not have to lead to an increase in expenditures. This discussion of the dubious benefits of a boom in receipts illustrates a dif- ferent point as well. The "government" is not a well-defined, cohesive unit in most countries. At least three components must be viewed separately from those parts of the government-including the economics or finance ministry and the central bank-that are responsible for managing overall economic policy. First, there are the "spending ministries," those responsible for carrying out the various functions of government such as providing education or public infrastructure or health care. Even leaving aside straightforward patronage, they almost always have unfulfilled wishes or even plans that are constrained by the lack of finance. If finance is avail- able, they will press forward. Second, while economic policy is framed by the central govemment, many or even most of the functions of government are carried out by its other units, prov- inces (called "states" in some countries), and local authorities. In many countries these are simply units of the central government, subject to much the same kinds of financial control as the spending ministries are. Some countries are organized as federations, in which the provinces (or states) have a constitutionally indepen- dent existence, often with their own sources of revenue, and with a constitutional division of responsibility between them and the central government. Among our countries, Argentina, Brazil, Colombia, India, Indonesia, Korea, Mexico, Nigeria, and Pakistan have federal structures, although the degree of provincial autonomy varies substantially from country to country, being especially high in Argentina, Brazil, India, and Nigeria. 2 In India, more than half of government expenditure 380 Boom, Crisis, and Adjustment is undertaken by the states (and even more if the local government is included, but data are unavailable), and more than 30 percent by provinces and local govern- ment in Argentina, Brazil, Colombia, Indonesia, Korea, and probably Nigeria.13 In most of our federal countries (Mexico has been an exception), a higher share of revenue has accrued to the national government than is true of spending responsi- bilities, so the national government shares revenues and makes grants (and some- times loans) to lower levels of government. In India and Pakistan, for instance, an independent commission reviews and sets a revenue-sharing formula between center and states at five-year intervals.14 The existence of a federal system of government poses no special problem for macroeconomic management so long as the provinces and municipalities are fis- cally constrained by their own revenue plus grants or loans from the national gov- ernment. The problem arises either when national financial control has broken down, as in Nigeria in the late 1970s, such that subnational levels of govemment are authorized (by someone) to spend at levels collectively in excess of the reve- nues available; or when provinces can borrow abroad or have direct or indirect ac- cess to the central bank. The latter circumstances have prevailed especially in Argentina and Brazil. As already noted in chapter 10, a number of Argentine prov- inces own banks, from which they borrow, and these banks in turn have access to the central bank. In Brazil until 1986, the partly public Banco do Brasil had un- limited overdraft facilities at the central bank, and states in turn could borrow from the Banco do Brasil, as well as from state-owned banks that had direct access to the central bank. The internal politics of both countries, combined with the consti- tutional autonomy of provinces, made it difficult to curtail these practices. In par- ticular, President Sarney depended for political support on several key state governors, and was disinclined to attempt to impose monetary discipline on them. An analogous problem arises with respect to state-owned enterprises (SOEs). Although as the name suggests these are owned by the government and thus should in principle be under the control of the government, the degree of effective control varies greatly from country to country. Some SOES have virtually become a state within a state, with a high degree of autonomy. We have already cited the cases of Indonesia's Pertamina and of Mexico's Pemex. SOEs are subject to the same analytical observation as provincial govern- ments: they cannot disrupt macroeconomic policy unless in practice they have un- constrained access to the government budget, or unless they can borrow abroad, or unless they can borrow directly or indirectly from the central bank. Unfortu- nately, examples can be found of all three of these "loopholes." Because govern- ments are reluctant to allow SOES to fail, and because managers of SOEs know that and are often politically powerful, they sometimes spend beyond what is formally allowed and then have the government pay the bill. Costa Rica's CODESA, a state-owned holding company whose function is to encourage development, had direct access to the central bank and spent some of its (borrowed) resources bail- ing out ailing firms, or buying them outright. The SOES in Brazil could borrow from Banco do Brasil and thus until 1986 had indirect access to the central bank, The Polititl Economy oj Stabbilzation and Adjuisiment 381 and until about 1980 they could borrow directly abroad without restraint by the central authority, as could the SOES in Turkey. Like any commercial firm, SOEs borrow routinely through suppliers' credits. In C6te d'lvoire, Morocco, Nigeria, and Turkey, arrears on SOE borrowings in this form became a substantial part of the debt problem of the 1 980s. Some situations are highly complicated and do not necessarily involve loss of treasury control. A country's SOES may run into financial trouble for a variety of reasons, some of which may have nothing to do with careless management. For example, a currency devaluation may have greatly and unexpectedly increased an SOE's debt-servicing costs; or as part of anti-inflation policy the government may impose controls on the SOE's product prices, even while its input prices continue to rise. When the firm runs into financial trouble, the government for a variety of reasons (for example. domestic or international prestige, to avoid contagion, and so on) may not want the firm to fail. It is allowed to borrow from a state-owned bank, even though its prospects are not good. The bank can certainly not be al- lowed to fail, it is thought. So it is allowed to borrow, or to rediscount its poor loan to the SOE, at the central bank. There are many examples of this pattern, especially following the widespread domestic financial crises of 1982-83 (see chapter 10), even in countries that run a relatively tight fiscal ship such as Korea and Thailand. Government relations with SOEs are complicated by the fact that politically powerful interests are often associated with them, for example, through patronage rewards to important political figures. even potential political rivals of the incum- bent leadership. Moreover, in some countries (Argentina. Brazil, and Indonesia, for instance) retired generals or even active military units are involved in manag- ing SOES, complicating the task of imposing financial discipline on them. Disci- pline is more easily maintained if the national leader is an economy-minded general or former general, such as Park and Chun in Korea, Suharto in Indonesia, Prem in Thailand. or Pinochet in Chile. Interest Groups and External Actors The function of politics, at least in democracies, is to reconcile the diverse and of- ten conflicting interests of the citizens. This process in turn represents the core of the study of politics: who gets what, when, and how? The working assumption of political economists is that various elements of society will press the government for policies and actions favorable to their economic interests, and that they will strongly resist actions inimical to their economic interests. In short. prospective losers from a given line of policy action will try to block its adoption, or under- mine its implementation. What can be said about interest group politics with re- spect to macroeconomic management in our countries? 382 Boom, Crisis, and Adjustment Interest Groups Surprisingly little, it turns out. This is partly because the various elements of so- ciety do not know. on balance, where their interests lie when it comes to an issue as complex as macroeconomic management. Most people in principle favor growth and oppose inflation; and they find it difficult to evaluate a policy that tem- porarily slows growth in order to reduce inflation, especially prospectively when the short-term trade-offs are not known. A policy to reduce inflation may be wide- ly applauded at first, yet resisted later on, as people become aware of the lost out- put and higher unemployment. Currency devaluation raises the local currency prices of imports, unwelcome to those who purchase them; but in a regime in which imports have been suppressed through exchange controls, a devaluation with import liberalization may actually be welcome. Macroeconomic relation- ships are complex, and are not well understood even by the relatively well-in- formed elite. So governments can often garner support or at least acquiescence in policies by making claims for them that seem plausible in prospect even if they do not materialize in reality. No one, however, likes to pay higher taxes; and increases in urban bus fares come close to universal dislike. In addition, with some notable exceptions. interest groups in most developing countries are not so well organized as they are in the wealthy democratic coun- tries, so they are less able to translate their interests, even when they understand them, into political action. In what follows, we briefly examine the role of the prin- cipal (actual or potential) interest groups: urban labor, farmers, businessmen, mil- itary officers, employees of SOEs (labor and management), civil servants, and politicians themselves. WORKERS. The "organized" or formal sectors of developing economies often have some form of labor organization, although its scope for political action is typ- ically limited by custom or by law. Particularly when the capital city is also a large part of the formal nonagricultural economy, as it often is, workers could in princi- ple have access to decisionmakers, and of course they can demonstrate publicly or go on strike. In practice, organized labor has often been co-opted by the leading political party, as in Mexico, or by the party attempting a stabilization program, as in Colombia and Costa Rica in the I 980s. In many othercountries, labor is not per- mitted to demonstrate publicly or strike, and force may be used to suppress such actions. Even in Mexico. the government in 1986 cracked down sharply on labor that deviated from the accepted path of negotiating within the PRI, dismissing the dissident leaders. And a civilian government in Brazil used the military to sup- press a strike in 1987. Argentina represents a partial exception to these generali- zations, in that labor is well organized and at least since Peron of the I 940s has engaged in political action, contributing to the sectional standoff in Argentine pol- itics. In reaction, the Videla military government ( 1976-80) was especially harsh with labor leaders, and even collective bargaining was banned from 1976 to 1986. The Political Economav oj Stabilazalion and Adjusitment 383 Only rarely does labor as an interest group greatly influence policy, and even then it usually has to appeal to a much wider constituency. An example is a strike by Chilean miners in 1983 over the reoime's severe economic policies. This strike encouraged protests by others, and the Pinochet reginme in response softened its macroeconomic actions temporarily (Nelson 1990). In Costa Rica of the late 1970s, however. organized workers in public enterprises successfully intimidated the (politically weak) Carazo government against cutting financial support to the SOEs, even though they were a substantial drain on the budget, and concern about labor unrest no doubt limits governmental action in many countries. FARMERS. Farmers or agricultural workers in developing countries are even less well organized politically than are urban workers. They nonetheless represent important segments of the population, and for that reason governments often find it in their interest to appeal for rural support. We have seen the political impetus to rural development projects in the 1 970s in the cases of Cote d'lvoire, Morocco, and Sri Lanka. Similarly, bothi Suharto of Indonesia and Park of Korea felt that mass rural support for their governments was politically important, particularly in the former case because the communists were strong in the rural areas of Java. Hence, they devoted considerable resources to rural development and to price sup- ports for some agricultural products. These examples involve political strategy by each country's leader rather than active political pressure by farmers. Some farmers are well organized. The coffee growers have long been an im- portant (although now diminishing) factor in Brazilian politics, one of the groups that has historically favored easy credit. Sugar growers in Costa Rica are well or- ganized and have on the whole successfully resisted government efforts to reduce the protection they receive. And the large landowners of Argentina are well orga- nized and politically active. like urban labor contributing to the political stalemate that existed for so long in that country. BUSINESS. The business community is generally rather better organized to ex- press its views on policy than either labor or farmers. This group, or various sub- sets of it, may also have a clearer idea of what its economic interests are. In any case, governments are more likely to pay attention to what the business commu- nity wants, but the relationships between business and the government vary. A number of governments, most notably Korea, have co-opted the business commu- nity, combining (until the relative liberalization of the late 1980s) guidance with incentives, largely in the formi of foreign exchange allocations and low-interest credit. Great pains were taken to explain to the business community what govern- ment policy is, and why. The business community expressed its reactions to new policy directions and modified the content or timing, but it has not challenged new directions frontally. In Chile and Thailand, too, the business community was generally favored by government policy, but often the government was pushed beyond what important elements of the business community would have preferred. Business muted its 384 Boom. Crisis, and Adjusiment criticism of Chile's severe policy largely because it preferred the existing Pinochet government to the likely alternative of another divisive Allende-type government. It took considerable time and some anxiety before the business community in Chile began to criticize the extreme free-market ideology of Finance Minister Castro and his "Chicago boys," but eventually Castro was replaced with a more moderate minister (see Stallings, in Nelson 1990 and in Bates and Krueger 1993). In Thailand, policy was less extreme but still not to the liking of many in the busi- ness community, but they muted their criticisms because they preferred Prem to a less democratic, less business-oriented military government. In Mexico, the geographically northern, more export-oriented parts of the business community became increasingly vocal in their criticisms of economic policy under President Lopez Portillo (1976-82), and support from this group was one of the factors that encouraged the change in structural orientation of Mexican economic policy in the 1980s. The business community in Brazil, mainly the Sao Paulo industrialists, is also well-organized and politically influential. This group has traditionally been growth-oriented and hostile to tight credit and high interest rates, so has generally opposed serious stabilization policies in Brazil; the finan- cial community, in contrast, has been relatively weak. '- Wherever the business community is thought to be largely in the hands of a minority group, such as the Chinese in Indonesia or Asians in Kenya, the political influence of the business community is likely to be weak, and indeed businessmen are likely to shun any role that suggests political activism. The business commu- nity has little influence in India, perhaps because the commercially successful Par- sees, Marwaris, and Gujeratis are regarded as being outside the mainstream of Indian society, both by themselves and by others. In other countries, such as Ni- geria, business influence is exerted informally through relatives in the government and through traditional channels rather than through formal organizations and public statements. MILITARY. Professional military men play a special role in many developing countries. They often see themselves as subordinate to the constitution and to the real "spirit" of the country, but not as subordinate to the existing government. Thus, half of our countries experienced military coups since 1965 in the name of true national purpose and proper governance (see table 12-1). Three others (Cam- eroon, Kenya, and Morocco) experienced attempted coups. The prospect of a mil- itary coup is thus something that many governments must constantly keep in mind. Costa Rica and Mexico dealt with this possible threat by eliminating, or vir- tually eliminating, the professional military. In other countries, the military, even when out of formal power, and sometimes merely by their presence, may influence policymaking. An obvious concern is the military budget; but preservation of per- sonal prerogatives and military status and prestige can also be important;'6 and in some countries, as noted above, military figures or military units are involved di- rectly in business activity, which governments must be cautious about threatening. Like other groups, professional military men do not always agree on what is best The Political Economy of Stabilization and Adjustment 385 for the country, or even for them, and that gives astute leaders some room for ma- neuver. Furthermore, strong leaders that are former generals may find it easier to deal with the military than civilians do. STATE-OWNED ENTERPRISES. The special role of SOEs in many developing countries has already been discussed. Their leaders are often individuals of con- siderable political influence, and their workers are often among the best organized of urban labor. Both management and labor may combine to oppose govemmental actions that involve substantial cuts in output and employment in these often over- staffed enterprises, or to oppose actions that put them in a financial squeeze (such as having to service in full their external debt after a currency devaluation). CIVIL SERVANTS. Civil servants can be divided into two groups, the higher- echelon professional administrators and technocrats, and the clerical and manual workers. The latter group makes up far the larger number, but they have little po- litical power-not least because they risk losing their jobs if they become openly critical of policy, and their individual services are rarely crucial to the functioning of government because of widespread overstaffing. Senior civil servants, in contrast, have substantial influence; it is their job to recommend policy, and often they are the most qualified people in the country to frame economic policy. In their advice and implementation, they are influenced by their formal training, by the traditions of the service in which they operate, and by the general intellectual currents of the time. U.S.