1 Fiscal Policy, Growth, and the Design of Stabilization Programs
- Mario Bléjer, and Ke-young Chu
- Published Date:
- June 1989
The objectives of Fund-supported stabilization programs include a balance of payments that is viable over the medium run, the promotion of growth in a stable economic environment, price stability, and the prevention of excessive growth in external debt. These objectives do not have the same weight, but each is important in stabilization programs. A narrow interpretation of the Fund’s role would emphasize the balance of payments objective and de-emphasize the others.
This paper deals with the role of fiscal policy in stabilization programs, emphasizing the structural aspects of fiscal policies, since, over the years, these aspects have attracted less attention than has demand management. The Baker initiative of October 1985 called attention to the importance of these structural aspects. The paper does not discuss other elements of program design, such as incentive measures implemented through the exchange rate, import liberalization, financial deregulation, or pricing policy, even though these structural elements are obviously important. In countries in which institutions necessary for the effective use of other policies are not adequately developed, fiscal policy may be the main avenue to economic development and stability, although, unfortunately, political pressures, external shocks, and administrative shortcomings have frequently weakened government control over this instrument. Tax evasion, inflation, and the proliferation of exonerations have reduced the government’s control of tax revenues, while political pressures, fragmentation of the public sector, and inadequate monitoring systems have undermined its ability to keep public expenditure in check. Far from being the stabilizing force in the economy that it should be, fiscal policy has, itself, in too many instances, become a major destabilizing force contributing to disequilibrium in the external sector.1
In recent years the connection between fiscal developments and external sector developments has been increasingly recognized. Some have gone so far as to suggest a “fiscal approach to the balance of payments” that considers fiscal disequilibrium as the main cause of external imbalances.2
Although growth was always a primary objective of economic policy, the sustained rates of growth experienced by most countries until the mid-1970s (except for occasional and transitory periods of balance of payments difficulties) made it possible for the Fund, in negotiating stabilization programs, to concentrate on the objective of stabilization, concerning which it had more expertise and an accepted mandate. The increase in the oil price during the 1970s, and especially the more recent debt crisis accompanied by the sharp fall in commodity prices, brought about a new environment in which external sector disequilibrium could not be easily financed. This forced many countries to pursue (over longer periods than they had earlier) stabilization policies aimed at reducing external imbalances or the rate of inflation—policies that some critics considered inimical to growth.
In the face of external shocks, some countries (for example, the Republic of Korea) succeeded in stabilizing their economies and in advancing once again along the road of economic development. Others were less successful. When the need to pursue stabilization policies extended over several years, the short-run political costs of these policies began to loom larger than the longer-run economic benefits; political fatigue set in, and some countries became restive under the harness of traditional stabilization programs. Critics cried more loudly that stabilization policies were inhibiting growth. They attracted a larger following and advised policymakers to abandon stabilization policies recommended by the Fund, concentrating instead on growth, regardless of the consequences for the balance of payments and the rate of inflation. They espoused the position that inflation is a lesser evil than stagnation and that the external sector can be kept in equilibrium by means of quantitative restrictions and export subsidies, or by repudiating external debt obligations.
As already mentioned, stabilization and growth have always been legitimate policy objectives. Although in the past it was thought that, at any given moment, a country could focus on policies aimed specifically at only one of these objectives, the view that it is unwise to separate these objectives currently predominates. Stabilization programs must pay attention to growth to ensure that stability is not won at the price of stagnation.3 Growth policy must pay attention to stability to ensure that the pursuit of growth is not aborted by excessive inflation or by pressures on the external sector, as has happened in several cases in recent years. Achieving growth without stability may be technically impossible over the longer run; achieving stability without growth may be politically impossible, except in the short run. This paper attempts to reformulate the fiscal design of stabilization programs in order to emphasize the growth objective.
