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FINANCE[•̂ DEVELOPMENT is published quarterly in English, Arabic,Chinese, French, German, Portuguese, and Spanish by the InternationalMonetary Fund and the International Bank for Reconstruction andDevelopment, Washington, DC 20431, USA (USPS 123-250). Secondclass postage is paid at Washington, DC and at additional mailingoffices. • English edition printed at Lancaster Press, Lancaster,PA. • English edition ISSN 0015-1947. • Opinions expressed in arti-cles and other material are those of the authors; they do not necessarilyreflect Fund or Bank policy. • New readers who wish to receiveFinance & Development regularly should apply in writing to Finance &Development, International Monetary Fund, Washington DC 20431,USA, specifying the language edition and briefly stating the reasons fortheir request. • The contents of Finance & Development are indexed inBusiness Periodicals Index, Public Affairs Information Service (PAIS),and Bibliographie Internationale des Sciences Sociales. An annualindex of articles and book reviews is carried in the December issue.

Bahrain NowzadEDITOR

Shuja NawazMANAGING EDITOR

Rachel WeavingASSISTANT EDITOR

Maxine StoughASSISTANT EDITOR

Richard StoddardART EDITOR

ADVISORS TO THE EDITOR

Mark AllenMichael P. DooleyVinod DubeyGregory IngramPaul IsenmanArturo IsraelAnthony LanyiClaudio LoserJ.C. Peter RichardsonAlexander ShakowAlan TailDavid Williams

Published for the World Bank by the Johns Hopkins University Press

Malnutrition-What CanBe Done?Alan Berg

Lessons from WorldBank Experience

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World Bank Publications66, avenue d'/ena75116 Paris, France

Among the most urgent goals of the

World Bank's lending and technical

assistance is to help the many coun-

tries that are unable to meet the broad

nutritional needs of their people. This

book suggests efficacious, affordable

ways to contend with the problem

and describes the characteristics and

cost-effectiveness of four World Bank

assisted nutrition projects and more

than 50 nutrition components that

were incorporated into the design of

agricultural, rural development, and

health projects. It also surveys Bank-

supported research on nutrition and

evaluates the nutrition analyses in the

Bank's economic and sector work.

These lessons provide insight into

how food policy and nutrition pro-

grams can be carried out efficiently.

And, at a time of structural adjustment

and stablization in many developing

countries, they show how vulnerable

groups can be protected or can benefit

from adjustment measures.

152pages/6'/8x91/4/

ISBN 0-8018-3553-4 / Paperback

©International Monetary Fund. Not for Redistribution

A QUARTERLY PUBLICATION OF THE INTERNATIONAL MONETARY FUND AND THE WORLD BANK

Voluntary Export RestraintsOften involuntary, their costs may outweigh benefits

Helping Structural Adjustment in Low-Income CountriesA new Fund facility assists medium-term reform efforts

Debt Relief for African CountriesThe Paris Club eases rescheduling terms

UNCTAD VII: New Spirit in North-South Relations?A constructive approach emerged from the Geneva meeting

Adjustment and the Import Intensity of OutputImport compression may hinder growth

Community Participation in World Bank ProjectsThe goals, risks, and rewards

Community Participation in Northern PakistanAn experiment with encouraging results

Determinants of Public Enterprise PerformanceWhy some perform better than others

The Decline of the US Steel IndustryWhy competitiveness fell against foreign steelmakers

Developmental Role of Central BanksBeyond monetary policy and regulatory functions

Foreign Currency Deposits in LDCs. . .and how they complicate economic policymaking

Alleviating Poverty under Structural AdjustmentProper policies can improve the welfare of the poor over the long run

Do Outward-Oriented Policies Really Favor Growth?Point and counterpoint on the World Development Report 1987

World Economy in TransitionExternal debt of developing countries, 1970-86

BooksThreats to International Financial Stability edited by R. Portes and A. Swoboda,Stability of the Internatonal Monetary System by W.M. Scammel, andReforming the International Monetary System by Robert HormatsDeficits, Taxes, and Economic Adjustments edited by Philip CaganThe Effects of Taxation on Capital Accumulation edited by Martin FeldsteinEconomic Adjustment and Exchange Rates in Developing Countries edited by Sebastian Edwards and Liaquat AhamedWomen in the World Economy by Susan JoekesEconomic Development by H.W. Arndt