-trained economists have played an especially important role as ministers and vice-ministers in Indonesia and Chile, where they were known as the "Berkeley mafia" and the "Chicago boys," respectively, and in Mexico during the late 1980s; but also as senior officials in Korea and in Thailand. Of course, most countries have some able economists; the key question is why they are or are not used. Many officials will try to frame policy in what they consider the national in- terest, but they may also have more parochial interests, often involving their future scope of responsibility. Thus, "turf battles," common in any bureaucracy, are far from absent in developing countries. In the area of economic policy, these are of- ten between the financial officials (generally in the finance ministry and central bank) and the economic planners or the officials of industry and agriculture min- istries. Of course, there may also be serious substantive disagreements on policy; but the point here is that the disagreements often reflect differences in personal and financial interests, since the line between public and private is not typically drawn sharply and many officials are also engaged in private business. Indonesia, indeed, has made a public virtue of the dual role of official/entrepreneur or general/entre- preneur, but the practice is widespread (see Woo and Nasution 1989. p. 62). POLITICAL LEADERS. Finally, in addressing interest groups we shall also in- clude the political leaders themselves. To the extent that they or their relatives ben- efit financially from political power, and even if they do not, political leaders like 386 Boom, Crisis, andAdjustmient to stay in power. To do so, as noted above, they typically must build public support for their tenure, and that often involves the inauguration of public works, the pro- vision of public employment for loyal followers, and government purchases from favored suppliers. Too much budgetary discipline, and too much restraint on total government spending. may not be in either the personal or the political interests of the key policymakers. External Actors The world is organized into sovereign nations, enshrined in the Charter of the United Nations and fully free to make their own choices regarding domestic eco- nomic policy. The role of external actors-foreign governments, international or- ganizations, foreign banks and businesses, human rights groups, and the like-is not to make domestic decisions for other countries. By holding out "carrots and sticks," they can influence the set of opportunities that domestic decisionmakers face, and in this respect they can influence national decisionmaking. The carrots and sticks normially have a financial dimension. but economic and political ana- lysts sometimes underestimate the potency of simple international approval or dis- approval of a country's course of action. Being a chief executive is lonely, and international approval and "understanding" from other leaders or prestigious in- ternational institutions can sometimes be important. The International Monetary Fund (IMF) and the World Bank are often cited as leading channels of foreign in- fluence on economic policy. The role of external actors and the extent of their in- fluence is beyond the scope of this study, but occasionally it has been important. For instance, the U.S. Agency for International Development (USAID) played a critical role in leading Korea in the mid-1960s to adopt both stabilization poli- cies and a policy of export orientation. The agency cajoled, but it also both offered and withheld aid at critical moments (see Haggard and others in Bates and Krue- ger 1993). U.S. assistance conditioned on changes in economic policy also seems to have played a crucial role in the Costa Rican stabilization of the mid- I 980s. Ob- viously, such external influence cannot carry the policy alone; but sometimes it can be decisive in tilting the domestic decisionmakers, or in helping to overcome domestic resistance to directions that economic officials would like to take. For example, in 1984 the international community reinforced growing domestic dis- satisfaction with the Betancur/Guti6rrez policy of fiscal expansion in Colombia. involving a larger budget deficit and a loss of foreign exchange reserves. Finance Minister Gutierrez was subsequently dismissed and the policy reversed. Some countries-most notably Brazil, Colombia, India, and Nigeria, among our countries-have shown extreme political sensitivity to international organiza- tions, especially the IMF. "Going to the IMF" was politically unpopular, and came to be viewed as an act to be avoided if at all possible. Brazil in 1981 adopted a stabilization program arguably more severe than the IMF would have required at that time. without gaining access to IMF resources (see Bacha, in Williamson 1983). (Brazil did finally go to the IMF two years later.) Similarly, Colombia in The Poliiical Econonmy of S,abiliza.ion and Adjustnent 387 1985 and Nigeria in 1986 declined to go to the IME In Nigeria the military gov- ernment of General Babangida opened the issue to public debate. and the response was a resounding negative. Nonetheless, each country needed IMF approval of its policies in order to qualify, in the case of Colombia, for a new jumbo commercial loan, and in the case of Nigeria for debt rescheduling under standard international practice, something they both wanted. The compromise was to allow the IMF to 'monitor" domestically determined policies for the benefit of the international fi- nancial community (including creditor governments), while not drawing on IMF financial resources to which they would have been entitled under the agreement. Other countries feel less constrained about going to the IMF, and indeed some have practiced it almost routinely in framing their economic policies. For instance, Kenya and Korea went to the IMF eight times during the period 1973-89, Pakistan seven times, and Costa Rica six times (see table 12-3). In truth, economic policy is always decided by the domestic government; no country is literally obliged to go to the IMF, although the costs of not doing so increased after the debt crisis of 1982, since alternative sources of funds were less readily available, and formal debt rescheduling typically required an IMF program. It is often convenient to blame some of the unpleasant consequences of stabilization policies on an exter- nal agency, a procedure that is sometimes politically useful, but in the long run it undermines confidence both in the national government and in the IMF. One source of the difference between these two groups of countries has been disagreements between IMF officials and national policymakers regarding what is appropriate policy. In Brazil, where structuralist views held sway. this difference of opinion centered on macroeconomic management; in India, it was more over the principles that should govern the allocation of foreign exchange. Such coun- tries went to the IMF reluctantly, for they resented its loan conditions (India's large extended fund facility in 1981 did not carry it into high conditionality). In other cases, officials from the IMF and other international organizations have reinforced the convictions of national financial officials. The provision of in- ternational intellectual and financial support makes it easier for these officials to overcome opposition at home to their preferred policies. Such ''side taking" of course sometimes creates resistance against the IMF in some segments of the pop- ulation, precisely because of its support of financial officials in a domestic dispute over policy. Mention should also be made of the general intellectual tendencies in world centers of opinion. which gradually diffuse throughout the world. During the late 1970s and especially the 1980s, academic opinion swung away from "planning" and an active role for the government. Many scholars had grown skeptical about the ability of governments to frame and especially to execute policies that were really in the interests of the average citizen, even in the long run. Correspondingly greater weight was given to the role of "market forces" in guiding economic deci- sions toward activities that were more likely to be efficient, hence more likely to raise average incomes over time. The market was also seen as a less personal force, diffusing power away from politicians and officials. 388 Boom. Crisis, and Adjustment Table 12.3 International Monetary Fund Standby Arrangements for Eighteen Countries, 19734-9 (millions of SDRs) Couniry /973 1974 1975 1976 1977 1978 Argentina Aug.'260.0 Sepi 159.5 Brazil Cameroon Chile JaW79A4 Mar,79.0 Colombia Jun/20.0 COsta Rica JuL' 1 1.6 C6ite d'lvoire India Indonesia May/50.0 Kenya Jul/67.2 NoWv 17.2 (3 year EFF) Korea, Rep. of Apri20.O May!'20.0 Oct/20.0 May/20.0 (8 mth) (7 mth) (8 mth) (7 mth) Mexico Jan/518.0 (3 year EFF) Morrocco Nigeria Pakistan Aug;75.0 Nov/75.0 Mari0.0 Mar/80.0 Sri Lanka Apre24.5 DMc093.0 Thailand Jul/42.2 Turkey Apr/300.0 Apr/3.360.0 (9 mthl Note: Blank cell - not applicable. EFF - Extended Fund Facility. canc. - cancelled. Source: IMF Annual Reports, 1971-89. The Political Economy of Stabili-ation and Adjusrment 389 1979 1980 /98/ 1982 /983 1984 Countrv Jan/ 1.500 0 Dec/1,182.0 Argenlina (canc. 1!84) Mar4,239.0 Brazil (3 year EFF) Cameroon lan/500.0 Chile Colombia May/60.50 Mar1276.7 Dec/92.95 Couta Rica (2 year) (3 year EPI') (canc. 12-81) Feb/484.5 Aug82.7 COle dIvoire (3 year EFF) (9 mth) Nov/5,000.00 India (3 year ElF) (cane. 5/84) Indonekia Aug/122.4 OJ1241.5 Jan/151.5 Mar/175.9 Kenya (canc. 10/80) (2 year) (18 mlh) (canc. 1182) Mar/640.0 Feb/576.0 July/575.8 Korea. Rep. of (canc. 2/81) (18 mth) aW3.6 11.0 JanW3,410.0 Mexico (3 year EAR) (3 year Eff) Oct/8 10.0 Mar/817.0 Apr/281.2 Sep/300.0 Morocco 3 year EFF) (19 mth) (18 mth) (canc. 3/81) (canc. 4/82) Nigeria Nov/ 1,268.0 Dec/919.0 Paki,ian (3 year EFF) (3 year EFF) (canc. 2/80) 3ati2603.3 SepilO0.0 Sri Lanka (3 year EFF) (10 mth) Jun/8 14.5 Nov/271.5 Thailand JuU250.0 Juwl,250.0 ul/225.0 Apr/225.0 Turkey (canc. 6/80) (3 year EFF) (canc. 4 84) (The table continues on the Jo/lowing page) 390 Boom, Crisis, and Adjustment Table 12.3 (continued) Counrry 1985 1986 1987 1988 1989 Argenmina JuU/947.5 Dec/l.104.0 ( 4 mth) (I 5 mth) Brazil Aug/109.0 (IS mth) Cameroon Sep/69.0 (6 mth) Chile Augl825.0 Dec/64,0 (3 year EFF) Colombia CoMa Rica Marl54.0 Ocl40.0 May/42.0 (19 mth) CCie d'Ivoire Jun'66.2 Jun/100.0 Feb,'94.0 Nov/75.8 (2 year) (14 mih) (5 mrh! (cane. 2/88) India Indonesia Kenya Feb/5.2 Feb/85.0 ( 8 mth) Korea. Rep. of Jul/280.0 (18 mth) Mexico Nov/1 .400.0 (18 nth) Morocco Sep/200.0 Dec/230.0 Aug/210.0 (18 mih) (16 mlh) (16 mih) (canc. 12/85) Nigeria JarV650.0 Feb/475.0 (14 mth) Pakislan Dec/273.0 (15 mih) Sri Lanka Thailand Jun/400.0 (21 mih) Turkey Note: Blank cell - not applicable. EFF - Extended Fund Facility, canc. - cancelled. Source: IM{F Annual Repons, 1971-89. The Political Economy of Stabitizarion and Adjusrnmeni 391 These intellectual tendencies were seemingly supported empirically by some outstanding economic successes, especially in East Asia, where Hong Kong was a leading example of minimal governmental interference in commercial activity. These tendencies inevitably diffused to officials of international organizations and, partly through them, into intellectual and policy circles in many countries. They contributed to the dramatic policy changes that occurred in many developing countries during the 1 980s, which greatly reduced the regulation of financial mar- kets and of foreign trade, and even allowed some state-owned enterprises to be sold to the private sector. Intellectual fashion in the area of macroeconomic management also changed, although no consensus developed on what mechanism other than an active gov- ernment could be used to stabilize aggregate demand and combat inflation. Argen- tina and Chile. as we have seen, both experimented with an alternative approach emphasizing stabilizing expectations through exchange rate policy, and both ex- periments failed, although for different reasons. Changing attitudes toward the role of market forces very likely contributed to the greater flexibility of exchange rates in the I 980s than had prevailed in earlier periods. The point here is that external actors and ideas are frequently influential in de- termining national economic policy in some developing nations, but that influence comes indirectly, by influencing the set of opportunities that national leaders face. The choice is theirs. Summary This chapter has briefly surveyed the political dimension of economic policymak- ing, which encompasses the form of govemment, the timing of transitional gov- ernments, the role of interest groups, and the role of history and tradition in shaping public expectations. It seems there is little correlation between the form of government and economic performance, as we have defined it-that is, on the basis of growth and inflation in the 1980s. Authoritarian governments have done both well and badly; democratic governments have also done both well and badly. Governments that suppress civil liberties do not, on average, perform better than governments that do not suppress civil liberties. There is a tendency, however, for ntew democratic governments, emerging from a period of authoritarian rule, to be somewhat more expansionist than other governments, regardless of whether un- derlying economic circumstances call for a more expansionist stance; when they do not, that can lead to later economic difficulties. In general, interest groups are not as well organized in developing countries as they are in developed ones. In many countries, that may be because they are in- timidated by the government, in others because the major political parties have channeled and co-opted them. The business community played an important role in resisting stabilization policies in Brazil, however, and labor in resisting stabili- 392 Boom, Crisis, and Adjgstrtneni zation policies in Argentina. Farmers are generally politically weak, but some leaders (in Indonesia, Korea, Sri Lanka, and Thailand, all Asian countries, and to some extent in Cote d'lvoire) have nonetheless adopted policies favorable to rural populations. to acquire and keep their political loyalty. History and tradition are extremely important in establishing what the public expects from the government and have considerable effect on the public's willing- ness to accept short-run hardship for the sake of desired longer-run aims that it be- lieves the government is pursuing. How exactly these traditions are established is not well understood. Often a traumatic past event lingers in the collective memory and creates an environment conducive to certain policy actions. The German hy- perinflation of 1923 is often mentioned in this regard, and the Colombian civil war of the early 1 950s. India, Pakistan, and Sri Lanka inherited a tradition of firm trea- sury control from Britain. Such explanations are often no doubt correct, but they are incomplete, for they fail to indicate why equally traumatic events in other countries-hyperinflation in Brazil, a civil war in Nigeria, or a tradition of British Treasury control in Nigeria and Kenya-did not have a comparable impact. Full explanation is beyond the scope of this book; the important point is that the ability of the government to succeed in a course of macroeconomic stabilization depends not only on the economic circumstances confronting it, and on the policies formal- ly adopted, but also on the convictions of the leaders and of the public with respect to desired outcomes. It goes without saying that (apart from good luck, which sometimes comes) good policy depends on a cadre of technically competent officials who can recog- nize problems, analyze them skillfully, and propose courses of action to redirect the economy as desired. Although such skills were sometimes absent in the 1 960s, officials with good technical training and experience were available in most coun- tries by the 1 980s, although not always in adequate numbers. They could often be augmented by foreign advisers. especially from the IMF and the World Bank. Good policy advice is necessary, but far from sufficient. Such officials must carry enough weight to get their recommendations adopted, and then must be able to execute the policies effectively. To achieve this, they must have the support of the country's political leader(s), and preferably also of the public's convictions. The political leaders must insulate their officials from short-term or sectoral pres- sures that would undermine a coherent medium-run policy and must provide them with sufficient authority over the spending agencies to maintain budgetary control. 1 7 Again, traditions are important. However, it requires exceptionally strong tra- ditions, or an exceptionally strong political leadership, to protect a country's econ- omy from a vigorous export boom. When incomes rise suddenly, and with them public revenues, treasury control and financial discipline can be too easily under- mined. Once that happens, they are difficult to recstablish. Finally, inflation is often the "impartial" reconciler of social conflict over re- sources. Politicians can avoid taking explicit decisions with respect to taxes and public spending priorities if they and the public are willing to tolerate some infla- The Political Econonzv oJ Stabilization and Adjujstnint 393 tion to reconcile those differences through the hidden taxation of financial assets, especially currency. Fractious societies with weak or uncertain political leadership are more prone to inadvertent but sometimes continuing inflation than are coun- tries with strong leadership and an anti-inflation consensus. Thus, although all eighteen of our countries relied on the inflation tax to some extent over the study period, that reliance varied greatly from country to country, reflecting differences in public and official distaste for inflation as well as differ- ences in politically irresistible pressures for expenditure running up against polit- ically immovable resistance to explicit taxation. These differences have their origin more in the histories of countries than in their economic structure. As we have seen, governments responded in different ways to similar external shocks. The two major oil price increases of 1974 and 1979-80 necessarily resulted in a once-for-all immediate rise in the price level and in an inflation bubble, or adjust- ment inflation as we called it in chapter 6. In some countries, the bubble was burst: the rate of inflation subsequently dropped, as it should do after a once-for-all in- crease in the price level. In other countries, however, this adjustment inflation be- came spiral inflation, because the public could not agree on, or the government could not impose, the decline in real spending that a worsened terms of trade re- quires. The possibility of borrowing abroad permits a country in this situation to tem- porize, in the hope perhaps that the adverse shock will be reversed and the difficult distributional decisions can be avoided. That sometimes works. If it does not, ex- ternal borrowing only worsens the problem by creating yet another claimant, the foreign creditors, on a national output that is already too small to meet all the claims on it. Societies with fragile social and political consensus are less likely to achieve appropriate macroeconomic management in the face of adverse external shocks than are others. Among our countries, Argentina and Nigeria, and Costa Rica and Turkey in the late 1970s, had such societies. Dissent was present but severely re- pressed in Chile until 1989, in Cameroon, and in Kenya in the late 1980s. Indeed, dissent was suppressed to some extent in many of our countries: it is a matter of degree. Sometimes, the economic or political situation gets so bad that a consen- sus can finally be formed around a corrective course of action, such as occurred in Colombia in 1958. That is the hope for Argentina and Nigeria in the 1990s. Chapter 13 Conclusion: The Lessons of Experience History does not repeat itself, but it does generate some lessons for the future. Compared with the previous two decades, the period from 1973 to 1989 was an exceptionally turbulent one for the world economy. That turbulence posed severe challenges to macroeconomic management in all countries, whether they had gained from the changes or had suffered. This volume contains accounts and anal- yses of many different policy reactions to similar circumstances and shocks. De- spite this diversity, a number of common themes have emerged. One is that it is not always possible to separate the effects of different policies from the effects of shocks of different magnitudes or kinds. The policies and gen- eral characteristics of an economy-especially its flexibility in responding to shocks-are more important than the size of shocks in determining their effects on growth rates. Indeed, the size of external shocks seems to have little bearing on subsequent economic difficulties: some countries adjusted well to large shocks, others adjusted poorly to small ones. Indeed, countries that experienced positive shocks, through mishandling, sometimes performed worse than countries that ex- perienced negative shocks. Thus, although it is sometimes appropn.ate to point to disturbances emanating from the world economy as the source of a difficulty, countries cannot avoid responsibility for coping with those disturbances badly, since others coped well. There is need for policy control, policy flexibility, and flexibility in the economy, which in part reflects past policies. Hence, we now reflect on the policies and in particular ask some counterfac- tual questions. Given the various changes in the world economy that the eighteen countries faced over the whole period, could policy reactions have been different and have avoided problems and painful adjustments? What was done wrong and what was done right? 