If stabilization were the only objective of economic policy, stabilization programs could rely mostly on traditional demand-management policies.4 Achieving stabilization with growth, however, requires demand-management policies to be complemented by policies aimed at increasing potential output. Misguided structural policies have reduced potential output by misallocating resources and by reducing the growth rates of the factors of production. They have thus been the main cause of stagnation and a contributor to economic instability. The design of adjustment programs should integrate stabilization with growth, or demand-management policies with structural, supply-side policies.
II. Fiscal Policy and the Design of Fund Programs
Stabilization programs can, in theory, emphasize either specific or general fiscal policies. For example, the member country and the Fund could agree on a whole range of specific fiscal measures, such as changes in various taxes and tax rates, and changes in specific public expenditures, subsidies, and public utility rates. These measures, however, would have to add up to the required adjustment in aggregate demand and supply. They would have to reduce the balance of payments disequilibrium and the rate of inflation to the desired levels by reducing aggregate demand and by increasing aggregate supply. For the purpose of identification, I shall call this the “microeconomic approach to stabilization programs,” an approach that explicitly recognizes both the demand-management and the supply-management aspects of fiscal policy. It recognizes that fiscal policy changes usually affect not only aggregate demand but also aggregate supply.5
Alternatively, the country and the Fund could limit their agreement on a program to general, macroeconomic variables. In the extreme version of this alternative, the Fund and the country might not even discuss specific fiscal policies, but would limit not only their agreement but also their discussions to the size of the fiscal deficit and to the expansion of bank credit associated with that deficit. If specific policies were discussed, it would be to assess their immediate impact on the size of the fiscal deficit and on aggregate demand.
In this approach, supply-side aspects of fiscal policy (what I have called the supply-management aspects) would be largely ignored. I shall call this the “macroeconomic approach to stabilization policy.” This approach implies that once the size of the deficit has been determined, the balance of payments consequences of that deficit have also been determined, regardless of the specific measures that the country may employ to achieve the stipulated level of fiscal deficit.6 Whether the deficit is reduced by raising taxes or by cutting spending, and regardless of the specific tax and spending measures used to achieve such a reduction, the balance of payments consequences are assumed to be the same.7
Although these alternative designs of stabilization programs have probably never been pursued in their pure forms, over the years the formulation of stabilization programs has been much closer to the macroeconomic, than to the microeconomic, alternative,8 in conformity with the common interpretation of the guidelines on conditionality.9Until recent years, stabilization programs established fiscal ceilings on the basis of an implicit model that connected monetary expansion associated with the fiscal deficit to developments in the balance of payments. The countries themselves would then choose the specific ways in which the fiscal ceilings would be observed. It was left to the authorities to determine which tax rates should be changed, which new revenue measures should be adopted, and which expenditures should be reduced (or expanded), although Fund missions did provide some advice based, where possible, on technical assistance reports. As Sir Joseph Gold puts it, “… performance criteria… must be confined to macroeconomic variables … The concept of ‘macroeconomic’ variables involves the idea of aggregation … [and] includes the broadest possible aggregate in an economic category.” Gold goes on to state that “… the Fund should not become involved in the detailed decisions by which general policies are put into operation …” He concludes that “[s]pecific prices of commodities or services, specific taxes, or other detailed measures to increase revenues or to reduce expenditures would not be considered macroeconomic variables.”10
Specific measures (such as the elimination of subsidies) were on rare occasions made performance criteria in Fund programs, but the main reason for doing so was often deficit reduction and thus demand management.11 Fiscal changes without direct and immediate bearing on the size of the fiscal deficit (say, revenue-neutral tax reforms) did not receive explicit attention in formal agreements, even though they might have a bearing on the efficiency of the economy. Changes that would increase the fiscal deficit in the short run but would have desirable supply-side effects on the economy in the medium run were not encouraged. The observance of the fiscal ceilings was the most essential fiscal element of a stabilization program.
If the country wanted advice on its tax structure, on the structure of its public spending, or on their respective administration, it could request technical assistance from the Fund. No conditionality was attached to the provision or the use of this advice, although Fund missions have occasionally used technical assistance reports to provide advice to the countries, especially on how to raise revenue.12 Technical assistance has been the major channel through which the Fund has directly influenced the structure of tax systems and their administration and, to a lesser extent, the structure of public spending.