Books in Brief

Letters

Index for 1987

Clemens Boonekamp

Michael Bell andRobert Sheehy

Thomas Klein

Carlston Boucher andWolfgang Siebeck

Abbas Mirakhor andPeter Montiel

Samuel Paul

Graham Donaldson

Mahmood Ayub andSven Hegstad

Lloyd Kenward

Anand Chandavarkar

Mohamed EI-Erian

Tony Addison andLionel Demery

L.K. Jha

Bahram NowzadFrederick RibeLans BovenbergAnthony LanyiMasooma HabibRobert Picciotto

2

6

10

14

17

20

23

26

30

34

38

41

44

47

484849495051

51

52

53

The Editor welcomes views and comments from readers on the contents of the journal.The contents of Finance & Development may be quoted or reproduced without further permission. Due acknowledgement is requested.

December 1987 Volume 24/Number 4FINANCE^DEVELOPMENT


Voluntary Export Restraints•7 \i mT .. ... - -* • NA-

They are often not voluntary; they are costly and discriminatory; but they can bea tempting form of protection relative to other measures.

Clemens FJ. Boonekamp

Successive rounds of multilateral tradenegotiations under the aegis of the GeneralAgreement on Tariffs and Trade (GATT)have progressively reduced the importanceof tariffs as barriers to trade. This, however,has not been matched by a correspondingliberalization of international trade. Since theearly 1970s, with the relatively slow rates ofgrowth and the rise in surplus capacity inmany countries, protectionist pressures havesteadily built up, especially in industrializedcountries whose international competitive-ness in traditional industries has declined, inparticular vis-a-vis Japan and the newlyindustrializing countries of Asia. As a result,nontariff barriers have become more prev-alent, to the point that they currently rival, ifnot exceed, tariffs as impediments to trade.

Voluntary export restraints (VERs) arenow a common form of nontariff barrier,having grown in number and spread, in recentyears, from textiles, clothing, steel, andagriculture to automobiles, electronic pro-ducts, and machine tools. This article dis-cusses the basic elements of VERs, why theyare employed, and their economic conse-quences.

What are VERs?A VER is a measure by which the

government or an industry in the importingcountry arranges with the government or thecompeting industry in the exporting country

for a restriction on the volume of the latter'sexports of one or more products. By thisdefinition, the term VER is a generic refer-ence for all bilaterally agreed measures torestrain exports. Strictly speaking, however,a VER is an action unilaterally taken andadministered by the exporting country and is"voluntary" in the sense that the country hasa formal right to eliminate or modify it.Usually a VER arises because of pressurefrom an importing country; it can then bethought of as "voluntary" only in the sensethat the exporting country may prefer it toalternative trade barriers that the importingcountry might use. Further, in a noncompet-itive, especially oligopolistic, industry export-ing firms might find it to their advantage tonegotiate a VER, which is then truly "volun-tary."

A VER that consists of a government-to-government agreement is normally referredto as an orderly marketing arrangement andoften specifies export management rules,consultation rights, and the monitoring oftrade flows. In some countries, notably theUnited States, orderly marketing arrange-ments are legally distinct from a VER asstrictly defined. Agreements which involveindustry participation are often referred toas voluntary restraint arrangements. Thedistinction between these forms of VER islargely legal and terminological and has littlebearing on the economic impact of VERs.

Finance & Development I December 19872


A typical VER limits the supply of exports,by commodity type, by country, and byvolume. GATT Articles, which are concernedwith governmental actions affecting trade,prohibit export restraints under normal cir-cumstances; when permitted, they must benondiscriminatory and applied only throughduties, taxes, and charges. However, theinvolvement of governments in VERs is notalways clear. Also, VERs do not always havefirm market-sharing provisions; they may, forexample, be in the form of an export forecastand thus become cautionary in nature. Forthese reasons, VERs fall into a "grey area"in that there can be doubt as to their illegalityunder GATT. Further, parties to a VER areunlikely to request a finding under theGATT's dispute settlement procedures—they have never done so—while third partiescan often appear to benefit from a VER andmay therefore be reluctant to initiate disputeprocedures. Finally, signatories to the Codeon Subsidies and Countervailing Duties Codethat resulted from the Tokyo Round of tradenegotiations seem to have acquired legalpowers to negotiate VERs. It is in theserespects that the decision of the GATTCouncil of Representatives in 1987 to estab-lish a dispute panel to examine the Japan-USsemiconductor agreement is important.