394 Conclusion: The Lessons of Experience 395 Boom, Crisis, Adjustment In the 1970s, borrowing on the international capital market became much easier for developing countries. Especially after the 1974 oil shock, it also became cheaper, as the earnings of oil-exporting countries were deposited in the world's large commercial banks. This enticed almost all our countries to engage in public investment booms financed by foreign borrowing. The timing differed, and some embarked on these investment spending booms quite late-after real interest rates had started rising-whereas others started early, usually motivated by some do- mestic political considerations. The debts incurred during this period led many of the countries into their debt crises. Should they not have borrowed? This would not be a valid conclusion to draw, for when borrowing becomes easier and cheaper, it is rational to consider borrowing more. The problem is that the expected rate of return over the lifetime of an investment should exceed the expected rate of interest over the same period. The returns must also be convert- ible into foreign exchange for external debt service, which implies that extra in- vestment should directly or indirectly earn or save foreign exchange. Furthermore, when the government borrows, or guarantees the debt. it should ensure that it can itself acquire the revenue and the foreign exchange needed to service the debt. Since so much import replacement had already taken place as a result of re- strictionist trade policies biased to inward-looking development, the new invest- ment in most of our countries needed to go mainly into export industries or into infrastructure that would indirectly foster exports. Furthermore, whenever foreign borrowing became large enough for mistakes to have significant macroeconomic repercussions, the expected present value of investments should have been re- duced in order to allow for this risk. The first and main lesson is that thorough cost-benefit analyses must be made that take into account the need for export growth.' In general, sudden. big spend- ing booms are unlikely to be sound. It takes time to plan and evaluate projects ef- ficiently. Countries should beware of huge dramatic government-inspired investments, whether in the public or private sectors. This lesson emerges from many countries, particularly from C6te d'lvoire, Sri Lanka, Mexico, Morocco, and even Korea. The second lesson concerns the possibility that loans may not be refinanced. In other words, investments need to generate resources not just for interest pay- ments but also for amortization payments. This implies that countries should be- ware of the risk of financing projects with short-term loans when the returns lie far in the future. It is, of course, easy to be wise after the event. The sudden changes that took place in the world economy after 1979-the increase in oil prices in 1979-80 fol- lowed by the gradual decline, the rise in real interest rates at the end of 1979, and the drying up of private bank lending to developing countries from 1982 on-were not foreseen by commentators and advisers in the developed world, including the World Bank. It is fair to say that in many countries a good part of the extra 396 Boom, Crisis, and Adjuistment borrowing for investment spending up to 1979 could be reasonably justified on the basis of generally accepted forecasts. The massive borrowing in the last stages, during 1980-82, cannot be justified in the same way. As noted in chapter 4, this was a period in which a potentially modest debt crisis turned into a very serious one for half our countries. In a few oil-importing countries the continued heavy borrowing went mainly to sustain consumption. This behavior was unwise since the deterioration in the terms of trade was not expected to be short-lived. In other countries, public investment financed by foreign borrowing continued apace. This, too. was unwise in the light of higher interest rates and the high debt already in- curred. Only in Chile was the heavy foreign borrowing private. In the case of every country that became crippled by debt, the immediate cause was the failure of the government to take early action to correct unsustainably large current account def- icits: the borrowing was not so much deliberate as the outcome of this failure. A third lesson this borrowing period teaches is to beware of euphoria. Export price booms seem to be especially seductive. For many countnes, especially up to 1980, growth rates were high, funds were easy to obtain, and the private and offi- cial international financial community was sympathetic. The country that, until a few years ago, was most subject to euphoria was Brazil-always the land of the future. The Mexican government and enterprises also seemed to be overcome by euphoria in their high borrowing period from 1979 and 1982 as a result of oil dis- coveries and the oil price rise. In Chile, and in Kenya during the coffee boom, the euphoria was in the private sector, but our remarks about government inaction still apply. The Chilean and Kenyan experiences show that a government cannot ig- nore the possibility of private sector excesses. Euphoria was a problem not just for the governments of the borrowing coun- tries, but also for the lenders-the international private and official financial com- munity. The international commercial banks were certainly euphoric about Mexico after 1979. Furthermore, two countries-Chile and Sri Lanka-had made sharp shifts toward liberalization which the international community looked upon favorably. Hence, private funds flowed readily into the private sector in Chile and public concessional funds similarly went readily to the government of Sri Lanka. Earlier, C6te d'lvoire had been considered a notable African success story, and this made it easier in the late I 970s for C6te d'lvoire to borrow to finance its mas- sive investment boom. In retrospect, certain investment expenditures were clearly unsound on the basis of reasonable expectations at the time-they were projects that good cost- benefit analysis would have turned down. It is difficult, however, to generalize about the extent of the "excess" investment in various countries when using the criterion of 'reasonable expectations." It could be argued that in many countries state-owned enterprises were so inefficient that the less they borrowed, the better. While one might agree that they would have been more efficient if privatized (a process that is now under way in several countries, notably Mexico and Argenti- na), it does not automatically follow from this that they were never justified in bor- rowing for investment. Conclusion: The Lessons oJ Experience 397 For the most part, the crises arrived in 1982, sometimes earlier, and in a few cases later. Could these crises have been avoided or their impact moderated? We have noted that eleven countries had a recession in the 1980-82 period, and that eight had to reschedule their debt service in the 1983-88 period. Here a few les- sons can again be drawn. First, given the policy mistakes of the 1970s-and indeed both the size and suddenness of the public investment booms were mistakes, even if excusable-the unexpected external shocks of 1979-81 inevitably resulted in serious problems. The essential lesson here would seem to be that countries should constantly be aware that unexpected and unfavorable events will sometimes happen. Such awareness will help them recognize a damaging situation in its early stages. Second, policies need to be flexible. Governments need to shift gears rapidly when circumstances change. Needless to say, this is easier said than done and does not necessarily imply that adjustment should be immediate and sudden. Some- times, gradual adjustment is appropriate, but the decision to make the adjustment needs to be made quickly. This recommendation may seem to conflict with the view that policies should be consistent and hence predictable so that governments should not shift gears too much. The most consistent approach is generally to follow cautious policies, which would include an appropriate adjustment when an adverse external shock occurs. Thailand, Korea, and Indonesia all provide good examples here, but we have also described many cases of obviously delayed adjustment. This is not to deny that there may sometimes be a genuine trade-off between commitment to a firmly proclaimed policy stance and adjustment to new circumstances. Chile faced this dilemma in 1982. and its delay in changing policies surely exacerbated the deep recession. Third, economies need to be flexible. The more flexible they are, the less ad- verse the impact of the shock will be. Rigid real wages, sectorally immobile labor, and strong dependence on imported intermediate goods for domestic production make economies inflexible. The more inflexible the economy, the greater the re- cession when a compression of imports is required. Such flexibility cannot be cre- ated once a crisis comes, but needs to be achieved in advance. Fourth, rapid export growth is crucial to successful recovery. When the bal- ance of payments has to be improved, imports have to be cut or exports increased. Domestic production in most countries depends heavily on imported intermediate goods, and-because of earlier import-substituting policies-the scope for reduc- ing imports of consumer goods is very limited. An ability to increase exports quickly is thus the best safeguard against a prolonged recession. The lesson here is twofold: countries should follow outward-oriented policies in good times and so develop a strong (and preferably somewhat diversified) export base; and deval- uations may be helpful. Finally, the ability to obtain foreign aid, concessional loans, or debt relief at a time of crisis-provided this is combined with strong adjustment policies-is helpful. This has certainly been true in a numberof ourcountries, notably Indonesia 398 Boom. Crisis, and Adjusiisnent 1966-70, and Turkey after 1980. In contrast, the severe decline in Mexico's growth rate after 1982 is at least partly explained by the lack of such relief and hence the need to generate a current account surplus and an average outward re- source transfer from 1983 to 1988 of more than 7 percent of GNP. Given the terms-of-trade shocks and the need to generate outward resource transfers, painful reductions in aggregate demand were inevitable. It was also in- evitable that this shift would, above all, lead to declines in investment, especially public investment. It can be seen from table 5.1 that over the period 1983-88, only two countries-Mexico and Korea-actually ran current account surpluses on av- erage; thus, all other countries were still borrowing. New borrowing often failed to cover the high interest payments, however, so outward resource transfers were in excess of 2 percent of GNP on average for C6te d'lvoire, Chile, Brazil. Nigeria, and Argentina, as well as for Mexico and Korea. Thus, there was an inevitable ad- justment problem. Leaving aside Korea, where debt repayment was voluntary, these countries would have had decidedly less difficulty if they had obtained interest rate relief or more new funds. In view of the need to cut aggregate demand, there were, of course, numerous choices to be made as to the pattern of the expenditure cuts. In general, the burden was borne by investment rather than public or private consumption, but some countries reduced real wages substantially, as well as various elements of public expenditure other than investment. The study of the distributional implications of expenditure cuts-such as the effects on the poor relative to the better-off, on the urban in relation to the rural sector, and so on-would deserve a separate book. The Crucial Role of Fiscal Control Yet another lesson to be learned-possibly the most important one to emerge from this study-is that fiscal control is essential, as discussed at length in chapter 10. Governments must not lose control of their fiscal situations. It is particularly important to note that public sector deficits can arise in many quarters of the economy-not only the central government's budget, but also state economic enterprises that are financed directly by borrowing either from commer- cial banks or from the central bank, the budgets of provincial authorities, and the central bank itself (through past rescue operations of the private financial sector or through purchases of foreign exchange). It is striking that many of the public sec- tor borrowing sprees originated not with the central government but with state economic enterprises, and it is also striking how large some Latin American cen- tral bank deficits were in the 1980s. The message is not that deficits should be zero, since borrowing for sound investment is often justified, but that the central government-and, above all, the Ministry of Finance-should maintain control: it should know how much the public sector as a whole is borrowing (which some ConcsI usion: The Lessons oq Experience 399 governments in the 1979-82 period, for example, Brazil's or Mexico's, did not know), and what contingent obligations are being incurred through private sector borrowing. Provincial governments and state economic enterprises should certainly not have automatic access to central bank finance. Above all, the Finance Ministry should be able to cut back on spending quickly if a crisis develops. This is a tall order, and is a problem for all governments, whether developed or developing; but it focuses on the central macroeconomic policy issue for many or even all of those countries that faced crises in the 1980-83 period. Deficits are not always the result of lack of control, if only because deficits can either be monetized or debt-financed. In sonic cases our countries had strong central control on borrowing, but conscious political decisions were made that led to the spending and borrowing booms. This was true, for example, of Korea, Sri Lanka. Thailand, and Colombia. Right through the 1980s, the fiscal control prob- lem was overwhelming for Argentina and Brazil, and during the whole period from 1965 to 1990, Chile, Costa Rica. Indonesia, Kenya, Nigeria, and Turkey lost control on one or more occasions. Inflation, Exchange Rates, and Trade Policies Conclusions about inflation and stabilization have already been drawn in chapters 6 and 7. We have made no attempt to quantify the costs of inflation. These are very clear in highl-inflation countries. notably Brazil and Argentina, but not so obvious when inflation rates are low or moderate and relatively steady. Here, there seems to be no statistical relationship between inflation rates and real economic growtlh. We pointed out that seigniorage, including that arising from inflation. has been a significant source of revenue for many of our countries. Perhaps the main argu- nient in favor of keeping inflation low is that once it gets above a certain level, ac- celeration and hence the slide into high inflation are difficult to prevent. Unstable inflation creates uncertainties that inhibit investment and efficient economic deci- sionmaking and also causes social dissatisfaction. Once inflation hits a high level. stabilization will inevitably be called for. and this can impose large costs in lost output. depending on the considerations discussed in chapter 7. As noted in chapter 6. the study of the low-inflation countries teaches two les- sons. The first is that temporary increases in inflation. which we have called "'bub- bles," niay be unavoidable at times of external or domestic shocks. Even so, it is important not to generate an expectation of high inflation. Rather, a firm comniit- ment must be made to low inflation on average, and thus to the appropriate poli- cies. The second lesson is an elementary one. As these countries show, it is possible to maintain relatively low inflation on average in spite of shocks, provided appropriate monetary-fiscal policies are pursued. The best examples conic from the six Asian countries. At the sanic time, Colombia and Costa Rica show that pol- icy mistakes can be made, or that there can be a brief loss of fiscal control, and yet 400 Boomn. Crisis, and Adjustnmenr matters need not get out of hand if there is a strong policy commitment to low in- flation (or moderate. steady inflation, in the Colombian case). Policy conclusions conceming stabilization from high inflation have been drawn in chapter 7 and need not be summarized here. Nevertheless, it is worth stressing the obvious: high inflation is difficult to reduce without cost-that is, without a recession-and certainly without considerable political cost. It is there- fore best not to embark on the road of high inflation, and above all, not to monetize fiscal deficits. Of course, high inflation is not directly planned, but rather is the consequence of earlier and concurrent policy failures. Conclusions about exchange rate policy have been drawn at the end of chap- ter 8 and, also, need not be repeated here. Nominal devaluations have clearly led to real depreciations that have been sustained for sonic time. Real depreciations can also lead to increases in exports, especially of manufactured goods. These generalizations do not apply at all times and to all countries, particularly when fis- cal policy does not support the devaluation. In a world of floating currencies, the case for fixing the nominal exchange rate to some leading currency or combination of them must be based on the idea that fixing an exchange rate to the currency of a low-inflation country "anchors" the country's rate of inflation. We have weighed this argument in chapter 8 and do not find that the evidence gives it strong support. A number of countries have re- mained low-inflation countries in spite of shifting from a (more or less) fixed to a flexible rate regime, while there have been several episodes in which fixing the ex- change rate has not put a halt to inflation, but has rather intensified import restric- tions. The costs of failure-that is, of fixing the rate while fiscal deficits or serious inflation, or both, continue-must be borne in mind. As shown in chapter 9, variations in quantitative import restrictions have been very important in the macroeconomic histories of all the countries. For long peri- ods, trade policy tightenings and occasional liberalizations have been the main in- struments of balance of payments policy. The tightening of restrictions has had adverse effects on output through the "import starvation" effect. From a study of numerous crises, we have drawn the conclusion that countries with outward-ori- ented policies have been better able to cope with those crises because they did not have to cut imports to dangerously low levels. An important conclusion conceming the relationship between exchange rate policy and import restrictions drawn in chapter 9 follows from simple theory and is clearly supported by the evidence. Trade liberalization, especially if it is sub- stantial, requires simultaneous or preceding exchange rate adjustment. This has been true for all major liberalizations to which we have referred. We conclude that, if a country has significant import restrictions or high tariffs covering a wide range of actual and potential imports, it is unwise to make a long-term fixed exchange rate commitment on the basis of the "nominal anchor" argument. Such a commit- ment would make liberalization much more difficult and indeed might discourage such an initiative. Even if liberalization has taken place, the possibility of the reimposition of import restrictions in a future crisis cannot be ruled out if the Conclusion: The Lessons of Experience 401 exchange rate instrument ceases to be available. If one accepts (as we do) the un- desirability of quantitative import restrictions, especially if-as is often the case- they stay on after the immediate need has passed, some degree of exchange rate flexibility is clearly necessary. Macroeconomic Policy and Growth The primary conclusion is that macroeconomic stability is good for long-run growth, and therefore that macroeconomic policies should be designed to stabilize real output in the face of exogenous disturbances, and to avoid the creation of un- sustainable booms. Few of our countries-Brazil and Korea are the notable excep- tions-systematically followed macroeconomic policies that tended to stabilize output growth around its trend. In many countries, fiscal policy was destabilizing. All the many determinants of growth in real income per head act through the level of investment in relation to GNP (the investment ratio), or through changes in the amount of labor input (in relation to population). and through changes in the quality of investment and of the labor force. Our research did not include any work on the labor force. We therefore limit ourselves to the effects of macroeconomic policy on investment and its efficiency. We found a negative relationship between the instability of GNP and invest- ment, on the one side, and both the investment ratio and the apparent efficiency of investment, on the other side (by 'apparent efficiency" we mean the growth rate of GNP per head divided by the investment ratio). When the authorities are forced to reduce demand in the face of a crisis, investment (both public and private) suf- fers most. The fact that often it was a previous boom in investment that partly caused the crisis does not usually compensate for the subsequent collapse. Our countries differ greatly in their apparent efficiency of investment. Al- though instability explains something, many other factors come into play. One is the choice of investments in the public sector (remember that all the investment booms in the period 1974-82 were mainly public, or publicly inspired, except in the case of Chile). There is evidence from the country studies and elsewhere that much public investment was poorly conceived, althiough this is an area in which further detailed research is needed. Aside from examining the investment ratio and the efficiency of investment, we did glance at the much discussed relationship between inflation and growth. In- flation may, of course. be both a symptom and a cause of instability. It is also liable to reduce the efficiency of investment by distorting prices and by increasing un- certainty. We found evidence of a negative relationship, but this vanishes when the very high inflation countries are removed from the sample. This finding, which implies that there is no econometric evidence that moderate inflation is harmful, echoes the work of others. 