With important qualifications, this macroeconomic approach to stabilization programs predominated until a few years ago. Starting with extended Fund facility programs, however, Fund missions began paying more attention to structural aspects in general, and specific fiscal aspects in particular,13 and today much more attention is paid to structural (supply-side) elements in stabilization programs. The transition from the macroeconomic to the microeconomic approach is, however, far from complete. The approach followed in negotiating stabilization programs begins with an estimation of the required reduction in a country’s fiscal deficit, given its balance of payments position and the foreign financing presumed to be available, and proceeds, separately and often ex post, to a discussion of specific policies.14 The connection that is likely to exist, especially over the medium run, between the “required” deficit reduction and the specific measures adopted to make that reduction possible is not accounted for in setting program ceilings. For example, the removal of growth-retarding taxes is not encouraged if alternative revenue sources are not immediately available, since such a removal will immediately increase the fiscal deficit and, given the underlying model used, will presumably lead to a deterioration in the country’s external position. Thus, the approach still goes from the macroeconomic to the microeconomic, and much attention is focused on the size of the deficit and on its financing.
Nevertheless, recent Fund programs have increasingly recognized that the specific measures through which fiscal deficits are reduced may determine, especially over the medium and long runs, whether a stabilization program will have durable, beneficial effects on the balance of payments and on growth, or whether these effects will vanish as soon as the program is over. An adequate macroeconomic framework (consistent with a viable balance of payments and with price stability in the short run) is a necessary, but not a sufficient, condition for growth and for stability over the longer run. In addition, stability requires efficient structural policies.
Should the Fund and the authorities focus mainly on macroeconomic fiscal variables, as they traditionally have? Or should they make specific fiscal policies equally important in designing a program? Putting it more starkly, should the Fund be prepared to walk away from an arrangement with a country in which resources have been badly misallocated, thus reducing its growth potential, if an acceptable core of structural policies is missing, even though the traditional macroeconomic framework appears adequate? Should Fund missions start the analysis of a program by identifying such a “structural core of required policies”—that is, a set of specific supply-side measures—that must be implemented over the course of the program before the macroeconomic ceilings are set?15 The answers to these questions are not as obvious as they might at first appear, since convincing arguments can be presented on both sides.
A first argument in favor of continuing with the traditional macroeconomic approach is that, at least in theory, this approach is objective. Whether or not performance criteria are satisfied is an issue subject, in most cases, to quantification and verification and is thus beyond dispute.16 As such, this approach reduces the uncertainty faced by authorities. They know that if the country satisfies the performance criteria, it will obtain the agreed financial support from the Fund. And, once again, those performance criteria normally relate to macroeconomic variables.
A second, and perhaps more important, argument is that performance criteria based on ceilings imply less political interference by the Fund in the internal affairs of countries than do criteria related to specific measures. Authorities are likely to object to having to agree to modify a tax in a given way or to modify the level or pattern of public spending.17 Critics who find present Fund conditionality too rigid are likely to object even more to what might be seen as an extension of that conditionality. Examples of this reaction exist in connection with Fund recommendations to eliminate or reduce subsidies. Many observers feel that these are political decisions that should be left to the authorities and that the Fund should, at most, offer only an opinion on them.
A third argument in favor of the traditional approach is that discussions of fiscal ceilings, as well as the review of the outcome of these discussions at Fund headquarters, require fewer and less specialized staff resources than do discussions of specific measures. For an institution concerned about its own budget, this is an important consideration. The design of a program can be based on a relatively straightforward view of the relationship between fiscal deficits and the balance of payments. Once some assumptions are made, it is far easier to decide what the size of a fiscal ceiling should be than to decide the details of specific policy changes and how these changes would influence program objectives.
A fourth argument, closely related to the preceding one, is that, at least in the fiscal area, it is far easier to write a letter of intent in which a country’s formal commitments are couched in the form of general ceilings than to write documents that spell out formal commitments in terms of many specific policy changes. It is always difficult, for example, to specify the precise requirements of a tax reform.
