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10 What Is Reasonable to Expect of the IMF on the Environment?

Ved Gandhi
Published Date:
June 1996
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Stanley Fischer

To a remarkable extent, the work of the IMF is still guided by its original mandate, as spelled out in the Articles of Agreement. In 1944, the founding fathers charged the IMF with, among other things, facilitating “the expansion and balanced growth of international trade and to contribute thereby … to the development of productive resources” and helping member countries with temporary balance of payments problems so that they do not have to adjust by “resorting to measures destructive of national or international prosperity.” These goals are pursued primarily through balance of payments assistance and what has come to be called surveillance.

Although the Articles of Agreement do not refer to the environment, it is clear that environmental issues must be taken into account in trying to attain what the Managing Director often refers to as “high-quality growth”—that is, growth that is sustainable, that improves living standards, and that does not mortgage the future for short-lived gain. As the Managing Director pointed out when he addressed the Earth Summit in Rio in 1992, IMF member countries, themselves, are redefining and expanding the concept of sustainable economic growth to encompass social and environmental objectives. In turn, the IMF is adapting its views on economic development and thus the advice it gives. For instance, the IMF is acutely aware that natural resource degradation that threatens growth cannot be ignored. But why should it be otherwise? Taking account of such environmental concerns is just good economics.

What are the links between macroeconomics and the environment? This seminar has explored the question at great length. The consensus seems to be that the causality is two-way, giving rise to three broad themes.

  • First, macroeconomic stability is good, indeed essential, for environmental protection.
  • Second, macroeconomic policies might, under certain circumstances, have an adverse impact on environmental conditions.
  • Third, environmental conditions themselves can have an adverse impact on economic growth and macroeconomic balances.

I would like to elaborate briefly on each theme and then conclude with some thoughts on what I believe the IMF can reasonably be expected to do with respect to the environment.

Why are stable macroeconomic conditions considered a necessary requirement for preserving the environment? Research efforts so far suggest that in the absence of economic stability, the critical incentives to preserve environmental resources or undertake investment in environmental protection are distorted. For example, high and variable rates of inflation—which frequently distort intertemporal choices, including those relating to the use of forests, mines, and other natural resources—reduce the incentive to preserve resources, as producers and consumers act as though they were facing high discount rates, thus ignoring the future.

Numerous country studies and our own experience suggest that when economic stability is restored, the necessary incentives are reintroduced. For example, a study of Costa Rica undertaken by the World Bank showed that lower and less volatile interest rates, brought about by macroeconomic stability, helped reduce the high rates of deforestation. This happened because logging firms were able to make better intertemporal choices—that is, they could more easily determine future benefits.

But do the results of these studies mean that good macroeconomic policies are always good for the environment? The answer appears to be a qualified no. That is, there are cases in which macroeconomic policy reforms might have an undesirable impact on the environment—but these cases occur only when appropriate environmental policies are lacking.

Let me give a few examples:

  • An exchange rate depreciation may raise the value of a natural resource that generates export earnings and it may encourage excessive exploitation. Of course, expectations of an exchange rate appreciation may also lead to the same outcome. Both cases, however, can only occur when the fiscal system does not adequately capture resource rents or reflect the country’s opportunity cost of extracting the resource.
  • Similarly, when governments raise taxes on petroleum products—such as kerosene—to improve fiscal balances, they may encourage the use of wood as fuel, leading to increased deforestation. While this will occur only when charges for the exploitation of forestry resources are inadequate and are not appropriately adjusted, it has to be recognized that charging for the use of forests may be difficult.

Thus, wherever environmental policies are lacking, there is a possibility that macroeconomic reforms may run counter to environmental preservation. But even then, the solution is not to give up on macroeconomic stability. Rather, countries should be encouraged to tackle the root causes of environmental degradation—the market, policy, and institutional failures—to ensure that households and businesses adequately internalize the costs of environmental damage.

How about the reverse causality? Studies increasingly confirm that the environment itself may affect macroeconomic conditions. Indeed, research shows that environmental degradation and depletion can give rise to structural balance of payments problems and can reduce economic growth prospects.