402 Boom, Crisis, and Adjustment The large literature on the relationship between trade restrictions and eco- nomic growth indicates that outward-looking policies have favorable effects on long-term growth. Above all, the distortions that variable trade restrictions cre- ate-including the "rent-seeking" effects-reduce the productivity of investment. This is one channel through which macroeconomic policies can affect long-term growth. It is clearly desirable to avoid the use of trade restrictions and to take ev- ery opportunity to liberalize. As we have noted, this implies the need for some ex- change rate flexibility. The first signs are that the "new liberalization" of the 1980s-where balance of payments crises led to liberalization rather than to trade policy tightenings-have had favorable growth effects, although in some cases it was, by 1992, too early to tell. Political Economy: Any Lessons? The form of government-democratic or authoritarian-does not determine the success or failure of macroeconomic policy. It is true that some of the most suc- cessful economies, notably Korea and Indonesia, have been authoritarian, but so have some of the least successful. Democratic transitions may create or intensify macroeconomic problems. as in Argentina and Brazil, but not, however, in Chile. Both authoritarian Pakistan and democratic India have followed conservative macroeconomic policies. There are no simple lessons here, other than that sound or cautious policies can be pursued under many forms of government. Tradition and history-notably traumatic experiences of chaos or inflation- can influence current attitudes of elites and the general public. To simplify, things may have to get worse-possibly very bad indeed-before they get better. The stabilization success of Mexico since 1988 and the possible success of Argentina since 1991 seem to bear this out. There is no real policy lesson here, however, since one would not advocate creating chaos or a hyperinflation in order to teach the community the need for macroeconomic discipline or common sense. The conclusion we would derive is rather elementary. Those who determine govern- ment policy must be convinced of the correctness of responsible macroeconomic policies. In a democracy, the relevant group may be the larger community or a lim- ited elite, and in an authoritarian state, it may be just one or a few individuals, or perhaps some influential members of the military. If high inflation is to be avoided, they must believe that inflation is undesirable and they must understand that fi- nancing budget deficits by monetization is likely to be inflationary; they must also understand that continuous debt financing, whether at home or abroad, will lead to trouble eventually if the debt grows too rapidly. They must appreciate the need for financial control. In those countries where macroeconomic policy has on the whole been a suc- cess, there have usually been particular individuals in high government posi- tions-above all the Ministry of Finance-who have been well qualified and who Conclusion: Thie Lessons of Experience 403 have been able to carry weight with the ultimate decisionmakers. They have been the actual makers and implementors of policy. In recent years these have often been professional economists. Such persons are increasingly available even in countries where they do not hold the high positions. Even when they do, their abil- ity to persuade and to carry weight has been crucial: among other things, this abil- ity has depended on all the considerations discussed in chapter 12-tradition, historical experiences, and the strength of pressure groups. In authoritarian states, the personal views of individuals-such as Presidents Park of Korea, Suharto of Indonesia, Pinochet of Chile, and Houphouet-Boigny of Cote d'lvoire-have ob- viously been crucial. Policy Advice We can sum up our policy advice, derived from our findings in this study, in nine injunctions to policymakers: * Assert firm overall budgetary control and budgetary accountability, in- cluding control over access to the central bank and to international capital markets. * Be aware of the "unpleasant arithmetic," namely, the implications for the future of both external and domestic government debt; relate borrowing to returns on investment, to borrowing rates, and to the prospective growth of exports and of government revenues. * Be sensitive to the maturity of debt, both external and internal. Maintain creditworthiness. * The pursuit of sound long-run fiscal policy in the sense of the above points will normally permit the use of monetary and fiscal policy to stabilize nonagricultural output around its long-run trend. * Resist euphoria when export prices rise exceptionally. new resources are discovered, or new borrowing opportunities open. * Avoid jerky movements in the real exchange rate and thus periods of over- valuation, which can have adverse effects on tradable goods industries. It is generally better to have a flexible exchange rate regime, with frequent adjustments. Furthermore, do not make a fixed exchange rate commitnment if there are still extensive trade restrictions. * Avoid using import controls, except in extrernis, and then remove them as soon as macroeconomic circumstances permit; if pursued credibly, this stance will enhance the effectiveness of import controls on the rare occa- sions they are used. * Avoid building rigidities into the economy, such as persistent import con- trols or extensive wage indexation. * Maintain flexibility in policy, and in particular correct mistakes quickly. 404 Boom, Crisis, and Adjustment Caution This study has revealed the diversity of macroeconomic experiences and policies of eighteen developing countries over a period of twenty years or so. Its primary aim has been to get the story straight and to try to answer various important policy- relevant questions. Caution must be exercised in drawing conclusions from our analyses, however, both because various aspects have not been fully researched and because so many generalizations are subject to important exceptions and qual- ifications. Furthermore, some important topics on which we have touched merit much more research. We have in mind particularly the need for ex post cost-ben- efit analysis of public investment spending, and the need to study further how much downward flexibility of nominal and real wages there is in various coun- tries: our limited work in this area suggests substantial flexibility in real wages in most developing countries. We have not dealt with the pattern of government ex- penditures in any detail, with income distribution, and with numerous factors that affect growth and welfare apart from macroeconomic policies. We would like to stress, finally, that a country's macroeconomic policies can explain only a part, often a small part. of its economic performance. A stable and sensible package of macroeconomic policies can be expected to provide only a solid framework both for other government policies and for private sector activi- ties. However stable and sound this framework, if other policies are poor, or the private sector lacks dynamism or is inhibited by political uncertainties, a country can still have a low growth rate. Yet, when something goes wrong on the macro- economic front, as it clearly did in the early 1980s in so many countnes. concern with macroeconomic policy (lominates everything else. Annex I Country Studies Studies of the experiences of seventeen countries were commissioned in conjunc- tion with the research project. No study was commissioned for Korea as there is an extensive literature available and a project on the Korean economy, in which Richard Cooper was involved, was under way. In particular, see Collins and Park (1989) and Haggard and others (forthcoming). We expect that nine of these studies will be published by the World Bank as part of the Comparative Macroeconomic Series. These nine are referenced in this study as "forthcoming" and are listed be- low with the provisional title of the finished work. The other studies will not be published by the World Bank and are referenced as "unpublished." Queries on these studies may be directed to the authors. A list of all the studies along with the authors and their affiliations is provided on the next page. 405 406 Boom, Crisis, and Adjustment Country Studies Argentina: Juan Carlos de Pablo, El Cronista Commercial, Buenos Aires Brazil: Macroeconomic Crises, Policies, and Growth: BraZil 1964- 1990 Donald Coes, University of New Mexico. Albuquerque Cameroon: Michael Connolly, University of Miami, Coral Gables Chile: Heeman Cortes, International Monetary Fund Colombia: Macroeconomic Crises, Policies, and Long-Term Growvth in Colombia, 1950-1986 Jorge Garcia Garcia, The World Bank Sisira Jayasuriya, Latrobe University, Australia Costa Rica: Macroeconomic Policies, Crises, and Long-Term Growth in Costa Rica Claudio Gonzalez-Vega, Ohio State University, Columbus C6te d'lvoire: Growth and Crisis in C6te d'lvoire Jean-Claude Berthelemy, Delta. Ecole Normale Superieure, Paris Francois Bourguignon, Delta, Ecole Normale Suprieure, Paris India: India: Macroeconomics and Political Economy, 1964-1991 Vijay Joshi, Merton College, Oxford Ian M.D. Little, Nuffield College, Oxford Indonesia: Macroeconomic Policies, Crises, and Long-Term Growth in Indonesia, 1965-1990 Wing Thye Woo, University of California, Davis Bruce Glassburner, University of California, Davis Anwar Nasution, Bank Duta, Jakarta Kenya: David Bevan, St. John's College, Oxford Paul Collier, Institute of Economics and Statistics, Oxford Jan Gunning, ESI-VU, Amsterdam Mexico: Francisco Gil-Diaz, Ministry of the Treasury, Mexico Morocco: Emil Claassen, Freie Universitat, Berlin Annex 1 407 Nigeria: David Bevan, St. John's College, Oxford Paul Collier, Institute of Economics and Statistics, Oxford Jan Gunning , ESI-VU, Amsterdam Pakistan: Nadeem Haque, International Monetary Fund Mohsin Khan, International Monetary Fund Sri Lanka: Macroeconomic Policies, Crises, and Growth in Sri Lanka, 1969-1990 Premachandra Athukorala, Latrobe University, Australia Sisira Jayasuriya, Latrobe University, Australia Thailand: Macroeconomic Policies, Crises, and Long-Term Growth in Thailand Peter Warr, Australian National University Bhanupongse Nidhiprabha, Thammasat University, Bangkok Turkey: Macroeconomic Crises and Long-Term Growth in Turkey Ziya Onis, Bogazici University, Istanbul James Riedel, School of Advanced International Studies, The Johns Hopkins University, Washington, D.C. Annex II Tables 409 410 Boom, Crisis. and Adjustment Table AIM.l GDP Growth Rates, 1966-91 Country 1966 1967 1968 1969 1970 1971 1972 /973 1974 /975 1976 1977 Argentina 0.7 3.2 3.8 9.0 4.6 4.4 2.1 3.8 5.5 -0.5 -0.2 6.5 Brazil 5.2 4.8 11.8 9.9 8.7 11.3 12.3 14.4 9.0 5.2 9.8 4.6 Cameroon 4.7 -12.0 6.5 4.9 2.9 3.8 2.3 5.5 10.7 -0.8 4.3 8.5 Colombia 5.7 4.1 6.5 6.3 7.1 6.0 7.6 6.7 5.7 2.1 4.8 4.1 Chile 11.0 3.3 3.6 4.1 2.0 9.1 -1.1 -5.5 0.8 -13.2 3.6 9.8 Costa Rica 7.8 5.6 8.4 5.4 7.6 6.8 8.2 7.8 5.4 2.0 5.4 8.9 Cote d'lvoire 10.0 5.6 14.5 7.5 9.6 11.6 6.4 4.3 6.2 10.2 5.8 -0.2 India 0.0 7.9 3.3 6.5 5.2 1.6 -0.6 3.4 1.2 9.2 1.7 7.2 Indonesia 3.0 0.8 11.3 6.2 7.4 7.0 6.3 8.7 7.7 5.0 6.9 9.0 Kenya 13.9 3.7 8.3 7.8 -4.7 22.5 18.3 5.8 3.6 1.3 2.2 9.4 Korea, Rep. 11.7 6.4 11.6 13.9 8.9 10.0 5.8 15.2 8.9 7.7 13.5 11.( Mexico 7.0 6.3 8.1 6.2 7.3 4.2 8.5 8.2 6.1 5.7 4.2 3.2 Morocco - - 8.5 9.9 4.9 5.6 2.4 3.5 5.4 6.7 11.0 4.9 Nigeria -6.1 -14.6 4.6 17.5 19.3 11.5 1.0 7.6 11.2 -3.2 9.2 6.1 Pakistan 5.8 5.2 7.2 5.7 11.3 0.5 0.8 7.1 3.4 4.1 5.3 4.0 Sri Lanka 5.7 6.7 3.7 9.5 3.1 2.3 -2.4 9.5 3.8 6.5 3.5 5.1 Thailand 12.0 8.0 8.4 8.0 9.6 4.9 4.2 9.8 4.3 4.K 9.4 9.7 Turkey 11.6 4.8 6.4 5.5 4.6 9.0 6.6 4.2 8.6 8.9 8.8 4.8 - Not available. Source: World Bank data. Table A11.2 Inflation Rates, 1966-91 Coantrs 1966 1967 1968 1969 197( 1971 1972 1973 1974 1975 /976 1977 Argentina 31.9 29.2 16.2 7.6 13,6 34.7 58,5 61.3 23.5 182,9 444.0 176,0 Brazil 41.3 30.5 22.0 22.7 22.4 20.1 16.6 12.7 27.6 29.0 42.0 43.7 Cameroon - -- - -1.1 5.9 4.0 8.1 10.4 17.2 13.6 9.9 14.7 Chile 23.1 18.8 26.3 30.4 32.5 20.0 74.8 361.5 504.7 374.7 211.8 91.9 Colombia 19.9 8.2 5.8 10.1 6.9 9.1 13.5 20.8 24.3 22.9 20.2 33.1 Costa Rica 0.2 1.2 4.1 2.6 4.7 3.1 4.6 15.2 3(0.1 17.4 3.5 4.2 C6te d'lvoire 5.6 2.3 5.3 4.5 9.4 -1.5 0.3 11.1 17.4 11.4 12.1 27.4 India 10.8 13.1 3.0 0.6 5.1 3.1 6.5 16.9 2X.6 5.7 -7.6 8.3 Indonesia 636 112 85 10 6.5 4.4 6.5 31.0 4(0.6 19.1 19.9 11.0 Kenya 5.0 1.8 0.4 -0.2 2.2 3.8 5.8 9.3 17.8 19.1 11.5 14.8 Korea, Rep. - 10.6 10.9 12.5 16.1 13.4 11.7 3.2 24.3 25.3 15.3 10.2 Mtexico 4.2 3.0 2.3 3.4 5.2 5.3 5.0 12.0 23.8 15.2 15.8 29.0 IMorocco -1.0 -0.8 0.4 3.0 1.3 4.2 3.8 4.1 17.6 7.9 8.5 12.6 Nigeria 9.7 -3.7 -0.5 10.2 13.8 16.0 3.5 5.4 12.7 33.9 24.3 13.8 Pakistan 7.2 6.8 0.2 3.2 5.4 4.7 5.2 23.1 26.7 20.9 7.2 10.1 Sri Lanka -0 2 2.2 5.9 7.5 5.9 2.7 6.4 9.6 12.3 6.6 1.3 1.2 Thailand 4.0 4.3 1.8 2.5 -0.1 0.5 4.8 15.5 24.3 5.3 4.2 7.6 Turkey 4.4 6.8 0.4 7.9 6.9 15.7 11.7 15.4 15.8 19.2 17.4 27.1 - Not available. Note: Consumer Price Index inflation rates. Source: World Bank data. Annex 11 411 1978 /979 1980 1981 /982 /983 /984 /985 /986 /987 /988 /989 1990 /991 -3.4 7.2 1.9 -6.9 -5.5 2.9 2.3 -4.8 6.0 2.4 -3.0 -4.1 -0.5 5.0 3.2 6.8 9.1 -4.4 0.6 -3.4 5.4 7.9 8.0 3.3 -0.2 3.3 -4.2 1.2 14.7 13.3 15.6 12.9 2.7 7.8 5.8 7.7 8.0 -6.5 -7.7 -3.4 -2.5 0.5 8.5 5.4 4.1 2.1 1.0 1.6 3.6 3.3 6.1 5.4 4.1 3.4 3.9 2.0 8.4 8.3 7.8 5.6 -14.2 -0.7 6.3 2.5 5.7 5.7 7.3 10.1 2.1 6.0 6.2 5.0 0.8 -2.3 -7.0 2.8 7.9 0.9 5.5 4.8 3.5 5.6 3.7 1.3 13.9 2.9 -0.8 4.3 1.6 -1.2 -1.1 5.2 3.1 -1.2 -1.6 -1.0 -2.6 -2.1 -5.8 -5.3 6.7 6.5 3.8 7.4 3.8 5.3 4.5 4.9 9.8 6.2 5.5 2.2 7.7 6.2 7.9 7.4 -0.4 8.8 6.8 2.7 5.8 4.9 5.8 7.3 7.2 6.6 6.8 7.5 5.4 4.1 1.9 1.5 1.7 4.3 7.1 5.9 6.2 4.6 4.3 1.7 10.9 7.5 -3.3 6.9 7.4 12.1 9.2 6.9 12.3 11.8 11.5 6.1 9.0 8.4 8.2 9.3 8.4 8.8 -0.6 -4.2 3.7 2.8 -3.9 1.9 1.5 3.2 4.0 4.0 2.9 4.6 9.1 -2.8 9.6 -0.6 4.2 6.3 7.8 -2.3 10.2 2.3 4.0 4.8 -5.5 6.8 3.7 -9.3 -0.8 -6.5 -3.3 10.2 -0.6 -1.8 9.9 6.0 5.7 6.5 8.1 3.7 10.4 7.9 6.5 6.8 5.1 7.6 5.5 6.4 7.8 4.8 5.3 6.5 5.4 6.4 5.8 5.6 7.5 3.9 -0.3 9.8 4.4 0.7 2.7 2.1 6.3 4.7 10.6 5.0 4.7 6.3 4.0 7.2 7.2 3.4 5.1 9.6 13.4 12.2 10.3 8.0 -3.5 -1.2 -0.7 4.2 4.9 3.8 5.9 5.0 8.3 7.5 3.7 1.6 8.7 1.5 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 175.5 159.5 100.8 104.5 164.8 343.8 626.7 672.2 90.1 131.3 343.0 3079.8 2314.0 171.7 38.7 52.7 82.8 105.6 97.8 142.1 197.0 226.9 145.2 229.7 682.3 1287.0 2937.8 440.8 12.5 6.6 9.6 10.7 13.3 16.6 11.4 1.3 7.7 6.0 8.6 -0.03 - - 40.1 33.4 35.1 19.7 9.9 27.3 19.9 30.7 19.5 19.9 14.7 17.0 26.0 21.8 17.8 24.7 26.5 27.5 24.6 19.8 16.1 24.0 18.9 23.3 28.1 25.8 29.1 30.4 6.0 9.2 18.1 37.1 90.1 32.6 12.0 15.1 11.8 16.9 20.8 16.5 19.0 28.7 13.0 16.6 14.7 8.8 7.3 5.9 4.3 1.9 7.3 0.4 7.0 - - - 2.5 6.3 11.4 13.1 7.9 11.9 8.3 5.6 8.7 8.8 9.4 6.2 9.0 13.9 8.1 16.3 18.0 12.2 9.5 11.8 10.5 4.7 5.9 9.2 8.0 6.4 7.5 9.2 16.9 8.0 13.9 11.8 20.4 11.5 10.2 13.1 3.9 5.2 8.3 9.8 11.7 14.8 14.5 18.3 28.7 21,3 7.2 3.4 2.3 2.5 2.8 3.1 7.2 5.7 8.6 9.7 17.5 18.2 26.4 27.9 58.9 101.8 65.5 57.8 86.2 131.8 114.2 20.0 26.7 22.7 9.7 8.3 9.4 12.5 10.5 6.2 12.5 7.7 8.7 2.7 2.4 3.1 6.9 8.0 21.7 11.7 10.0 20.8 7.7 23.2 39.6 7.4 5.7 11.3 54.5 50.5 7.4 13.0 6.1 8.3 11.9 11.9 5.9 2.5 10.1 5.6 3.5 4.7 8.8 7.8 9.1 6.6 12.1 10.7 26.2 18.0 10.8 14.0 16.6 1.5 8.0 7.7 14.0 11.6 21.5 12.2 7.9 9.9 19.7 12.7 5.3 3.7 0.9 2.4 1.8 2.5 3.9 5.4 5.9 5.7 45.3 58.7 110.2 36.6 30.8 31.4 48.4 45.0 34.6 38.9 75.4 63.3 60.3 66.0 412 Boom, Crisis, and Adjustment Table A11.3 Current Accounts, 1965-91 (As a percentage of GNP) Country 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 Argentina 1.0 1.2 0.7 -0.3 -1.0 -0.7 -1.6 -0.9 1.8 0.2 -3.4 1.7 2.7 Brazil 1.3 -0.1 -0.9 -1.6 -0.9 -2.0 -3.4 -2.9 -2.7 -7.3 -5.7 -4.4 -3.0 Cameroon - - - - - -2.7 -3.9 -7.0 -1.0 -0.8 -6.0 -3.2 -3.0 Chile -0.7 -1.4 -0.9 -2.0 1.2 -1.1 -2.0 -4.0 -2.7 -2.7 -7.1 1.6 -4.2 Colombia -0.2 -5.3 -1.3 -2.8 -2.7 -4.2 -5.9 -2.3 -0.5 -2.9 -1.3 1.1 1.9 Costa Rica -11.7 -7.0 -7.4 -5.7 -6.0 -7.6 -10.8 -8.3 -7.5 -16.4 -11.5 -8.6 -7.5 Cote d'lvoire -2.0 -2.9 -4.3 -0.0 -0.0 -2.7 -3.9 -7.0 -1.0 -0.8 -10.6 -5.9 -3.1 India -2.5 -2.2 -2.4 -1.4 -0.4 -0.7 -0.6 -0.5 -0.5 -0.9 0.3 1.7 1.8 Indonesia -1.3 -2.4 -4.2 -3.0 -3.8 -3.2 -3.8 -2.9 -2.8 2.3 -3.5 -2.3 -0.1 Kenya 0.1 -1.6 -5.0 -3.1 -0.6 -3.2 -6.5 -3.3 -5.3 -10.8 -7.0 -3.8 0.6 Korea, Rep. 0.3 -2.7 -4.1 -7.4 -7.3 -7.0 -8.7 -3.5 -2.3 -10.8 -9.1 -1.1 0.0 Mexico 0.7 -3.3 -2.7 -2.6 -1.9 -2.9 -2.1 -2.0 -2.5 -3.9 -4.4 -3.7 -2.2 Morocco 0.1 -1.8 -2.3 -1.8 -0.4 -3.2 -1.4 1.0 1.6 3.0 -5.8 -15.0 -16.9 Nigefia -1.9 -1.5 -3.9 -4.4 -4.9 -3.0 -3.0 -2.2 0.0 16.3 0.1 -0.8 -2.0 Pakistan -4.1 -3.9 -6.2 -3.1 -4.0 -6.7 -4.6 -2.6 -1.3 -5.7 -9.5 -6.3 -6.1 Sn Lanka 0.7 -3.3 -3.0 -3.2 -6.5 -2.6 -1.6 -1.3 -0.9 -3.8 -2.9 -0.2 3.5 Thailand -0.3 0.5 -0.9 -2.3 -3.0 -3.5 -2.4 -0.6 -0.4 -0.6 4.2 -2.6 -5.6 Turkey 0.0 -0.7 -0.5 -1.0 -0.8 -0.3 0.3 1.3 3.2 -1.9 -4.6 -4.9 -6.6 - Not available. Source: World Bank data. Annex 11 413 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 4.4 - 1.0 -8.5 -8.4 -4.5 -4.1 -3.4 -1.6 -3.8 -5.5 - 1.8 -2.4 1.9 -2.0 3.6 -4.8 -5.6 -4.7 -6.1 -3.6 0.0 -0.1 -2.1 -0.5 1.3 0.2 -0.6 - 4.5 -2.3 -5.8 -5.8 -4.8 -0.7 2.7 4.3 -6.0 -10.2 -7.5 -1.9 -2.6 - 7.2 -5.9 -7.4 -15.1 -10.2 -6.2 -12.2 -9.9 -8.0 -4.7 -0.8 -3.3 -3.2 0.3 1.1 1.6 -0.6 -5.5 -8.0 -8.0 -3.8 -5.4 1.1 1.0 -0.6 -0.5 1.8 6.2 10.6 -14.4 -14.4 -17.6 -12.3 -9.9 -4.5 -3.5 -1.9 -6.1 -4.2 -8.6 -9.5 -2.6 11.7 -16.9 -18.4 -17.8 -14.4 -14.8 -1.2 1.1 -3.4 -10.2 -12.0 -14.5 -14.6 -12.3 0.1 -0.3 -1.3 -1.7 -1.4 -1.3 -1.6 -2.7 -2.5 -2.4 -3.1 -2.8 -2.9 -1.0 2.7 1.9 4.0 -0.6 -5.9 -7.7 -2.2 -2.3 -5.1 -2.9 -1.7 -1.2 -2.9 -4.0 13.0 -8.3 -12.6 -8.4 -4.8 -0.8 -2.1 -1.9 -0.5 -6.5 -5.6 -7.3 -5.8 - 2.2 -6.5 -8.8 -6.9 -3.7 -2.0 -1.6 - 1.0 4.5 7.7 8.4 2.4 -0.9 - 3.0 -4.0 -5.7 -6.7 -3.9 3.9 2.5 0.6 -1.4 3.0 -1.5 -2.0 -3.1 -4.9 10.2 -9.8 -7.8 -12.6 -12.7 -6.7 -8.1 -7.3 -1,3 1.0 2 2 -3.7 -0.8 - 6.8 2.4 5.7 -7.3 -9.4 -5.6 0.1 3.3 0.9 -0.3 -0.7 3.8 15.3 3.8 2.8 -4.2 -3.7 -2.7 -3.7 -0.6 -2.1 -3.9 -2.3 -1.0 -2.9 -3.3 -3.3 - 2.4 -6.8 -16.4 -10.3 -11.4 -9.1 0.0 -7.0 -6.5 -4.9 -5.7 -6.0 -3.7 -6.2 4.8 -7.7 -6.5 -7.5 -2.9 -7.3 -5.2 -4.2 0.6 -0.8 -2.8 -3.7 -9.( -8.6 2.4 -2.1 -6.1 -3.4 -1.8 -3.9 -2.9 -2.0 -2.6 -1.2 2.3 1.2 -2.5 0.2 Notes Chapter 1. Introduction 1. Multicountry studies of developing countries were pioneered in the field of trade policy by Little, Scitovsky, and Scott (1970); Bhagwati and Krueger (see Krueger, 1978); and Balassa (1982). More recent is the World Bank study of trade liberalization experiences, involving seventeen countries (Michaely, Papageorgiou, and Choksi, 1991). Apart from our own project, the principal nmulticountry project concemed with macroeconomic policies (focusing on the effects of intema- tional debt) is a National Bureau of Economic Research project (Sachs and Collins. 1989). It in- volves eight countries, including six of our group, and we have drawn extensively on the country studies produced by that project. The World Bank has sponsored several other multicountry re- search projects on various topics. A recent one of particular relevance here concerns the macr- oeconomics of the public sector deficit (Easterly, Rodriguez, and Schmidt-Hebbel, forthcoming). 2. In this volume a billion is 1,000 million. 3. The dependent economy model is expounded in Corden (1985, chapter 1). The model originated with Salter (1959) and Swan (1960), and the main elements go back to the writings of Meade (1951) and Johnson (1958). A fuller exposition of the basic theoretical framework for studying macroeconomic adjustment in developing countries is in Corden (1989). Cbapter 2. A Brief Survey of the World Economy I . This gold convertibility applied only to the monetary authorities of other countries and to certain international institutions. Private citizens lost their right to convert dollars into gold freely in 1934. 