There are, however, arguments that caution against exclusive or excessive emphasis on traditional performance criteria that emphasize fiscal ceilings. They favor paying close attention to the microeconomic aspects of fiscal policy, such as the structure of individual taxes, the structure of expenditure, the allocation of investment, the prices charged by public utilities, and public employment. To avoid any misunderstanding on this issue, I should emphasize here that the questions raised below about fiscal ceilings should not be interpreted as supporting Fund critics of conditionality. They simply call attention to the arguments (a) that a good stabilization program must not rely exclusively on demand management, and (b) that the ceilings used to serve demand management should not be set independently from the structural changes that the country is willing to make. The main justification for this change of emphasis is that, provided the supply response is not insignificant and occurs fairly rapidly, the more far reaching the structural reform agreed to by the country, the greater will be that supply response (in terms of output, exports, capital repatriation, and the like). Such a supply response may imply that a less stringent demand-management policy is necessary.
Problems have at times been encountered when ceilings have been imposed on macroeconomic variables. These problems are mentioned to indicate that a program that relies exclusively on performance criteria related to macroeconomic variables may not provide the hoped-for results. First, the longer ceilings on macroeconomic variables are in use, the more ways countries learn to get around them. Ceilings are most useful when a country complies not just with the letter of an agreement but also with its spirit. Unfortunately, there have been instances in which countries have complied with the letter, and defied the spirit, of agreements. They have engaged in operations aimed at circumventing the ceilings in order to draw resources from the Fund without making genuine adjustments. To deal with this problem, the Fund has been compelled, in some programs, to increase the number of performance clauses related to the fiscal deficit. This has created a perception of excessive conditionality.
Second, the usual formulation of a stabilization program may give the impression that the relationship between fiscal deficits and program objectives, and especially their relationship with the balance of payments, is clear cut and unambiguous. It may give the impression of a single-valued functional relationship—that is, so much fiscal deficit implies so much deficit in the current account of the balance of payments. Unfortunately, our knowledge about important economic relationships (such as (1) that between changes in the money supply and changes in prices, and (2) that between changes in prices, changes in nominal exchange rates, and their effects on the balance of payments) is too limited to inspire excessive confidence about the precise level of the fiscal deficit required to achieve a given change in the current account of the balance of payments or in other economic objectives. The truth is that a given fiscal deficit may be associated with a range of balance of payments outcomes.18
Third, the ceilings may, in some cases, divert attention from the basic objectives of economic policy. Meeting the ceilings within the program period may come to be seen as an end in itself. During this period, programs may be judged successful or not depending on whether ceilings are being met rather than on whether the ultimate objectives of the program (durable improvement in the balance of payments, growth, price stability, and so forth) are being achieved.
Finally, and most important, excessive reliance on macroeconomic ceilings may divert attention away from the quality, as well as the durability, of the specific measures used by a country to comply with its performance clauses. Let me give some examples, starting with the question of the durability of the fiscal measure. The question to be raised is the following: will a fiscal measure have a permanent impact on the fiscal deficit? Will, for example, a revenue increase or an expenditure cut affect the deficit for years to come, or will it have a once-for-all effect? This is an important question if the program’s objective is, as it should be, a permanent improvement in the economy.
In some cases, tax payments by enterprises have been paid in advance at the request of the government,19 or public expenditures have been postponed (through the building up of arrears or the postponement of inevitable expenditures),20 so that the country can meet the fiscal ceilings and, thus, make the next drawing. In other cases, temporary sources of revenue (once-for-all taxes, temporary surtaxes, tax amnesties, sales of public assets, and so forth) have allowed the country to stay within the agreed ceiling without doing anything to reduce its underlying or core fiscal deficit.21 At times, governments have used up so much of their political capital in introducing these temporary measures that they no longer have had the stamina necessary to make the permanent and growth-promoting policy changes required to achieve durable adjustment with growth.