Take the case of exhaustion of both nonrenewable natural resources (such as mines) and renewable natural resources (such as forests and fisheries) through exports. Without adequate replacement and renewal, the future export base of resource-dependent economies can be seriously curtailed. Similarly, soil erosion can seriously diminish a country’s domestic food supply and curtail its agricultural exports.

The Fund’s Role

What do these findings mean for the IMF? The confirmation of the two-way links suggests that environmental issues could show up in our dealings with member countries in a number of ways.

First, developing countries. The economic growth strategy of a developing country that relies on depletable resources for current economic activity has to be different from that of other countries. Resources need to be used at an optimal rate, and provision needs to be made—through saving and investment—for the time when economic activity cannot rely to such an extent on raw materials. Most obviously, these considerations are paramount in the oil-exporting countries, but they are also important in other natural resource-exporting countries. For example, Kiribati built up a reserve fund as it used up its stock of guano.

Next, the economies in transition. For countries switching to a market-oriented economy, the opportunities for efficiency gains—through realigning prices, removing subsidies, and ending soft budget constraints for state-owned enterprises—are enormous. The IMF can encourage these countries to adopt policies that would serve both the economy and the environment. These might include, as a first step, adjusting energy prices to their market value, which the World Bank has estimated could reduce atmospheric emissions of sulfur by up to 60 percent in Central and Eastern Europe.

Finally, the industrial countries. In countries where IMF efforts focus largely on surveillance, the Fund can draw on the work by national governments, international organizations, and academics on country-specific studies of the impact of environmental policies and conditions on the macroeconomy (for example, proposed carbon taxes and common environmental policies in the European Union), and bring these to bear, where pertinent, on our policy discussions.

There is no question, however, that environmental issues tend to be sectoral and require special analytical expertise. For this reason, we in the Fund look to the World Bank—our sister organization—to take the lead on these issues. At the same time, though, we cooperate closely with the Bank in two key ways.

  • First, in connection with some of the IMF’s longer-term lending programs, we work closely with the Bank to help countries prepare Policy Framework Papers, which often include medium-term plans for addressing environmental problems. For example, as part of Burkina Faso’s Policy Framework paper the medium-term (1995–97) macroeconomic and structural program includes the implementation of the National Environmental Action Plan, the reform of environmental institutional and regulatory structures, and the strengthening of the water management sector.
  • Second, together we assist countries in designing public policy reforms supportive of the environment.

Finally, environmental or “green” accounting can help policymakers fashion better environmental and economic policies. For that reason, the IMF has been supporting the work of the World Bank, the United Nations, and others that have more direct mandates to develop methodologies for environmental accounts that augment conventional national accounts. Although the recently completed version of the System of National Accounts does not fully integrate environmental concerns into the core accounts, it does recommend the compilation of satellite accounts, denominated in both physical and monetary units, that record the depletion, degradation, and other changes in the environment. Already, several countries are experimenting with variants of the satellite account approach—notably Costa Rica, Mexico, the Netherlands, Norway, and Papua New Guinea.

The work being carried out on green accounting promises to be important in practice, particularly in providing a framework for thinking through the two-way interactions: the ramifications of environmental problems on production and consumption, and the ramifications of production and consumption on the environment. Moreover, some of the early results are showing just how significant environmental factors may be for long-term growth, with indicative estimates suggesting that conventionally measured GDP may, in some circumstances, exceed GDP adjusted for natural resource depletion and environmental degradation by an appreciable margin. The cost of depleting petroleum reserves in Indonesia, for example, has been estimated to have averaged approximately 2 percent of GDP between 1971 and 1984. For Mexico, the cost of oil depletion, deforestation and soil erosion has been estimated at between 6 and 13 percent of net domestic product in 1985. For Italy, net domestic product was estimated to have been reduced by about 1.6 percent in 1986 owing to environmental degradation.

Note: These remarks were made at a luncheon talk during the seminar.

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