2. For convenience, we use the term "industrialized countnies' to mean the twenty-four members of the Organization for Economic Cooperation and Development (OECD). which includes westem Europe, Japan, Australia and New Zealand. Canada, and the United States-the rich, market-ori- ented economies. The OECD also includes several poor countries ot Europe, however, among them Turkey. one of our eighteen countries. 3. As already noted, the International Tin Agreement collapsed in 1986 when the Intemational Tin Council (ITC) could no longer pay its debts collateralized on 5tocks of tin, the price of which was in decline. The Sugar Agreement collapsed on expiration in 1977, largely because the European 415 416 Boom, Crisis, and Adjustment Community had become a large exporter of sugar and would not agree to restrain its exports. The Coffee Agreement collapsed in 1989 over leakages through nonagreement countries (mainly the German Democratic Republic) and because of Brazil's unwillingness to reduce its historically high export quota in favor of countTies and coffees that consumers had come to prefer. The Cocoa Agreement was renewed in 1983, but without several major producers (Malaysia, Indonesia) and consumers (United States). Its purchases of cocoa ceased in 1988 when it reached its stockhold- ing limit, producers went into arrears with the cocoa organization, and in any case it had too few resources to have a major impact on the market for cocoa. 4. National jurisdiction remains limited to a maximum of 12 miles from the coast, but for the control of fisheries, continental shelf minerals. and some aspects of pollution, about one-third of the ocean surface was appropriated. 5. These data are drawn from International Financial Statistics, and thus exclude several Commu- nist countries. The United States developed an exceptionally large trade deficit during the mid- 1980s as a consequence of its macroeconomic policies and a sharp appreciation of the dollar until early 1985; its share of world imports did not fall as much as its share of world exports. By the end of the decade, the U.S. trade deficit had declined substantially, but remained high by pre- 1984 standards. 6. The IMF-sanctioned program did not always succeed, of course. See Gwin and Feinberg (1989). 7. See Cooper and Lawrence (1975). 8. Real gross domestic product in the industrialized countries declined 0.5 percent in 1975, in conm- parison with the 5.7 percent growth in 1973-a very sharp swing. 9. Figures are for net lending to developing countries from reporting banks in the industtialized countries; loans exclude those to offshore banking centers such as Singapore and the Cayman Is- lands. From the Bank for Intemational Settlements, Annual Report (1990) and earlier issues. 10. See Cooper (1992) for a detailed discussion of the forecasts of late 1981 and early 1982. 11. The number is ten if the 1981 aid consortium to Pakistan is counted, since some official debt was rescheduled there, although that was not the main focus of the meeting. Cameroon rescheduled for the first time in 1989. 12. See Schultze and Lawrence (1987). 13. The exclusion of the U.S.S.R. and some other Communist countries accounts for only a small part of the discrepancy. 14. They failed to recognize that a strong principle of nondiscrimination in fact protects small coun- tries against arbitrary actions by large ones, and later paid the price for this failure in the increas- ing use by the industrialized countries of 'selective" safeguards against imports from developing countries. 15. One interesting characteristic of the 1970s is that the first oil shock, which hit a number of oil- importing developing countries severely, was officially welcomed by them, as at last giving the developing countries as a group a powerful enough "weapon" to get the serious attention of the industrialized countries. The OPEC decision to raise oil prices was nmotivated mainly by a desire for increased revenue to foster economic development, especially to advance the Shah of Iran's ambitious plans for his country (he hosted the December 1973 OPEC meeting). However, OPEC members, led by Algeria and Venezuela, were sensitive to the need to maintain "solidarity" with oil-importing developing countries and pressed the use of oil as a bargaining weapon into the dis- cussions on a new economic order. Chapter 3. The Period of Cheap and Easy Credit 1. India was a net lender from 1975 through 1978. Nigeria and Indonesia were also lenders, but only very briefly in 1974. 2. The formula used for the terms of trade effect in year t is Noles 4/ 7 Pi" PE' TOTEFF - EXP P tPi PE where EXP, is the dollar value of exports, and pt and PE are unit value indices for imports and exports respectively. TOTEFFt is expressed in the table as a percentage of GDP ,. and exports t- I. This formula is conventional and widely accepted by national income statisticians. (It is, however, arbitrary to use potential imports to express the gain or loss from a movement in the terms of trade.) For a critical discussion of this and other formulae see Scott (1979). 3. The issue of the choice between the exchange rate and import control measures is discussed in chapters 8 and 9. At this point it should be noted that many substantial real devaluations in the period 1984-88 did succeed in raising exports markedly and quite quickly. 4. In principle, the average price increase could be avoided by revaluing the currency. In view of the deterioration in the current account of the balance of payments. this was not contemplated by any of our countries (it was seriously considered in Taiwan [China], but finally rejected). The fear of funher increasing prices was a deterrent against devaluation. 5. Indian fiscal years run from April I to March 31. References are always to fiscal years, unless a calendar year is specified. 6. Gelb (I1988: table 5.2). The windfall is estimated in relation to a simple counterfactual. 7. In Indonesia, the investment boom continued through 1981 and reached 30.6 percent. In Nigeria. 1976 was the peak year. 8. There may even have been an absolute fall in Nigeria, but estimates are too unreliable to be sure. 9. The "coffee" boom was really a beverage boom. Cocoa and tea prices also rose. Cocoa was par- ticularly important for Cdte d'lvoire. 10. Table 3.3 shows a larger rise for private investment in Cameroon and Indonesia. In these cases "private" includes public enterprises. 11. See, for example, Gelb (1988), Auty (1990), Bevan and others (unpublished). 12. See Gonzalez-Vega (forthcoming) for an extensive discussion. 13. See Bevan and others (unpublished). 14. Turkey had a minor investment boom in 1980 and 1981 that is not recorded in table 3.3. 15. See Little and Mirrlees (1974) and Squire and van der Tak (1975). 16. Net borrowing is equal to the change in foreign assets and liabilities, but it will fail to correspond to a change in recorded debt for several reasons. The latter excludes changes in reserves. It also necessarily excludes unrecorded and often illegal purchases and sales of foreign assets. The re- corded debt measured in dollars will also change as the value of assets and liabilities in other cur- rencies varies with the exchange rate of those currencies against the dollar. The value of the debt may in some cases in recent years also be affected by rescheduling, debt forgiveness, and debt/ equity swaps. Table 3.4 is based on the appendix to this chapter, which lays out the algebra relat- ing to the concepts used and for each country provides tables giving annual values for the relevant concepts, and the error implicit in the figures. 17. We speak of association rather than of the loans incurred being used for, or causing, investment. For instance, a rise in borrowing in relation to GNP may coincide with a rise in the ratio of invest- ment to GNP. This latter rise might have taken place without the borrowing. The borrowing would thus be preventing a fall in consumption that would otherwise have taken place. It is, however, usually reasonable to suppose that in the absence of borrowing there would have been little change in the proportion of GNP saved, in which case it is legitimate to ascribe causation in one direction or the other to an association between borrowing and increased investment. 418 Boom, Crisis, and Adjustment Chapter 4. Heading for Crisis: 1979-1982 1. For brevity, we frequently refer to deficits, debt, and so on, when we mean the ratio to GNP. 2. The state of affairs described in this paragraph is known as the debt trap. The debt trap may arise also in the case of domestic borrowing. The simple mathematics behind the intuitive account of debt dynamics given in this section is laid out in chapter 10. Although the temi "primary def- icit" usually refers to a budget deficit, it is convenient to let it refer also to the current account of the balance of payments. 3. Figures quoted for oil are average OECD spot import prices as given in the OECD Economic Out- look (1 986). 4. The formula used for the terns-of-trade effect is the same as in chapter 3. 5. Interest Effect - -(1, - 1, [D,ID,-,]). where I is interest payments on total debt (including short- term debt) and D is total outstanding debt, including public, publicly guaranteed, and private non- guaranteed debt. 6. It was allowed for in Balassa and McCarthy (1984). Their calculations suggest that the effect of a fall below trend in the quantity of exports was, in most cases, small in relation to the terms-of- trade and interest effects. 7. These volumes are calculated by taking the value of imports into all developed countries fronm each of our countries as given by the United Nations trade data system, and deflating by the World Bank export price indices for each of our countries. 8. Three percent is about equal to the historical long-temi rate of interest. This leads one to suspect that projectors were influenced by the Hotelling theorem (-otelling 1931). If the price of oil is expected to rise by more than the rate of interest, then it pays to leave the oil underground, and the price rises until the expected price rise falls: and similarly, mutatis mutandis, if the price is expected to rise less than the rate of interest. Therefore, the expected price rise equals the rate of interest' As a corollary, it should have been predicted that the real rate of retum obtainable by oil producers on their investments would fall to 3 percent. The Hotelling theorem has now been abandoned as a guide. 9. An excellent comprehensive account is Edwards and Edwards (1991). 10. As a percentage of GNP in current prices, this does nol show up. 11. The figures are from Claassen (unpublished). World Bank figures diverge considerably, and look wrong. 12. Cardoso and Fishlow (1990) vividly describe his expansionary policies and their consequences. 13. This is the so-called operational deficit, which is explained and discussed further in chapters 7 and 10. The figure comes from Coes (forthcoming). 14. Figures fir Cameroon are from Connolly (unpublished). 15. Canieroon's relatively successful adjustment, despite a fixed exchange rate, is further analyzed in Devarajan and de Melo (1987). 16. Gil-Diaz and Ramos Tercero (1988, table 8.1). The public sector borrowing requirement in such an inflationary situation is not, of course, a correct indicator of the destabilizing effects of the def- icit (see chapters 6 and 10), although all deficit measures indicate a very large imbalance. For instance, the prinmary deficit was 8.4 percent and the "adjusted operational deficit" allowing for all inflation effects as calculated by the authors was II percent (Gil-Diaz and Ramos Tercero 1988, tables 8.1 and 8.5). 17. A more comprehensive and longer-term comparison is made in Pinto (1987). Chapter 5. A Slow Recovery for Most: 1983-1989 I. The figures given in appendix tables 5A.1 to 5A.] 8are for interest paid, not due. Votes 419 2. These surpluses do not arise only from a desire to reduce the debt. As in the case of Japan and Taiwan, it became politically difficult to reduce the trade surplus. 3. The simple correlation coefficients between the variables are given in the correlation matrix (ta- ble 5B-I ) in appendix B to this chapter. 4. We di) not have separate figures for public and private investment in all our countries. The fol- lowing account derives fr(oint Serven and Solinano ( 19931. They give figures for Argentina. Bra- zil, Chile. Costa Rica. and Mexico among our eight reschedulers. When we compared the same periods as used in table 5-2. we found the larger pan of the fall in Mexican investment was public. In Argentina the private fall was greater, but both fell heavily. In Chile public investment actually rose, but total investment fell. Of the nonreschedulers for which figures are available, total in- vestment fell heavily in Kenya. mainly in the public sector. Serven and Solintano's figures differ fromn ours, but are not very different except for Costa Rica, where they found a drop in total in- vestment of 4.2 percentage points of GNP, in comparison with our figure of 0.5. 5. The damaging effect of import starvation in Mexico is emphasized in Buffie (1990). Nigeria is another case in which impot starvation was very damaging. See chapter 9 for a discussion of in- port starvation in Indonesia, Sri Lanka, India, and Cfte d'Ivoire. 6. It may be argued that economic theory suggests that an increase in comnpetitiveness would result in a higher lex-el of exports in relation to .DP. However, the achievement of this new level would imply for sonie time a rate of growth of the value of exports greater than the rate of growth of GDP: and the greater the rise in competitiveness the higher this growth rate of exports is likely to be. 7. Celhsun and Rodrik (1989) make this point. They also cast doubt on whether the export drive can continue to rely son much on repeated real devaluations and subsidies. More export-oriented in- vestment that requires less implicit and explicit subsidization will he needed. 8. This was also the case in Turkey in 1980. 9. See World Bank ( 1990), table 5.5. 10. The World Bank has made its own assessments. See World Bank ( 1989, 1990a). IH. We have used World Bank (I 990c) here. 12. See Joshi and Little (forthconming), especially chapters 5 and 9. 13. Nigeria's fiscal situatilln also deteriorated in 1989 when the economic reform plan introduced in 1986 broke down. Extemal debt payments were in arrears and by 1992 the inflation rate was 45 percent. Chapter 6. Inflation in the Eiohteen Countries I. The following figures come fTom nIIernarional Financial Statistics and refer to average CPI in- flation rates for 1980-89 for all developing economies. Only five countries averaged 300 percent inflation or more-Bolivia, Nicaragua, Argentina. Peru. and Brazil. Nine coluntries had average inflation rates of 50 to 200 percent: these included Mexico and Turkey from our group, and an- other sixteen had inflation rates ranging fronim 20 to 49 percent, including Costa Rica, Colombia, Chile. and Nigeria. All the rest (eighty-lne) had rates less than 20 percent, and 51 less than 10 percent. 2. In several countries central banks also ran large deficits that are fiscal in character but not budg- eted through the govemnient. These also stimulate the growth of the money supply. This and nth- er seigniorage issues are discussed firther in chapter 10. 3. See Tanzi (1977). It is somnetimes called the 'Olivera-Tanzt effect" because the general idea can also be found in Olivera (1967). 4. These reniarks do not refer to Morocco, which was an oil importer but benefited from a temis- of-trade improvement owing to the rise in the price of phosphates. They also do not refer to the five high-inflation countries discussed in chapter 7, three o(f which (Brazil. Chile, and Turkey) suffered significantly from the oil price rise. 420 Boonm, Crisis, and Adjusionent 5. The Sri Lankan inflatihn rate fluctuated a great deal. The 1983-89 average of 10.5 percent was well above the 1976-79 average of 6 percent. The fluctuations were caused by sharp changes in fiscal (public expenditure) and monetary policies, combined with a high flexibility of wages and nontradable (especially construction) prices. 6. Cameroon's debts were rescheduled in 1989. 7. See Woo and Nasution (1989). Woo). Glassbumer. and Nasution (forthconming) and Thorbecke (1991). 8. See Castilio (1988). 9. By 1993 Nigeria looked rather different. The fiscal situation had deteriorated since 1990, extemal debt was in arrears and in 1992 the inflation rate had leaped up again to 45 percent. 10. As noted in chapter 5, this is a particularly important but also relatively novel issue foir India, which has a long tradition of low inflation but in 1990 was in an unstable public debt situation. There has been a steady rise in the ratio of public debt to GDP This cannot go on indefinitely. The question is what combinatioin of fiscal restraint and increased monetization will ultimately re- solve the issue. Chapter 7. Stories of High Inflation and Stabilization 1. This discussion draws on Coes (forthcoming) and also on Baer (1987), Simonsen (1988), Car- doso and Dantas (1990), Cardoso and Fishlow ()990), Kiguel and Liviatan (1991), and World Bank and IMF sources. 2. Base money consists of currency issued to the public plus reserve deposits of the banking system with the Central Bank. M I, referred to below, also includes demand deposits (which are also non- interest-bearing). 3. At the beginning of 1991 the blocked cruzados were valued at 6 percent ofGDP, and subsequently they were gradually deblocked. Other measures were taken to reduce liquidity (compelling banks to put more deposits into government long-temi bonds). 4. This discussion draws on de Pablo (unpublished), Calvo (1986), Canavese and di Tella (1988), Corbo, de Melo. and Tybout (1986), Epstein (1987). Fernandez (1985), Machinea and Fanelli (1988), Rodriguez (1988, 1991), Dombusch and de Pablo (1990), Kiguel and Liviatan (1988, 1991). Kiguel and Neumeyer(1989), Kiguel (1991), and on World Bankand MFsources. 5. See especially Corbo), de Melo, and Tybout (1986), Calvo (1986), and Cumby and van Wijnbergen (1989). 6. Much of this discussion is based on Rodriguez (1991). 7. This discussion draws on Edwards and Edwards (1991), Corbo (1985), Corbo, de Melo, and Ty- bout (1986). Meller (1990). Corbo and Solimano (1991). and World Bank and IMF sources. 8. This discussion draws on Gil-Diaz (unpublished, 1984), Gil-Diaz and Ramos Tercero (1988), Buffie (1990). Beristain and Trigueros (1990), and various World Bank and MIF sources. See also Cardoso and Levy (1988), Dombusch (1988). Ortiz (1991), and van Wijnbergen (1991). 9. The demand for money (the MI/GNP ratio) had been steadily falling from 1982, but this is not sufficient to explain the high inflation rates of 1987 and 1988. 10. See Khor and Rojas-Suarez (1991) for a detailed analysis of the detemnination of Mexican inter- est rates from 1987 to 1990. They find that the large expected exchange rate changes implicit in the interest rate differentials did not take place, but -that domestic interest rates of Mexican assets denontinated in US dollars are closely linked to the behavior of the implicit yield derived from the secondary market for Mexican debt" (p. 852). 11. This discussion draws primarily on Onis and Riedel (1993), Celasun and Rodrik (1989), Rodrik (1991), and World Bank and IMnF sources. See also Kopits (1987), and Dervis and Petri (1987). 12. This continued to be the story in 1991 when the announcement that elections would be held led to various measures that increased the fiscal deficit. The inflation rate in 1991 was 66 percent, much the same as in 1989 and 1990. Notes 421 13. Onis and Riedel (1993) have estimated the demand for money in 1965-86. They find that the elasticity of demand for aggregate real money balances with respect to inflation was -0.5 (but higher for real-time deposits alone). 14. There were substantial real wage increases (the result of strikes) in early 1991. 15. This discussion draws on Woo and others (forthcoming). Sundrum (1973), and Pitt (1991). See also Sutton (1984). 16. This observation is based on the revised figures calculated by Rosendale (1978) and reported in table 7-2. There is considerable doubt abo)ut the official figures over this period: the official fig- ures (also reported in table 7-2) suggest that there was a deficit also in 1965-67, and that it in- creased in 1969. 17. For details, see Pitt (1991). who also gives real effective exchange rates for various categories of trade over the relevant period. 