In addition to the question of the durability of the fiscal measures (of whether their effects will survive the program), there is the important question of the quality (or, if one wishes, the economic efficiency) of those measures. As far as short-term demand-management policy is concerned, whether a country reduces the fiscal deficit by raising revenue or by cutting expenditure is inconsequential.22 It is also inconsequential whether it does it through the use of measures that have disincentive effects, or of measures that do not have such effects. The stabilization program will fail if the ceiling is not observed; it will not fail if it is observed through the use of growth-retarding measures.
The above discussion should not be interpreted as arguing that stabilization programs should no longer rely on demand management based on a macroeconomic framework that sets ceilings on relevant macroeconomic variables. In my view, the need for such a framework is too obvious to require justification. The discussion simply argues that this framework needs to be supplemented by measures aimed at ensuring that stabilization programs are, first, durable and, second, as growth promoting as possible. According to the present guidelines on conditionality, under which the Fund staff operates, the change advocated in this paper might not be possible. A decision taken by the Executive Board of the Fund on March 2, 1979 states that “Performance criteria will normally be confined to (i) macroeconomic variables, and (ii) those necessary to implement specific provisions of the Articles [of Agreement] or policies adopted under them. Performance criteria may relate to other variables only in exceptional cases …” (italics added).
III. Stabilization Policy and Economic Growth
Growth-promoting stabilization policy requires that the reduction in the fiscal deficit be carried out through fiscal measures that are (a) durable in their effects, and (b) efficient in their impact. In other words, the policies chosen must not self-destruct once the program is over and must achieve their deficit-reducing objective with the least possible inhibition of economic growth.
The efficiency of fiscal instruments is important for growth, as much recent work on this issue has demonstrated. Work effort, exports, productive investment, saving, capital flight, foreign investment, and so on can be affected by the choice of specific fiscal instruments.23 These choices may play a large role in determining the amount of foreign resources a country will have available during and after the program period. Thus, the relationship between changes in the size of fiscal deficits and changes in the ultimate objectives of economic policy, such as growth and stability, is inevitably influenced by the fiscal policy measures utilized. It can make a substantial difference to the growth prospects of a country if the fiscal deficit is reduced by eliminating a totally unproductive expenditure or by raising a tax that has strong disincentive effects, even though in terms of traditional stabilization policy (in terms of short-run fiscal deficit reduction) the result would appear to be the same. The more efficient the measures used to achieve a given deficit reduction, the greater will be the rate of growth, and, assuming an unchanged monetary policy, the lower will be the rate of inflation.
The implication of the above conclusion for stabilization programs is obvious: provided that a country is willing to implement considerable structural measures early enough in a program so that the positive effects of these measures can be felt relatively soon, the Fund should be prepared to require less reduction in the overall fiscal deficit (i.e., to require less austerity) than it would if the structural package were less far reaching or if the country delayed its introduction. Thus, the Fund should explicitly recognize, at the time it enters into an agreement with a country, a tradeoff between quantity and quality of fiscal adjustment—one that would also be influenced by the timing of the introduction of the structural measures. This trade-off should be recognized and, possibly, formalized in program design and negotiations.24
This is not the place to discuss in detail the quality of the fiscal measures that could form the structural core of a stabilization program, but a few examples may help convey the importance of this issue. Suppose that an agricultural commodity of wide consumption (say, wheat, corn, or rice) has been subject to an export tax in a country negotiating a Fund program. The elimination of this tax would reduce tax revenue and thus raise the fiscal deficit. This, in turn, would have monetary and, consequently, balance of payments implications, which the macroeconomic framework used for Fund programs would assess. But let us consider whether there are countervailing supply-side effects. The removal of the tax would raise the domestic price of the commodity and lead to a reduction in domestic consumption, thus making an additional supply available for exports.25 In addition, the removal of the export tax would encourage producers to produce more of that product. When this additional production became available, exports would increase further. Since the availability of foreign exchange is always a key factor in a stabilization program, focusing only on the demand effect (through the increase in the fiscal deficit) that the elimination of the tax will have, and ignoring the supply effect (through the incentive to produce and export more), is likely to introduce a bias against the elimination of that tax. It may thus lead to programs that require greater demand reduction than was necessary.26
Or suppose that some additional spending is carried out by the government to repair a road that facilitates the shipping of agricultural products out of the country. Here again, the short-run negative effect on the balance of payments associated with the larger fiscal deficit is partly or fully neutralized by the positive effect associated with larger exports. These examples may be extreme, but they are far from rare. It would be easy to provide additional illustrations of the link between quantity and quality of fiscal adjustment.
A perusal of stabilization programs indicates that despite an increasing awareness of these issues, political difficulties, guidelines on conditionality, and timing concerns have prevented their being taken formally into account in Fund programs.
In negotiating programs, the Fund has attempted, with increasing frequency, to ensure that cutbacks in government expenditure are focused on less productive activities. The World Banks guidance is sought in this connection. Nevertheless, obvious political sensitivities have limited the degree of Fund involvement in decisions on expenditure policy. As a result, the expenditure policies pursued have, in several instances, not been as supportive of the growth objective as they could have been.27
An examination of actual cutbacks in capital expenditure in various countries indicates that they have, at times, been borne by some of the more productive projects. To reduce the budget deficit, cutbacks have in some cases affected productive, externally financed projects despite the fact that loans for part of the total cost of the projects were highly concessionary. In other cases, cutbacks have focused on productive, domestically financed, small-scale projects, while externally financed, highly visible, but less productive projects backed by important donors have been protected. Even where a core investment program has been agreed between the country and the World Bank, higher implementation rates for lower-priority projects have often occurred.
A common feature of such policies has been the disproportionate cutback in expenditure on materials, supplies, and maintenance, relative to other types of expenditures. As a result, the condition of roads, bridges, public buildings, irrigation projects, airports, and other public sector infrastructure has deteriorated by more than would have been required notwithstanding the inevitability of certain adjustments necessitated by the debt crisis.28 Inadequate maintenance eventually requires expensive projects for reconstruction of deteriorated plants and equipment.29 In agricultural regions, impassable roads have drastically limited the impact of market-oriented policies aimed at encouraging increased agricultural production. Shortages of materials and supplies have also dramatically limited the productivity of public sector employees, whether in education, medical care, agricultural extension, or tax administration. Across-the-board cutbacks in expenditure have been common. Such an approach fails to address the enormous waste of expenditure in many politically sensitive but unproductive sectors, including defense spending. Significant cutbacks in public sector employment remain the exception. As a result, efforts to cut the public sector wage bill have typically resulted in a deterioration in real wages, which are often greatest among the higher-paid civil servants. The factors encouraging corruption, low productivity, and multiple jobs of civil servants have therefore been intensified.
Tax increases have, in some instances, included measures that can be expected to have detrimental effects on growth. This has, at times, occurred in countries that already had very high tax ratios. For example, on many occasions the rates of export duty have been raised (or an export duty has been imposed) following devaluation, on grounds that the exporters would enjoy some sort of “windfall” profits. However, devaluations often simply offset past cost increases. Import surcharges have been levied, or the rates of import duties have been raised, for balance of payments and revenue reasons. As these surcharges have been imposed on products already highly taxed, they have, by increasing the differences between taxed and untaxed imports, increased distortions and reduced growth prospects.30 Surcharges on the income taxes of individuals and corporations have often been used. Sometimes countries have raised payroll taxes or taxes on interest incomes with undesirable repercussions on employment, saving, and capital flight. In a few cases, countries have levied taxes on expatriate employment raised the rates of mining taxes, or levied taxes on foreign exchange transactions, thus discouraging foreign participation in economic development.