18. Views on inflation stabilization policies must, of course, be based also on experiences of other countries. Two countries that succeeded in stabilizing from very high inflation in the 1980s with- out declines in growth rates-and that are generally considered great successes in this respect- are Bolivia and Israel. On each of these there is a large literature. See Morales and Sachs (1990) on Bolivia, and Bruno and Piterman (1988) and Bruno and Meridor (1991) on Israel. The Boliv- ian program was purely "orthodox" and the Israeli program had the necessary orthodox elements but also contained important heterodox elements-that is, above all, a wage-restraining compact with the trade unions. The experiences of Germany and other European countries in the 1920s are also relevant. See Dombusch and Fischer (1986). Overviews of stabilization issues can be found in Kiguel and Liviatan (1988) and Blejer and Cheasty (1988). 19. In Brazil various stabilization programs have also had other components, notably de-indexation or blocking of financial assets. 20. Wage indexation for the public sector was introduced in 1974 to avoid further declines in real wages that had resulted from the big inflation of 1972-74. From mid-1979 such 100 percent lagged indexation (i.e., nominal wages adjusted on the basis of price increases in the previous period) was extended compulsorily to all collective bargaining-detemiined wages in the private sector. Chapter 8. Exchange Rate Policy: Devaluations and Regime Changes 1. In table 8-1, a real depreciation is a decrease (nominal exchange rates being defined as units of foreign currency [dollars] per home currency [rupiahsl). Hence, to calculate from these indices a real devaluation between periods I and 2 using the definition adhered to in this book, the change must be expressed as a proponion of the period 2 figure. 2. Nigeria's real depreciation was about 400 percent. Korea and Mexico bo)th appreciated in 1988, so their net real depreciations over the whole period were only 7 percent and 3 percent, respectively. 3. A thorough study of the erosion of the initial real effects of nominal devaluations in developing countries can be found in Edwards (1989a, chap. 7). Like the present study, it highlights the di- versity of experiences: thirty-nine devaluation episodes over the period 1961 to 1982 are ana- lyzed. When real exchange rates three years after devaluations are compared with the rates one year before, in general, some net effects remained, hut there was significant erosion. In nine countries with a crawling peg regime, erosioin was much less-though at the cost of increased inflation. 4. All figures of exports of manufactures cited come, unless otherwise stated, fr(im the UN Trade Data System and refer only to exports to developed countries. They are based on figures of im- poirts by the developed countries and are thought to he much more reliable in gencral than export data from the developing countries themselves. Only dollar value, not volume, indices are readily 422 Boom, Crisis, and Adjustment obtainable. Some idea of volume growth can be obtained by relating the (more than) 20 percent dollar value growth per year in 1986-89, cited here, to the average annual rate of U.S. inflation, which was about 2 percent for producer prices and 3.6 percent for consumer prices. 5. These figures are based on national sources. The UN Trade Data System actually suggests that increases were substantially larger. The total increase 1986-88 was 121 percent according to these figures, and the annual rate of growth in 1986-89 was 44 percent. 6. The figure of 42 percent a year quoted in the text comes from Onis and Riedel (I 993), who cite Turkish official sources. They also report that the value of exports to countries of the Organiza- tion for Economic Coo)peration and Development grew at 20 percent a year over that period. The UN Trade Data System gives lower figures, but still shows large increases: an average rate of growth of exports to developed countries 1980-85 of 16 percent. For 1986-89, it gives a remark- able growth of 39 percent a year. Owing to export subsidies, there appears to have been a tenden- cy for Turkish figures to overstate the true value of exports: hence data from partner countries (UN data) may be more accurate, although this may also have some problems. In any case, it can be agreed that since 1981 there has been a booam in Turkish manufactured exports' 7. An interesting result in Pritchett's paper is that the only discemible positive relationship is for the most recent short period. 1985-88, which suggests that the large real depreciations that have been discussed above did not just increase exports of manufactures but also played some role (to put it minimally) in improving the trade balance during that period. 8. The extensive theoretical literature on the contractionary effects of devaluation is surveyed in Lizondo and Montiel (1989) 9. This measure is also used by Edwards(1989a, p.103). He covers the period 1972-85 using quar- terly data, and refers to 33 countries, including eleven in our group. 10. The figures come out as follows. The standard error of estimate of the equation for real exchange rates in 1978-88 (RER), where RER - a + bt (where t is the year). is: Nigeria, 48.9; Argentina, 16.6; Colombia, 15.6; Chile, 15.2; Sri Lanka, 13.9; Indonesia, 13.4; and Mexico. 13.0. Turkey is only 7.3. ii. The foillowing discussion is based on quarterly IMF figures. supported by figures in several coun- try studies and World Bank sources. See also Edwards (1989a). 12. The second is the Martinez de Hoz episode discussed in chapter 7. The IMF: real exchange rate index (where an increase is appreciation) shows a movement from 47.2 in 1978(l) to a peak of 116 in 1981(i)and down to 39.7 in 1983(1). 13. This explains the high standard deviation from the mean cited above, the highest of any country for the 1978-88 period. 14. It might be said that "flexible peg" is an oxymoron. How can a peg be flexible? There is clearly no fimi line between an adjustable peg regime in which the rate is infrequently adjusted (as was usual under the Bretton Woods system) and (ine in which the adjustment is frequent; nor(as noted below) between the latter and a managed float. Some countries have had flexible peg regimes in the sense of the definition here, but have described them as managed floats. 15. The condition for absence of capital flows, that is, the equilibrium condition, is r - r + el + q. where r is the relevant domestic interest rate. r* is the comparable foreign interest rate, d is the expected rate of depreciation of the donmestic currency, and q is the risk factor. This is expounded in every intemational economics textbook. When the exchange rate is defined (as in this study) as pesos (domestic currency) per doillar (foreign cunrency), then the fommula becomes r - r + (E'- E)IE + q, where E is the spot exchange rate and F' the expected exchange rate. 16. Figures of the parallel market premiums cited here have been calculated in the World Bank from figures of parallel market rates in various issues of the World Currency Yearbook. 17. An econometric attempt at measuring average capital mobility for the period 1969-87 in fifteen developing countries, including seven of our group, has been made by Haque and Montiel (1991). They needed to make rather heroic assumptions, including rational expectations that the expected rates of depreciatioin were equal to the later actual depreciations. and that the demand for money functions were constant. In addition, actual capital flight has heen estimated by Cud- dington (1986,1987). As noted earlier, however. there can be capital mobility without capital flight. Notes 423 18. See Cuddington (1986, 1987) on which much of this discussion of capital flight is based. He showed econometrically that overvaluation of the real exchange rate was the main detenttinant. Problems of measurement are extensively discussed by hinm and in Lessard and Williamson (1987). 19. Venezuela is the only other country in which capital flight on this measure was large. 20. See Cuddington (1986. p. 29). 21. As noted in chapters 4 and 7, Chile had a large inflow of pnvate capital 1980-81, the source of later problems. The capital market was liberalized in 1980. 22. Econometric work by Garcia Garcia and Jayasuriya (forthcoming) suggests that the domestic in- terest rate is very sensitive to external factors, though in the short run the monetary authority can influence it. See also Rennhack and Mondino (1988). 23. Berthelerny and Bourguignon (forthcoming). They estimate that such financial arbitrage flows were equal, on average, to 1 percent of GDP annually, that is, one-fifth of the total remittances. 24. Using the residual method, Joshi and Little (forthcoming) estintate that 40 percent of the (mtod- est) increase in India's debt in 1980-84 was explained by private capital outflow. 25. See Devarajan and de Melo (1990) for a careful analysis contparing the growth rates of members of the zone with other sub-Saharan African countries, ftir the period 1973-81 (when the zone members did better) and 1982-89 (when they did wntrse). In the latter period zone nientbers, no- tably, had larger declines in investment. 26. Berthelemy and Bourguignon (firthetoming) cite an indcex of the average real wage in the modem seetor. Owing to quite high inflation, it fell sharply 1979-80, but has been quite steady after that. The minimuim guaranteed nominal wage was constant 1982-86, so that it fell in real lemis; but the authors point out that most workers are paid more, and that wage data in C6te d'lvoiire are not satisfactory (which is also true of many tither countries in our study'). 27. There is an extensive literature on the concept of the real exchange rate. See especially Harberger (1986), Edwards(1988), Edwards(1989b), and Coes(1989). In preparing this note, Max Corden is indebted to Sisera layasuriya. 28. See Salter (1959) and Corden (1985, chap. 1), for full expositions of the '"dependent ectnomy" model. 29. The IMF real exchange rate indices are all derived fronm trade-weighted nottiinal rate indices (that is. 'nominal effective exchange rates" ). The weighting scheme takes into account buith bilateral trade and third-country competition, and the trade flows used are averages of the three-year pe- riod 1980-82. 30. The motist comprehensive study of real exchange rates in developing countries is by Edwards (1989a). He also defines the real exchange rate as p/p,,, that is, the Salter ratio. In his calculations, the foreign WPI is used to proxy the ftireign price level. The doniestic CPI is used to proxy the price of nontraded gttods. 31. See Meller (1990), who reports the Chilean Central Bank's index, and Warr (I 986), who calcu- lated it fur Indonesia in 1971-82. 32. One appn)ach is to take into account all the differential effects of changes in trade regimes tn different exports and imports. Thus, Athukorala and Jayasuriya (firthcoming) have calculated real effective exchange rate indices fir Sri Lanka separately foir traditiuhnal and for nontraditional exports, and have shown the fuillowing changes between 1976 and 1978 (that is, reflecting the effects of the 1977 devaluation and associated trade regime changes). For traditional exports, the index rose froni 68 to 94; fttr nontraditional exports, it rose from 62 to 80. Hence, owing to re- duction of expon taxes, real devaluation was greater in the first case; that is, the bias in the system against this category was reduced. 33. Full explanations of the various real effective exchange rate indices calculated by theIMFft)r sev- enteen developed countries are given in each issue of lnternalional Financial Slitisuits. 424 Boon. Crisis. and Adjustnient Chapter 9. Trade Policies: Tightening and Liberalization I. These trade liberalizing episodes relate to the ten countries common to the present study and that of Michaely and others (1991) up to 1984, the last year of the period of the latter study. 2. The exceptions were the following. There were three episodes in period two of fixed rate liber- alizations, all relatively minor and associated with balance-of-payments imprnoerments (Kenya. Korea, and Nigeria). In period four, there was one, namely, Cute d Ivoire (1985). The QRS were eliminated, while export subsidies and tariffs were raised. Subsequently, however, QRS were re- introduced following a strong deterioration in the ternis of trade. 3. See Krueger(1978). World Bank (19871, Dollar(1990), Edwards (1991) and Michaely and oth- ers (1991). 4. The following information is based on Nogu6s and Gulati (1992) and other World Bank sources. 5. The following discussion is based on World Bank sources and on Pitt (1991), Athukorala and Ja- yasuriya (forthcoming), Joshi and Little (forthcoming). 6. Kwang Suk Kim (1991). Pitt (1991). Coes (forthcoming). Woo and others (forthcoming). Athu- korala and Jayasuriya (forthcoming), Gil-Diaz (unpublished). Claassen (unpublished), and World Bank sources. 7. Help fron Pedro Videla in preparing the statistical appendix to this chapter is gratefully acknowledged. 8. The source of the variables is the economic and social data base of the World Bank and the cal- culations are done with RATS 3.11 statistical package. 9. Given that the dependent variable takes values 0 and I. the Mt.S model will give biased estimators for any sample size. The altemative is to use (binary choice) probit or logit models. These models take the form: P(IY = IX,I = F(XjB). The probit model uses a cumulative nomial function while Logit uses a logistic function. Since the two functions are very similar and since the use of the standard nomial cumulative density function is less contested in the literature, we use the probit model to test our hypotheses. 10. Here and in the subsequent equations, the t-staiistic appears in parentheses. Superscript * indi- cates significance at the 0.1 Ilevel, superscript ** indicates significance at the 0.5 level, and su- perscript *** indicates significance at the 0.01 level. N indicates the number of observations, Lr. the log-likelihood, and AL the average likelihood. 11. The 153 evenis are the sum of all episodes times the duration of each episode counted as one for each year. 12. The Godfrey-Breusch test (GB) is used instead of DW because in the AR( I) method the depend- ent variable is regressed on itself and is lagged. The GB is an LM test for autocorrelated ertors when the altemative hypothesis is either AR(q) or MA(q). Chapter 10. Fiscal and Monetary Policies ). In developing countries as a group, the ratio rose from 21.9 percent in 1972 to 27.4 percent in 1982, or 5.5 percentage points. In general, foTr most years aggregate figures for all developing countries differ little from those for nonoil developing countries, so we cite only the latter The source for all these figures is the SMF. lntertnanionJal Finan ial Statistics, Supplemlent on Govern- ment Finance. Supplement 11 (1986). and its Government Finance Statisciis Yearbook (1990). Statisticians convert national data into standardized categories, which means the IMF data are more likely to be comparable across countries. Because of these adjustments. however, the data Notes 425 reported here may differ from those in national budgets, for example, in the treatment of state- owned enterprises that perform governmental functions. such as fix)d price stabilization. 2. Most of our countries have a fiscal year that corresponds to the calendar year. In India. Indonesia, and Nigeria (until 1981), the fiscal year begins on April 1. In these cases, 1985" means fiscal 1985/86 in the tables. In Cameroon, Kenya, and Pakistan the fiscal year begins on July l, and in Thailand it begins oin October I. In these cases 1985"' means fiscal 1984'85. 3. The pattem in industrialized countries is somewhat different, with the 1972-82 rise being con- centrated in transfer payments (up by 4.4 percentage points, to 17.2 percent of cGP) and interest payments (up 1.9 percentage points to 1982, and another 0.7 tt 1987). Current consumption also rose by 0.5 percentage points, while capital expenditures and net lending remained unchanged in temis of GDP (table 10- I). 4. According to official data as reported to the Intemational Monetary Fund, defense spending was substantially lower in Argentina in 1982 and in Chile in 1982 and 1987, and significantly lower in Indonesia (1973 and 1982), Sri Lanka (1987), and Turkey (1981 and 1987). We have relied on the Stockholm Intemational Peace Research Institute (SIPRI) figures. 5. The distinction between capital expenditure by the central government and that by soEs is usually clear; the fomier undertakes traditional infrastructure projects such as roadbuilding, major land irrigation, canal dredging, and so on: and the latter undertakes investments that can be expected to yield a commercial retum. The distinction sometimes blurs, depending on whether or not large infrastructure projects are organized as a separate enterprise; in Coite d'lvoire, for example, the sugar development pr(gram was switched at a certain stage from public expenditure to state- owned enterprise. 6. This figure reflects a substantial increase in lending frtini Brazil's social security funds in 1987, possibly associated with the eliminatitn of the monetary correction as pan of the 1986 Cruzado Plan. 7. Brazil shows 33 percent, but that includes interest and other incotie froim the social security sys- tens that began to be loaned out in 1987. See note 6. Brazil's tax revenue fell from 19 percent of GDP in 1982, itself down from 25 percent in the mnid-1970s, to 15 percent in 1987. 8. See Goode (1984), pp. 92-95. Where commiodity taxes are specific rather than ad valireni, rev- enues will decline in relatitn to GDP when inflation occurs. By 1989 the number of countries re- lying on commodity taxes for more than half their revenue had fallen fromn ten to eight, and thtise relying on them for mtore than 40 percent dropped from fiurneen tni thirteen. 9. Asian deficits were somewhat larger than Western Hemisphere deficits in the peritid 1977-81 and were sonmewhat lower in every year after 1981. 10. In Sri Lanka, the leading investors in govemnient securities are the National Savings Bank, the Employees' Provident Fund, and several insurance cetipanies and savings banks. In Kenya. they included the govemnient social security fund. 11. Gottde (1984), pp. 200- 1. The median ratio (if the central government's debt to GDP in the late 1970s was 26.7 percent ftir all developing countries, and among our countries ranged from a low of 9.5 percent for Argentina to a high of 108 percent ftir Costa Rica, although figures for sotie countries, including these two, represent the budgetary central government only, excluding ex- trabudgetary accounts and state-owned enterprises. 12. This practice was stopped in all three countries in the second half of the 1980s. 13. Calculated from IMF,. Go ernment Finance Statistics Yearbook (1980). These figures exclude pro- vincial enterprises and those owned by local govemments. Such enterprises were numerous in Argentina. Brazil, Colombia, India, Korea, and Thailand. Shirley (1984, p. 5) shows a miore than ftiurfold increase in number tf SOEs between 1960 and 1980 in Argentina, Brazil, India, and Sri Lanka, and a trebling in Mexico. the only countries in our group reported there. Mexico began to privatize so5s in a serious way in the mid-1980s: so did Argentina after the election of Carlos Menenm as president in 1989. 14. Mexico greatly enlarged its number tf SOEs in 1982 when it nationalized the banks and the gov- emnient became owners of nonfinancial enterprises tiwned by the banks. So Mexico sold, con- solidated. or liquidated more enterprises in the mid- 1980s than the text figures suggest. I5. Shon in Floyd, Gray, and Short (1984) for the 1970s, Nair and Filippides (1988) for the 1980s. 426 Boonm, Crisis, and Adjustment 16. But not the 1980s, in Schenone's view. See Larrain and Selowsky (1991). 17. Short in Floyd and others (1984, table 5); and Nair and Filippides (1988, table 2-3). Schenone, however, reports current account surpluses for Argentine SOES in each year during the period 1966-85. See Larrain and Selowsky (1991 p. 15). 18. Generalization from perusing table 2-2 and correlations on p. 8 of Nair and Filippides (1988). 19. The figures for these eight countries are from Nair and Filippides (1988. table 2-5). 20. See Schenone in Larrain and Selowsky (I 99 . p. 32). 21. Reported by Schenone in Larrain and Selowsky (1991, p. 37). 22. Ayub and Hegstad (1986, pp. 16, 75-76). This document arrays other circumstantial evidence, for example, from studies on Israel and India, that support this finding as well. 23. Onis and Riedel (1993) show that sOEs in Turkey had lower interest payments as a share of sales than did private enterprises in the 1980s. 24. To the extent that market prices are highly distorted in general, mainly through import controls but partly also through the direct govemmental management of prices, financial rates of return such as those discussed above may provide a misleading guide to the true rates of return to the economy (although they are relevant to the financing problems of government). A study done of Egypt. admittedly an economy with greater-than-average price distortions, showed no meaning- ful correlation between financial rates of return and economic rates of return in 1980/81 over twenty-six branches of manufacturing. Shirley (1984, p. 33). 