The main point of this discussion is worth repeating. The impact of changes in fiscal deficits on economic objectives depends to a considerable extent on the quality of the specific measures employed. A change in the quality of those measures will change the relationship between the fiscal deficit and the balance of payments, especially over the medium and long runs. The required reduction in the fiscal deficit (that is, the required austerity) needed to achieve a given effect on the basic objectives of economic policy will be more severe as less efficient measures are chosen. For this reason, stabilization programs should systematically deal with microeconomic issues of public finance in addition to other structural policies. Programs must include needed structural changes and must integrate them with the macroeconomic framework.
Several problems arise in connection with the implementation of the approach suggested in this paper. They relate to (a) our knowledge of incentive effects, (b) timing considerations, and (c) political implications.
As to the first point, one could argue that not enough is known about the incentive effects of particular policies to place precise quantitative values on them. The validity of this argument is apparent, but irrelevant. Stabilization programs often rely on exchange rate devaluation, even though precise estimates of these responses are not available. They also rely on changes in real interest rates, even though, again, the size of the response of financial (and real) saving to changes in real rates cannot be known with precision. The important point is to have a sense of the direction of the effects and some “feel” for their size. If one waited for precise and objective quantifications of these effects, no formal agreement on a stabilization program would ever be included.
As to the timing issue, one could agree that the choice of better policies would in time bring about a more efficient economy and higher rates of growth. But what about the present? Would not, for example, the elimination or the reduction of an efficient tax, or an increase in a highly productive government expenditure, raise the deficit in the short run, thus necessitating more external or inflationary financing? A simple answer is that important structural changes often bring with them immediate changes in expectations that can influence individuals and corporations to make further changes reinforcing their initial effects.31 For example, changes that create an environment more favorable to the private sector may encourage individuals to repatriate capital, encourage foreign enterprises to invest in that country, and facilitate foreign borrowing. More foreign money is likely to be made available to countries pursuing structural reforms.32 Still, part of the answer is that, as shown in the example of the export tax, some real effects will often occur early. If structural changes are made early in a program, or even before its formal approval by the Fund, their supply-side effects would probably also occur within the program’s duration, so that the initial negative effect on the size of the fiscal deficit could be balanced by a positive effect in the latter phase of the program. Reluctance to allow some initial expansion in the deficit through, say, the removal of inefficient taxes may contribute to the postponement of essential structural adjustment.33 Finally, this timing question is not limited to these policies. For example, the existence of J-curves indicates that the same problem exists with the effect of exchange rate devaluation. Also, so-called ratchet effects may postpone the time when the impact of demand-management policies is felt on effective demand.
The proposed departure is not without political implications. The conditionality guidelines may have to be amended to make it possible for the Fund to include, in a stabilization program, formal understandings about tax or expenditure reforms in the countries that approach the Fund for programs and where there are significant structural distortions.34 In some ways, this would be a change of form more than substance, because the Fund has already, in recent programs, gotten involved in structural aspects and has tried to persuade some countries to implement particular policy changes. Countries’ authorities may object to the proposed changes, especially if they perceive them it as additional conditionality without receiving anything in return. Nevertheless, if they became aware that, at the time a program was negotiated, there might be some trade-off between the size of the required macroeconomic adjustment, on the one hand (the required austerity), and structural changes, on the other, their objections to the proposed change might, in some cases, be less serious than one would assume a priori.
IV. Concluding Remarks
The above discussion indicates that if at all possible, a more inductive approach to determining the particulars of the fiscal policy required in stabilization programs would be desirable. According to this approach, in addition to identifying the range of adjustment needed at the macroeconomic level, the Fund, in cooperation with the member country’s experts, would make an inventory of the various changes in both the level and structure of taxes and of public expenditure that would be required to promote the country’s growth objective.35 In this search, the Fund would have to take into account the importance the country’s authorities attached to such objectives as equity and the provision of basic needs. The task would then be to determine whether the proposed changes added up to a macroeconomic adjustment package that was consistent with the balance of payments objective. The structural adjustment would be made up of a basic structural core of fiscal measures constituting a sine qua non for a program. If this structural core did not add up to the macroeconomic adjustment assumed to be needed, the Fund and the local experts would look for progressively less efficient ways to add to revenues or to reduce expenditures. If the country’s economic difficulties were assumed to originate exclusively in excess demand (that is, if no major structural problems were identified), the negotiations would proceed along more traditional lines.
The country’s authorities would be aware that there was a trade-off between the size of the needed demand constraint and the extent of the structural changes. They would know that the more daring and timely they were in introducing structural changes, the more flexibility they would have in demand management. In essence, the program would be made up of three elements, possibly all of major importance: (a) the traditional macroeconomic framework with ceilings and targets; (b) the structural core; and (c) the investment core, which presumably would indicate, on the basis of World Bank recommendations, the minimum investment, as well as the allocation of that investment, consistent with both growth and balance of payments objectives.
One should not underestimate the difficulties, both technical and political, that a formal pursuit of this alternative would present; and one should recognize that this alternative would be considerably more labor intensive for both the Fund and the countries’ experts and policymakers. It is an alternative that would require further thought before it could be fully implemented.36 Initial experimentation in well-chosen and willing countries would be indispensable to a full assessment of its general feasibility and to an outline of the procedural steps to be followed.
In this year  when the Nobel Prize in economics has been given to James Buchanan for his contributions to public choice theory, it may be appropriate to conclude this paper with a few highly personal thoughts on the political implications of the suggestions it contains.
While aggregate demand may grow independent of structural policies, so that a traditional stabilization program will be sufficient in itself to bring about the needed reduction in that demand and, thus, the needed adjustment to the economy, it is more often the case that excess demand exists not (or not only) because demand has grown more than it should have but (or but also) because supply (including that of foreign exchange) has been constrained by misguided structural policies. For example, financial savings may have been reduced by constraints on nominal interest rates or by excessive taxation of interest income; this reduction may have constricted the supply of domestic financial savings available to finance the deficit and private investment in non-inflationary ways, and because of capital flight, it may have reduced the availability of foreign exchange.37 Agricultural output may have been reduced by low producer prices that necessitated the import of food. Agricultural exports may have been limited by excessive export taxes, by overvalued exchange rates, and by low prices paid to producers. Food supplies may have been limited by the deterioration of transportation systems brought about by misallocation of public expenditures. In all these examples, the supply has been reduced, thus creating imbalances that, in time, have manifested themselves as excessive demand. In these cases, demand-management policies alone would have reduced the symptoms of these imbalances but would not have eliminated the causes. Thus, stabilization programs might succeed stabilization programs without bringing about a durable adjustment unless the basic causes of imbalances were addressed.
One major difficulty in dealing with these basic issues is that the policies that I have called “misguided” may be misguided only in an economic, and not in a political, sense. Public choice theorists would emphasize the fact that these policies may be quite rational, at least in the short run, if they were assessed from a purely political viewpoint.38 They would argue that structural problems do not necessarily exist because policymakers have made technical mistakes in their policymaking, perhaps because of poor economic understanding. Rather, public choice theorists would argue that through these policies, policymakers have tried to promote their own political objectives. Furthermore, the time horizons of policymakers are generally so short that they do not take full account of the long-run implications of their policies on the economy. These policies create “rents” for groups whose support the government needs in order to stay in power, even though such policies may, in time, reduce the incomes of the majority of citizens.39
If this public choice interpretation of economic policy is at least partly valid—and I do not know to what extent it is—it implies that policies aimed at structural reform will often be resisted more than macroeconomic stabilization policies. They would be resisted because they would remove these rents from precisely those whose support the government needed and would thus reduce the leverage that the policymakers had over consituencies whose support they needed to stay in power. In part, structural reforms would weaken the government in power’s raison d’être. As a consequence, it would seem to follow from these theories that major structural reforms have the best chance of being carried out when there is a major political change—that is, when a government that has long been in power is replaced by a totally different one—so that the political interests of the new policymakers are not tied to existing structural policies. This public choice-inspired hypothesis should be amenable to testing. It seems to have some plausibility, but only a careful analysis of actual situations will permit one to accurately assess its validity as a tool in explaining changes that occur in economic policy.
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