25. Joshi and Little (forthcoming). 26. World Bank (1988b, p. 155). 27. Argentine provincial and municipal deficits were exceptionally large in the mid- 1970s, reaching 6.2 percent of GDP in 1975. and in the mid- 1980s, when they exceeded 4 percent of GDP. See Sche- none in Larrain and Selowsky (1991, p. 14). 28. World Bank (l988b, p. 165). 29. This foTrmulation treats borrowing from the central bank as debt, on which interest should in prin- ciple be paid, even though under favorable circumstances most of that will be retumed to the gov- ernment in the foirm of earnings on seigniorage, discussed below. In fact, most governments do not pay interest on their debts to the central bank, in which case that portion of the debt should be excluded from this discussion. 30. The point in the text can be put more formally as fiollows: dD - C - R +iD, where D is the outstanding govemment debt, R - govemment revenues, G - govemment expenditures exclusive of debt service, and i is the average interest rate on the gov- emment's debt. If the primary budget is balanced, G - R and dD - iD. DIR will stabilize, the con- dition for long-run sustainability, when D and R are growing at the same rate. In the case of primary budget balance, this condition is met when dRIR - dD/D - i. When the prinmary budget is not in balance, the condition for long-run sustainability is more complicated: dR/R - dD/D - i + (G - R)ID; that is, the growth in revenue must exceed the interest rate by the size of the primary budget def- icit in relation to outstanding debt. Historical experience suggests that the revenues of developing countries can grow more rapidly than national production for many decades, but presumably this process has some limit, so ulti- mately dRIR - dYlY, where Y is GDP, and a primary budget deficit will not be sustainable unless GDP growth exceeds the interest rate. For instance, with growth in GDP at 4.5 percent (the 1965- 89 average for middle-income countries) and revenue growing at the same rate, a real interest rate of 4 percent permits a primary deficit of only 0.5 percent of GDP, far lower than what pre- vailed during the 1970s and early 1980s. Obviously, a country with a low initial D/R ratio can run a deficit in excess of that allowed by long-run sustainability for some time, by permitting D/ R to rise, but at some point continued ability to service the debt will come into doubt, and the country will find itself having to pay a premium interest rate to continue to float debt with volun- tary lenders. That in tum stiffens the requirements of sustainability. Notes 427 This analysis does not allow for seigniorage. discussed further below. To the extent that seignior- age actually accrues to the government, it can be treated as revenue in the equation above, reduc- ing the primary deficit and therefore, for a given interest rate, reducing the required rate of growth of revenue for D/R stability. 31. This phenomenon has given rise to the concept of "operational deficit," which is the nominal def- icit reduced by the extent to which interest payments on outstanding debt simply preserve the real value of that debt. That is, the operational deficit is the nominal deficit less the inflation premium embodied in the interest payments. For a discussion of primary and operational deficits, see chapter 6. 32. Where oil or other export revenues accrue directly to the govemment, by the same token, curren- cy devaluation results in a proportionate increase in domestic currency revenue, a point discussed tn chapter 8. 33. See table 10.8, which shows that in 1980 the first four of these countries financed abroad 10 per- cent or more of their expenditures. A number of govemments increased their extemal borrowing during the 1980s. when commercial credit to enterprises, public and private, became scarcer. 34. Direct comparisons between the lower and upper panels of table 10-12 are not always valid, be- cause the lower panel was calculated on a fiscal-year basis and the upper panel on a calendar-year basis, and the two do not always coincide. See note 2. 35. In the United States, despite its highly sophisticated financial market and widespread use of credit cards. the ratio was more than 4 percent. although that figure is misleading to the extent that a substantial amount-perhaps more than one-quaner--of L.S. currency is held outside the United States. 36. See, for example, Bailey (1956) and Friedman (1971). 37. Coes (forthcoming), calculated over the period 1966-89, when extensive indexing prevailed. At this rate of inflation, seigniorage is estimated to be more than 3 percent of GDP. Of course, the optimal inflation tax will be lower than the maximum possible tax, the extent depending both on the social costs of inflation and of other forms of taxation. Onis and Riedel 11993) provide an estimate for Turkey that puts the maximum inflation tax revenue at 5 percent of GDP, at an infla- tion rate of 75 percent. Rodriguez (1991) calculates that the revenue-maximizing inflation tax in Argentina over the period 1960-88 was 22 percent a month (966 percent annually), yielding "revenue" equal to 7.3 pervent of GDP. The first six percentage points are gained by an annual in- flation of 213 percent; diminishing retums set in thereafter, as with other taxes. 38. It is often said that an inflation tax is highly regressive. falling disproportionately on the poorest members of society. This proposition is highly doubtful, since the poorest members of poor coun- tries probably hold very little currency and have no bank accounts. On the contrary, in many so- cieties they live largely on retail credit for their purchases. Rich persons can find ways to economize on their holdings of money, but they probably hold a higher ratio of money in relation to income than do the poorest members of society. If so. the inflation tax in poor countries would be progressive rather than regressive, on the usual definitions of those terms. This is an area in which some research on asset holdings by income class would be helpful. Such data for Mexico in 1980 suggest that the highest decile by income class is hit hardest by the inflation tax, and that fourth from the lowest decile the least. See Cooper (I1992, chap. 2), drawing on Gil-Diaz, in New- bery and Stem (1987). 39. This paragraph is based on simple regressions for each country of the budget deficit on the current account deficit, both in relation to GDP, using annual data. 40. When a correction is made for inflation, as in the regressions descfibed below, only Brazil shows a decline; that is probably due to the emergence of highly liquid govemment securities, not count- ed as part of M2, as a near-money. 41. Cross-section regressions of changes in the consumer price index on changes in reserve money (MO) over 1973-86 and on changes in money plus quasi-money (M2) for all our countries except Argentina and Brazil-the two countries with extreme inflations over the entire period-pro- duced the following R2: 428 Boom. Crisis, and Adjustment All except All except Chile, All Chile Mexico, and Turkey cpi on MO .95 .77 .72 (Pt on M2 .99+ .92 .52 The correlations are high, but they are dominated by the high-inflation countries. Dropping the highest inflation country in the group, Chile, reduces the correlation substantially, and dropping the next two highest-inflation countries, Mexico and Turkey. reduces it further. Moreover, the re- gression coefficients are extremely sensitive to the sample of countries. For reasons noted in the text, inflation should be less than the growth in either reserve money or M,, but this is not the case during the period in question foreither Chile or Mexico with respect to reserve money. Thus, the regression coefficient of changes in the consumer price index on changes in reserve money is 3.36 for all sixteen countries, but drops to 1.0 if Chile is excluded, and drops further to .29 when Mexico and Turkey are excluded. 42. Concretely, the equation: ln(Mi/P) = aO + a(lnI[GDP/Pl) + a,(Inf) + ao(lnf) I was fitted for each country with annual data over the period 1965-88 (or shorter periods when data availability required). Here i = 0,2 for base money and M2. respectively, P is the GDP defla- tor. and Inf(=inflation) is measured by the consumer price index. Interest rates are often included in such estimated equations, but in almost all of our countries interest rates were controlled and inflation rates represent a better indicator of the opportunity cost of holding money. In the estimated equations for M2, only those for Argentina, Indonesia. Thailand. and Turkey showed a statistically significant (5 percent level) influence of contemporaneous inflation, and only those for Argentina, Chile. Indonesia, Pakistan, Thailand, and Turkey showed a statistically significant influence of inflation the previous year. 43. The adjusted R2 exceeded .90 in all but five of the equations for M2, and in all but eight of the equations for MO, as can be expected from time series. 44. For business loans, a value added price index for business would be more appropriate for com- puting real interest rates, but such an index is not generally available in our countries. 45. To attract eamings of overseas workers, for instance, Turkey in the early 1970s created convert- ible lire accounts, whereby nonresidents could deposit foreign funds in Turkish banks at attrac- tive interest rates. The banks sold the foreign exchange to the central bank for money-creating deposits: the central bank in tum sold the foreign exchange to the govemment, or govemment agencies. in exchange for (non-money-destroying) govemment securities, which in tum used the foreign exchange to finance the import content of govemment expenditures, including SOE investments. The result was a large expansion of the money supply owing to (desired) capital inflow. See Onis and Riedel (1993); also Celasun and Rodrik in Sachs and Collins (1989, pp. 640-54). 46. By comparison, the Federal Reserve Banks of the United States changed their discount rate on average more than once a year throughout this period. 47. See Emery (1991, chap. 8). 48. The motivation for these reductions may have lain elsewhere, however. Korea was trying to stim- ulate domestic demand in 1981, but its leading economic adviser, Kim Jae Lk, believed that in- terest rates were such an iniportant part of business costs that they should be kept as low as consistent with monetary stability-a view maintained for years in the United States by Wright Patman, chairman of the House Banking Committee during the 1960s. 49. Concretely. regressions of year-to-year changes in (the logarithm of) bank credit to the private sector shows virtually no relationship to year-to-year changes in bank credit to the govemment, and therefore suggest that govemiment financing did not crowd out private financing in the short run, although some countries show a gradual rise over time of the total share of bank financing that went to govemment, and some a gradual decline. Only the results for Pakistan and Thailand suggested some annual crowding out, and in those countries it was less than 50 percent of lending Notes 429 to private borrowers. In contrast, the results for Brazil, Chile, and Mexico showed evidence for crowding in-that is, the greater the extension of credit to the govermnent, the greater the exten- sion ofcredit also to the private sector. In Brazil's case, this result may reflect accelerating infla- tion during the 1980s; in Chile's, the tight fiscal and monetary policy maintained both in the late 1970s and in the late 1980s. 50. Official gold holdings at national valuation in 1987 were typically less than one-quaner of for- eign exchange reserves, and for some countries were negligible. The exceptions were Argentina and Thailand, which held about a third of their reserves in gold, and Turkey and Pakistan, where the ratio was one-half or more. 51. See Sundararajan and Balino (1991). 52. See Brock, Connolly. and Gonzalez-Vega (1989, p. 127), and Larrain and Selowsky (1991, pp. 124-33). 53. Larrain and Selowsky (1991, p. 131). 54. See Haggard and others (firthceoning, chapter 5). From an economic point (if viewk, central bank purchase of a nonperforiming loan from a commercial bank is not expansionary and may help avoid financial collapse. The expansionary impulse occurred when the loan was initially made. 55. Schenone in Larrain and Selowsky (1991, p. 22). 56. See Bodart (1990), and Leone (1991). 57. Much is made of the importance of central bank independence, and Gemiany's Bundesbank is often cited in illustration. It is true that the government cannot legally give instructions (as dis- tinguished from suggestions) to the Bundesbank in its areas of conmpetence. The Bundesbank is simply a creature of legislation, however, and this legislation can be changed by parliament. In a parliamentary system, a sitting government by definition controls enough votes to pass legisla- ti(n. It is thus public opinion, not legal arrangements, that protects the 'independence" of the Bundesbank. Similar statements can be made about the Swiss and Dutch central banks. The U.S. Federal Reserve System is also a creation of ordinary statute. but because of the separation of powers, legislation is more difficult to change in the United States than in a parliamentary system. Chile's new central bank, in contrast, has constitutional independence. 58. These results are augmented and confimied in Cukiemian and others (1992). For a sample of 117 developing countries, which includes IS of our countries. they find that most of several measures of central bank independence have no significant influence on the rate of inflation over the period 1950-89, or on the growth of central bank credit to the public sector. The exception is tumover of central bank governors, which is significantly related to inflation rates, although it is unclear what is the direction of causation. Three of our countries-Argentina, Chile, and Brazil-show the highest tumover of central bank govemors in their large sample. See also Cukiemian (1992). 59. For a detailed discussiin of the arrangements. see Bhatia (1985). Chapter 11. Macroeconomic Management and Long-Run Growth I. A large numberofeross-country studies relating many possible explanatory ariables to long-run growth are surveyed and analyzed by Ross Levine and David Renelt (1991 a, 1991 b). They find very few variables robustly related to growth, in the sense that their statistical significance sur- vives alterations in the list of independent variables included in the regressions. Indeed, they find the only policy-related variable that is robustly significant is the share of investment in GDP. This tends to excuse our neglect of many contmlling variables in the simple correlations of this chap- ter. We ourselves are rather skeptical if the value of regressions for a hundred or mire countries whose statistics are extremely unreliable. 2. As we understand them, this proposition should be acceptable to) most proponents of non-neo- classical grniwth theories, characterized by the endogeneity of technical change and grOwth. For a recent example of such theorizing, see Romer (1990). The proposition is certainly accepted by 430 Boom, Crisis, and Adjuistment Scott (1989). It is also notable that most or all development economists have implicitly rejected the neoclassical growth model, which implies that policy with respect to savings is irrelevant for long-mun growth. 3. None of the regressions we have seen include labor input, whether adjusted for quality or not. This is doubtless because employment figures are scarce in developing countries. It might be use- ful to select a set of countries on the basis of the existence and reliability of statistics for certain variables that theory and common sense suggest to be important for growth. 4. The GNP figures reach back to 1960, but our investment figures only to 1970. Thus, we could use a longer period for regressing growth on its own variability, than on investment and its variability. 5. This suggests that we should measure variability by the standard error of estimate (deviations from trend) divided by the mean, rather than the coefficient of variation (deviations from the mean) divided by the mean. Since Indonesia and, to lesser extent, Korea. were the only countries with a strong rising trend, this improvement would make little difference. 6. Their figures are given as percentages of GDP, not GNP. They appear to differ somewhat from ours, but not seriously. 7. For these thirteen countries, Serven and Solimano (1993) also give public and private investment separately. We regressed the growth of GNP per head on the total investment ratio and the ratio of public to private investment, since it is widely held that public investment is less efficient. The coefficient of the latter was insignificant. This, of course, provides no evidence for or against the hypothesis. 8. Scott (1989, chap. 16) explains the slowdown of productivity growth froni 1973 to 1985 in OECD countries in terms of the rise in instability. 9. The growth rate of GNP per head was taken from World Development Report (1991). table I. The growth rate of the GDP deflator was calculated from the same table. 10. The top set remains the same whether ordered by column I or column 7. 11. A fourth (Cameroon) also suffered greatly in 1979-81, according to table 4.2, but we distrust the figures. 12. Our figures for Costa Rica differ nmaterially from those of Serven and Solimano (1993). Using constant prices, we found there was a severe fall in investment (see below). 13. The determinants of private investment are closely exaniined in several of the essays in Serven and Solimano (1993). 14. Constant price series were unavailable for some countries and were available for very few over the whole period 197089. 15. Costa Rica is an extrenie example of the divergence of current and constant price scrics of invest- ment. Starting from a peak in 1981, there was only a small fall in the investment ratio in 1982 and 1983 when measured at current prices; but in terms of constant prices, the falls were dramat- ic. Thus, according to Serven and Solimano (1 993) and as seen in chapter 6, the price of invest- ment rose by 82 percent from 1980 to 1982 in relation to the (iDP deflator, befire falling back by 1987 to a mere 6 percent above 1980. This is almost unbelievable, especially since no sintilarly large movement is recorded by them for any other country. 16. The work of Little, Scitovsky, and Scott (1970) is recognized as a landmark. 17. The probably low or negative retums on much of this investment are discussed in Gelb (1988) and in Auty (1990). 18. There have been numerous cross-country studies relating lower growth to trade repression. Chap- ter 4 presents some evidence suggesting that trade repression and low interest rates are negatively associated with investment efficiency. Another recent study (Gelb 1989) related real interest rates to the investment ratio, the efficiency" of investment (the incremental output-capital ratio), and GDP growth. for thirty-four countries over the period 1965-85. Real interest rates and growth were positively and significantly associated. Most of this association stemmed fronm an associa- turn of interest rates and the efficiency of investment: the investment ratio related only weakly to interest rates. Gelb found that the relationship between interest rate and growth reflected mainly reverse causality. That is, growth and efficiency caused higher yields on all assets: but at least part of the relationship reflected a causal chain from interest rate levels to growth rates via the Notes 431 degree of financialization of savings and investment efficiency. Similar results have been report- ed by Fry (1988, chap. 6). 19. The case of India, where this is true, is examined in Joshi and Little (forthcoming). 20. For an evaluation of fertilizer projects, see Kilby (1991). He suggests that many, perhaps most. fertilizer projects (including those supported by the World Bank) used more foreign exchange than they saved and were in the negative value added category. 21. There are more than two thousand reestimated rates of retum (RERRs) on World Bank projects, but these do not rate as ex post cost-benefit analyses. See Little and Mirrlees (1991). 22. Auty (1991). Very high apparent retums to investment may partly be due to our neglect of labor's contribution, which may have been exceptionally high in the case of Korea. See Kim and Park (1985). 23. However, an ex ante econormic retum of 12 percent has been calculated for the heavy machinery project. See Sabin and Kato ( 1989). 24. That this might happen is implied by the dubious Ricardo equivalence theory. 25. Joshi and Little rely largely on Krishnaswami, Krishnamurti, and Sharma (1987). Chapter 12. The Political Economy of Stabilization and Adjustment 1. A coup was attempted in Cote d'lvoire in the early 1960s. 2. The characterization "unstable" for Thailand and Turkey applies largely to the 1970s; Thailand had five prinme ministers and seven finance ministers during the period 1973-80; Turkey was run by a series of coalition governments. altemating between conservative and progressive until the military coup of September 1980. Both were more stable during the 1980s. 3. Helliwell (1993) has performed a more sophisticated analysis of ninety countries and found no significant relationship between democracy (measured quantitatively in several ways, including use of the Freedom House index on civil and political liberties) and economic growth over the period 1960-85. Democracy, however, is positively and significantly related to per capita income. 4. Here the zeitgeiss discussed above may be especially relevant. C6te d'Ivoire President Felix Hou- phouet-Boigny may have reasoned that the intemational commodity agreement he strived to achieve for cocoa would prevent the high prices of cocoa prevailing in 1977-80 from declining to levels (in real terms) that they had experienced earlier, and that they subsequently experienced in the f980s. As a condition for participating in a renewed international cocoa agreement, he in- sisted on a floor price of $1 .10 per pound for cocoa, a price to which the United States and some other importing countries could not agree. The agreement limped forward without membership of either the major producer or the major consumer; prices in fact fell below $.70 per pound in 1982. Cote d'lvoire joined the renewed agreement in 1983 (the United States did not), but the Cocoa Organization withdrew from the market in 1988 because it reached its stockholding limits. 5. See chapter 7. Samey was in an especially weak political position, being an unpopular vice-pres- idential running mate of the popular Tancredo Neves, who died after being indirectly elected, but before he could take office. The length of Samey's temi was not even defined, and to bolster his weak position he tried to avoid alienating any segment of society, particularly those who would have some role in defining his constitutional position. See Kaufman in Nelson (1990). 6. Whitehead (1990. p. 1138) observes that these cycles go back to at least 1952. 7. Turkey is included here even though Turgut Ozal in 1983 was not the preferred candidate of the outgoing military govemment, since he was the architect of the 1980 austerity program and was so identified in the public nmind. Costa Rica's overall economic perfomiance was not outstanding, but the government wion the vote by doing an exceptionally good job (in Nelson's view) of ap- pealing to urban dwellers by granting a large wage increase to government employees and launching an ambitious housing program. See Nelson in Haggard and Kaufman (1992). 432 Boom, Crisis, and Adjustment 8. The major issue in Pakistan. as also in Chile, was not economic policy, but a return to democracy and with that a restoration of civil liberties. 9. Of these, Nigeria (1983) and Thailand (1991) subsequently experienced military coups. although the military leadership in both cases proclaimed its intention to return to democracy as soon as possible; several other countries remained under close military watch. 10. Until Lopez Portillo took office, presidential candidates had generally been drawn from the Min- istry of the Interior (Gobemagion); thereafter, they came from the Ministry of Planning and Budget. When Luis Echeverria was selected, he was thought to be a center-right candidate, not well regarded by the liberal wing of the PRI. See Hansen (1971, p. 228). II. A restraint on Pertamina's medium and long-term borrowing had already been imposed in 1972. Sutowo adopted the simple expedient of borrowing at short-term in the Euro-dollar market. For a discussion of the Pertamina episode, see Wo(o and Nasution (1989), Woo and olhers (forthcom- ing). 12. Canenroon was also a federation until 1972, when a unitary state was created under a new consti- tution. 13. Data from IMF, Government Finance Statistics Yearbook, various years: and from World Bank (1988b), pp. 155-58. Comprehensive data for Nigeria are not available, but the federal govern- nment passes over one-third of its tax collections to state and local govemnents: in addition, they have their own taxes. 14. In Pakistan, however, the commission did not meet between 1974 and 1991. IS. See Maxfield (1991). who notes especially the contrast with Mexico in the low influence of the financial conimunity; and Kaufiman in Nelson (1990). But with Brazil's extensive indexation of financial assets, the interests of the financial community are also less likely to be strongly op- posed to infation than in a less highly indexed economy. 16. The military coup in Thailand in 1991 is said to have been motivated mainly by "inadequate re- spect" paid to the military by Prime Minister Chatchai, although budget issues apparently were also involved. 17. As discussed in chapter 10, however, endowing the central bank with some degree of legal inde- pendence is not sufficient for ensuring effective monetary control. Chapter 13. Conclusion: The Lessons of Experience I. Proper cost-benefit analysis using shadow prices that take into account the distortions created by tariffs and impor restrictions will do so. See Little and Mirrlees (1974). This work also deals with the need to allow for risk. References Aghevli, Bijan B., Mohsin S. Khan, and Peter J. Montiel. 1991. Exchange Rate Policy in Developing Countries: Some Analytical Issues. Occasional Paper 78. Washington. D.C.: International Monetary Fund. Athukorala, Premachandra, and Sisira Jayasuriya. Forthcoming. Macroeconomic Policies, Crises, and Growth in Sri Lanka, 1969-1990. 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Subject Index Adjustment inflation, 33. 154-55 Capital market. 14 Alfonsin, Raul, 371 Capital mobility: exchange rate Allende, Salvador, 47, 193, 368, 369, policy and. 249-51; extent of. 375.376 247-49, 333 Argentina, 37, 46. 87, 96, 100. 127, Cavallo, Domingo. 127, 191 185-92, 239, 265, 291. 337-38, Central banks: independence of, 339. 371.376-77 376 Chile, 35. 36, 47. 82-83, 96, 100, Babangida, lbrahim, 387 192-95. 233, 260,336-37,368. Bandaranaike, Mrs. Sirimavo. 288 376. 383-84 Bank lending. 14-15, 309-10 Chun, Doo Hwan. 167. 376. 381 Bolivia. 421n Clark. Joe. 28 Brady Plan, 128 Cocoa, 341 Brazil, 36. 87-88, 96. 100. 127, 174- CODESA. See Costa Rican Develop- 85,247,265,283-84,292,355,377, ment Corporation, 316, 355. 380 380, 384 Coffee: booms. 30-31.33,40-41, 105. Bretton Woods: exchange rate policies 117; exporting countries, 30,40-42. during, 222-25: system, 9-10, 16. 44-45, 88, 117, 162-63: prices, 40. 26: trade policies during, 266-67: 77. 81. 88, 117,341 Budgetary control, 315, 317, 342, Collor de Melo, Fernando. 127, 179 374-81; Colombia. 37, 40, 41, 88-89, 96. 114- Budget deficits, 306-10: operational, 16,127,162,168-69,224.226,248, 158, 179-80: primary, 318-19 292 Budgets (central government), 123, Consumption. 50-51 126; borrowing under, 306-10; Copper price. 27, 81, 83, 1)5 expenditures within, 299-304; Cost-benefit analysis: and investment lending under, 304-05; revenue.s efficiency. 354-55. 359 for, 305-07 Costa Rica, 36, 40, 41. 44. 83-84, 96, 100, 117, 163, 169-70. 355 Cameroon,37,40,41,91,114-16,128, Cote d'lvoire. 36. 37, 40, 41, 44, 163, 248. 251-54, 355. 375.379 83-84,96. 100.117.128X 161. Capital flight, 22, 87. 92, 94, 247-48, 163, 248. 251-54. 339-42, 355, 356 372-73. 375 447 448 Boom, Crisis, and Adjustment Current account (of balance of pay- Exchange rate regimes (policies), 273; ments): deficits and surpluses in, crawling peg, 168, 183; fixed but 23-25,52.96-97, 103-06,125-26; adjustable, 222-25 257; flexible effects of trade policies on, 275-77; peg, 220, 226-28, 241,412; and deficits, financing of, 32; and floating rates, 241-42; and real inflation, 159-60; deficits, exchange rate targeting, 197-98 sustainability of, 52, 74-76 Exogenous shocks: interest rates, 20; Debt: amortization and service of, 75, terms of trade 17, 19 104-05,319-21; domestic, 181-82, Exports, 12-14, 232-35; devaluation 321; interest on, 75-76, 318-19; as stimulus to 118-23, 232-35; Mexican moratorium on, 21,74,92; manufactured, 13, 118, 119-21, ratios (to GNP and exports) 30, 52, 232-34 74-76,96, 125-26, 320-21; rescheduling of, 23-24, 75, 90, 96, Figueiredo, Joao Baptista, 88 103-04, 164. 321; short-term, 378 Fiscal balances: deficits and surpluses in, 123, 126, 306-10; effects of Defense spending, 302-03, 374 trade policies on, 278-80 De la Madrid, Miguel, 198, 287, 378 Fiscal Policy: control of, 315, 317, 342, Delfim Neto, Ant6nio, 88, 178 374-81; effects of trade policies on, Demirel, Suleyman, 90, 370 278; inaction in, 97, 98; inflation Devaluation: contractionary effect of, caused by, 179-81, 191-92; 235-36; episodes of, 222-28; stabilization and, 54, 211-12, erosion of, 230-31; exports 324-26. See also Inflation stimulated by, 118-23, 232-35; Flexibility of policies, 97, 98, 353 external debt and, 320, 336, 343; Flexible exchange rates era, 226-27, growth rates affected by, 235-38; 267 import restrictions and, 32-33, 53, Foreign aid. See Development 101, 273-74, 291; rate of, defined, assistance 7; trade balance affected by, 234-35 Foreign borrowing, 31-33; sources of, Development assistance, 14-15, 372, 18-23; uses of, 49-51, 306-10 386 Forms of government, 362ff; authori- Discount rate. 334 tarian, 363, 367-68; democratic, Droughts. See harvest failures 363, 368, 370-72; federal, 316-17, Dutch disease, 225, 284 379-80 Franc zone (African), 37, 83, 251-54, Echeverria, Luis, 46, 196, 377-78 339-40 Euro-currency market, 14, 17, 378 Freedom House, 363 European Monetary System, 11 Exchange controls, 45, 246-49, 333 Gandhi, Rajiv, 127 Exchange rate overvaluation, 99, 229- Garcia, Alan, 369 30 GAIr, 10-12, 26, 122-23 Exchange rate policy, and trade policy, Ghana, 252 255, 273-74, 400-01 Group of 77, 26, 362 References 449 Growth in the 1980s: exports and, 113- money and, 158, 180,204, 207-08, 23; initial conditions and, 106-07; 330-31 investment and, 108-13, 147-49; Intellectual climate, 25-28, 387, 391 rescheduling and, 108-13; terms of Interest groups, 382; in business, 383- trade and, 113-14, 147-49; 84; civil servants and, 385; and transfers and, 108-13, 147-49 farmers, 383; military, 384-85; workers, 382-83 Harvest failures, 100, 102, 331 Interest rate, 332-35; controls over, Hassan 11, King Muhammad, 372 332-33; on debt, 20, 29, 32, 77, Heavy and chemical industries 103-04; policy, 200, 332-35; program (Korea), 48, 373 shocks, effects of, 77-80 Houphouet-Boigny. Felix, 45, 372 Institutional Revolutionary Party (PRI), Hyperinflation, 179, 190-91, 205 368, 369 International Monetary Fund (IMF), Import starvation, 93, 101, 271, 274, 9, 11, 16, 123-24, 269, 271, 275. 280, 282, 288-91 386-90, 392 Imports: automatic approval of, 285; Investment: booms, public and private, liberalization of, 45, 120-22, 126, 31. 42-49,303-04,312-13,359; ef- 264, 271, 274-75; negative list of, ficiency of, and returns to, 314-15, 264; positive list of, 264; quantita- 344, 353-58; foreign direct, 55; for- tive restrictions on, 45, 101, 264, eign portfolio, 18-23, 55 heavy in- 268, 289, 352 dustry, 373; import-substituting, 32; Indexation: of financial assets, 184-85: ratios to GNP (or GDP), 50-51, of wages, 82, 83-84, 214-16 108-12,125-26,147-49,344,346; India, 37, 38, 89, 123, 127, 224, 249, resource-based, 353. See also 282, 292, 355 Growth in the 1980s Indonesia, 38-39, 42, 43,91-92, Iran, 8, 19 93-95. 100, 114-16. 128. 161-62, Israel, 17, 421n 165-66, 205-09, 225. 233, 248, 282, 284-85, 356, 376, 378 Jayewardene, Junius, 289, 358 Inflation: 8, 17-21, 27; as tax, 172, 212, 322-24; bubbles, 160-61, Kenya, 35, 36, 40,41, 84, 96,117,163, 164-65, 169-70; caused by budget 375 deficits, 179-81, 191-92,204,205; Keynesian revolution, 25, 27 domestic debt and, 181-82; during Korea, 37, 47, 48, 84-85, 100, 166-67, Bretton Woods, 8-9, 150-52; effect 224, 242, 269, 285-86, 320, 338, of fixed exchange rate on, 164, 356. 371-72, 373, 376 171, 242-45; in coffee boom coun- tries, 162-63; in oil exporting London Club, 22-23 countries. 161-62 in oil importing Long-run growth: inflation and, 344, countries, 161; long-term growth 348-50: growth of labor force and, and. 344, 348-50; terms of trade 345-46; investment efficiency and, changes and, 153: velocity of 344-45, 348-49, 359; investment 450 Boom, Crisis, and Adjustment ratios and, 344, 346, 348-50, 359 re- Pakistan, 37, 47, 89-90, 248 scheduling and, 346, 351-52; sav- Parallel market premium, 246-49 ings ratios and, 344-45, 348; Paris Club, 23 stability of investment and, 345-46, Park, Chung Hee, 48, 356, 373, 375, 348-51; technical progress and, 345 376, 381, 383 Lopez Portillo, Jose, 46, 357, 377, 378, Pemex (Mexico), 315, 378, 380 384 Peron, Isabel, 46, 186-87, 377 Peron, Juan, 369, 376-77, 382 Martinez de Hoz, Jose,46-47,87,187- Pertamina (Indonesia), 315, 356, 378, 89 380 Menem, Carlos, 191, 369 Peru, 369, 371 Mexico, 37, 46, 92-95, 96, 100, 115- Phosphates: boom 1973, 39, 44, 162, 16, 127, 128, 195-201, 227, 231, 327, 372;prices, 81, 85 247, 286-87, 357, 368, 377-78 Pinochet, Augusto, 47-48, 368, 375, Military coups, 361, 369-72, 384 381, 383, 384 Monetary correction, 184-85, 318 Prem, Tinsulanonda, 376, 381, 384 Monetary policy: credit controls and PRI (Mexico). See Institutional rationing, 332-33, 352; inaction 97, Revolutionary Party 98; relation to fiscal policy, 335, 342; stabilization, 54, 334 Rao, Naresimha, 127 Money, demand for, 328-32. See also Rational expectations, 27 Inflation (and velocity) Real exchange rate: changes in, 97,99, Morocco, 38-39, 44, 85, 96, 100, 162, 119-20; defined, 219-20, 258; in- 226-27, 287-88, 357, 372 stability of 238-40; measurement of, 258-63; trade liberalization and, New Liberalization, 271-72, 274-75, 260-61 287 Recessions: causes of, 18-20,99-102; Nigeria, 38-39,42,43, 93-95, 96, 100, episodes of, 18-20, 97, 99-102, 106 115-16, 162, 170-71, 227, 242, Remittances. 47, 54, 85, 89-90, 103- 249, 282, 356, 371, 375, 378-79. 04, 246-08, 333, See also transfers 409 Rhee, Syngman, 375 Nixon Doctrine, 48, 373 Roh, Tae Weo, 371 Nominal anchor argument, 256-57 Salinas, Carlos, 198, 287, 369, 378 Official lending, 123-24 Salter model, 258 Oil (petroleum): exporting countries, Sarney, Jose, 368, 380 19, 21, 24, 38-39, 42-46, 91-95, Saudi Arabia, 23 114-16, 269; prices, 17, 19, 23, 29, Savings: influence of interest rates on, 77, 80 358; spread of banking, effect on, Oil shock 1986, 23, 105, 114 358 OPEC, 14, 17, 23, 92, 120, 354, 362 School of thought: central planning, Ozal, Turgut, 84, 370, 371 26; Keynesian, 25, 27; New Classical, 27 Refeir-en es 451 Seigniorage, 156, 180. 192. 321-24. Terms of trade: long-run growth and, 335, 338, 342 345: movements of. 51-52; shocks, Seigniorage inflation, 156-59,321-24, effects of, 29, 31-33, 77-80. See 335. 338, 342 also Growth in the 1980s Senanayake, Dudley, 288 Textiles: recession. 1974. 37 Shagari. Shehui, 371, 379 Thailand. 35. 36, 47, 86-87, 128, 226. Simonsen, Mario, 88 234, 334 Singh, Manmohan. 127 Trade: liberalization of, 11 -12. 264. SODESUCRE (COte d'Ivoire). 355 283. 291; policy episodes. 266, 268, Soekarno, 205. 284, 375 270,274.276-77, 293-94; changes Soviet Union (U.S.S.R.), 25, 26. 28, in openness of. 272: regime chang- 362, 373 es, 268, 270. 274. 289: restrictions Spiral inflation, 155-56 of, 264, 278, 354; revenues from, Sri Lanka, 35. 36, 47. 48. 85-86, 96, 278-80: tightening of, 265. See also 98, 224-25, 228, 229, 234. 282. Imports 288-89, 357, 372 Trade-off model. 159-60, 169, 189, Stabilization: Austral Plan (Argentina) 196-97. 202-03 for, 190; Bulhoes-Campos program Transfers: private unrequited, 54. 333: (Brazil) for. 177; Cruzado Plan of resources, 103-05; public (Brazil) for, 178.211. 368; unrequited (aid), 14-15, 54 exchange-rate-based. 188-89, Turkey. 37. 47, 90-91, 100, 202-05. 193-94, 201, 216-18: heterodox. 233. 245, 370 178-79, 212-14; Pacto program (Mexico), 198-200: wage restraint U.S. Agency for International Devel- and, 213-14. See also Fiscal policy oprnent (USAID), 386 Stabilization fund (for cocoa. coffee), 314 Velocity of money. 329-32. See also State and local financing, 316-17 Inflation State-owned enterprises (SOEs), 311- Videla, Jorge, 87 16 Viola. Roberto, 87. 189 Structural adjustment loans. 124 Suharto. 166. 206, 284, 375, 376, 381, Wage and price flexibility, 101. 197. 383 253, 255 War: Cyprus, 47, 361; Indo-Pakistan. Tablita, 82. 87,188, 199, 241 38; Nigerian civil, 361. 375 Taiwan, 356 West African Monetary Union, 339- Tanzi effect. 157, 189. 203, 409 40. See also Franc zone Tea boom, 85 World Bank. 123-24, 269. 271. 275 Index of Names Athukorala, Premachra, 234, 357, 358, Collins, Susan, 358 423n.424n Connolly, Michael, 355, 418n Auty, Richard, 354, 356, 417n, 430n. Cooper. Richard. 234. 416n, 427ni 43] n Corden, W. Max, 256, 41 Sn, 423n Ayub, Mahmood Ali, 426n Cuddington, John, 422n, 423n Cukierman. Alex. 429n Baer, Werner, 420n Cumby, Robert, 420n Bailey. Martin J., 427n Balassa, Bela, 415n, 418n Dantas, Daniel, 420n Balino, Tomas, J. T. 429n Dervis, Kemal, 420n Beer, Samuel H., 374 Devarajan, S., 423n Beristain, Javier, 420n Dollar, David, 424n Berthelemy, Jean Claude, 355, 423n Dornbusch. Rudiger, 369, 420n, 421n Bevan, David, 41, 417n Bhagwat, Avinash, 234 Edwards, Alejra Cox, 41 gn, 420n. 423n Bhagwati, Jagdish, 415n Edwards, Sebastian, 234, 369, 418n, Bhatia, Rattan J., 429n 420n,421 n,422n,423n,424n Blejer. Mario, 421n Emery, Robert. 428n Bodart, Vincent, 429n Epstein, Edward, 421n Bourguignon, Francois, 355, 423n Bruno. Michael, 256, 421n Fanelli, Jose Maria, 42ln Buffie, Edward F., 419n, 420n Feinberg, Richard. 416n Filippides, A., 425-426n Calvo, Guillermo A., 121, 420nr Fishlow, Albert. 350,418n,420ni.421 n Canavese, Alfredo J... 420n Friedman, Milton, 427n Cardoso, Eliana A., 350, 418n, 420n Fry, Maxwell J., 358, 430n Castillo. Carlos Manuel, 420n Celasun, Merih, 122, 202, 419n, 420n, Garcfa-Garia, Jorge, 423n 428n Gastil, Raymond, 363 Claassen, Emil-Maria, 44, 99, 357, Gelb, Alan. 38, 417n, 430n 372,418n,424n Gil-Diaz. Francisco, 357, 418n, 420n, Coes, Donald, 355, 420n, 423n, 424n, 424n 427n Glassburner, H. Bruce, 420n 453 454 B Clm. Crisis, and Adjustnent Gonzalez-Vega. Claudio. 355. 417n Liviatan, Nissan, 420n. 42 In Goode, Richard, 425n Lizondo, J. Saul, 422n Gulati, Sunilh 424n Gwinm Catherine. 416n Machinea, Jose Luis, 420n Maxfield, Sylvia, 432n Haggard, Stephan, 367, 370-371, 386, McCarthy, F. Desmond, 41 8n 429n Meade, J. E., 415n Hansen, Roger, 432n Meller, Patricio. 420n, 422n llaque, Nadeem, 422n Melo, Jaime de, 420n, 423n Harberger, Arnold, 423n Meridor, Leora. 421 n Hegstad, Sven Olaf, 426n Mirrlees, J. A., 354, 417n, 43 In, 432n Helliwell, John. 43 In Montiel, Peter, 422n Hotelling, Harold, 4] 8n Morales, Juan Antonio, 422n Ingram, James, 375 Nair, G., 425n, 426n Nasution, Anwar, 385, 420n, 426n Jayasuriya, Sisira, 234,357, 358.423n, Nelson, Joan, 383, 431 n, 432n 424n Neumeyer, Pablo Andres, 186, 420n Joshi, Vijay, 241, 314, 355. 358, 419n, Nidhiprabha, Bhanupongse, 35. 376 423n,424n, 426n, 431n Nogues. Julio. 424n Kamin, Steven, 234-235 Olivera, Julio H. G., 419n Kato, Hiroshi, 43 In Onis, Ziya, 358-359, 420n. 42 In, Kaufman, Robert, 367, 370-371,43 In, 422n,426n, 427n 432n Onitsuka, Yusuke, 234 Khan. Mohsin, 248 Ortiz, Guillermo, 420n Khor, Hoe, 420n Kiguel, Miguel, 186, 420n. 421n Pablo, Juan Carlos de, 420n Kilby, Peter, 431n Pazos, Felipe, 201 Kim, K. S., 424n Petri, Peter, 420n Kopits, George. 420n Pinto, Brian, 418n Krishnamurti, K.. 431n Piterman, Sylvia, 421n Krishnaswami, K. S.. 431n Pitt, Mark, 41 In, 424n Krueger, Anne, 424n Pritchett, Lant, 235, 422n Larrain. Felipe, 429n Ramangkura, V., 376 Lawrence, Robert. 416n Renelt, David, 429n Leone, Alfredo, 429n Riedel, James, 358-359, 420n, 42 In, Lessard, Donald, 423n 422n, 426n, 428n Levine, Ross, 429n Rodriguez, Carlos Alfredo, 186, 420n, Levy, Santiago, 420n 427n Little, I. M. D., 314, 354, 417n, 419n. Rodrik, Dani, 122, 202, 419n, 420n, 423n.424n.426n,430n,431n,432n 428n Referenees 455 Rojas-Suarez, Liliana , 420n Sundararajan, V., 429n Romer. Paul, 429n Sundrum. R. M., 421n Rosendale. Phyllis, 421 n Sutton, Mary, 421 n Swan, T. W., 415n Sabin, Lara, 431n Sachs, Jeffrey. 421 n Tanzi, Vito, 419n Salter, W. E. G., 41 Sn, 423n Tercero, Raul Ramos, 418n, 420n Sargent, Thomas J., 172, 181 Thorbecke, Erik, 420n Schultze, Charles, 416n Trigueros, Ignacio, 420n Scitovsky, Tibor, 430n Tybout, James, 420n Scott, Maurice, 346, 430n Selowsky, Marcelo, 429n van der Tak, Herman G., 417n Serven, Luis, 349, 419n, 420n, van Wijnbergen, Sweder, 420n 430n Sharma, P. D., 431n Wallace, Neil, 172, 181 Shirley, Mary, 425n, 426n Warr, Peter G.. 35, 424n Short, R. P., 425n, 426n Whitehead, Lawrence. 374, 43 In Simonsen, Mario Henrique, 420n Williamson, John, 423n Solimano. Andres, 349.419n, Woo, Wing Thye, 236, 356. 376, 385, 420n,430n 420n,421 n.424n,425n Squire, Lyn, 417n Woods, Dwayne, 373 I Ua 60891 DEV 050 BOOM, CRISIS, & ADJUSTMEI *~~~~~~~~~~~~~~~~~~ 40000195588 9 $42.95 ISBN 0-19-520891-9