Why are VERs introduced?

Broadly speaking, restrictive trade mea-sures are taken usually for two purposes: toprotect or improve the balance of paymentssituation, and to provide relief for industriesadversely affected by foreign competition, inprinciple allowing them time to undertake theadjustments necessary to regain externalcompetitiveness. VERs are employed for thislatter purpose and, compared to other formsof protectionism, offer several advantagesfrom the viewpoint of the protecting country.

Under GATT rules, safeguard provisionsexist for the temporary, emergency pro-tection of domestic industries injured byimport competition. Such safeguard actions,however, involve negotiating compensationwith the countries affected by the measures.These negotiations can be difficult and maynot succeed. In that case, the protectingcountry risks retaliation by the exportingcountry. In either case—compensation orretaliation—the exports of the country takingthe safeguard action may suffer. VERs, onthe other hand, have built-in compensation,

- in the form of rents (i.e., higher earningsarising out of the scarcity of a product). This

, makes acceptance by the exporting sourceI more likely and retaliation less probable.

The importing country, in negotiating aVER, tends to avoid the frequently lengthy,public, and often multilateral, debate that

invariably precedes other forms of protectio-nism, such as increasing tariffs or imposingquotas. In such a debate, the cost of theprotective measure is likely to become moreclearly recognized, making the action polit-ically expensive and risky. A VER then hasthe advantage that, as an action taken by aforeign source, a domestic legislative strugglemay be avoided; it often can be negotiatedquickly without its costs becoming obvious.Further, in the context of exports which are,or are suspected of being, subsidized, thedomestic authorities can bypass the oftenexpensive and time-consuming process of acountervailing-duty investigation by comingto a VER agreement with the exporter.Finally, it can be argued that a VER, byaddressing the source of the problem, that isthe one or few low-cost suppliers disruptingthe domestic industry, obviates the need forwider action that could harm third countries,as would be the case with a nondiscriminatoryimport quota of equivalent import-reducingeffect (see below). For any of these reasonsdomestic policymakers often prefer a VERto alternative measures; it offers relativelyquick, politically inexpensive assistance to anindustry threatened by import competition.

A VER can also be attractive to theexporting country. As indicated above, itoffers rents which, at least in the short-run,are windfall gains to the extent that demandin the rest of the world is elastic so that termsof trade losses are minimal or zero. This canbe important relative to alternative tradebarriers that the importing country mighttake; tariff revenues, for example, accrue tothe government that levies them. Also, VERscan serve to assure the exporter of marketaccess to the importing country, terminatethe uncertainty inherent in a countervailing-duty investigation, and provide the exportinggovernment with an element of control overits domestic industry. These factors suggestthat when faced with the probability ofprotection by the importing country, particu-larly if it is an important market for otherproducts, the exporter might agree readilyto a VER.

Prevalence of VERs

Quantitative export restraints first seemto have appeared in 1935 when Japan wasinduced to limit its textiles exports to theUnited States. However, only in the pastdecade or so have they come into widespreaduse. The accompanying table lists almost 100major, known VERs. The actual number maywell be greater as there are reported to bevarious undisclosed industry-to-industry andgovemment-to-industry arrangements. Of theknown number of VERs, 55 restrict exportsto the European Community or its individual

member states, and 32 restrain exports tothe United States. In general, VERs havebeen introduced to protect industries inOECD markets where certain developingcountries, East European countries, or Japanhave become serious competitors. Indeed,the exports of these countries are restrainedby about 80 VERs.

The above numbers do not include theMulti-Fibre Arrangement (MFA), which to-gether with its predecessor, the Long-TermArrangement on Cotton Textiles (1962-72),has been the model for VERs. The MFA is anegotiated, multilateral departure from GATTbased on the principle that industrial coun-tries, which are the main importers oftextiles, require special protection against"market disruption" by lower-cost, normallydeveloping-country, exports. Under its aegisa multiplicity of bilateral export restraintagreements have been concluded, coveringapproximately 50 percent of trade in textilesand clothing. In addition, as the table notes,there are 11 known VERs in this sectoroutside the scope of the MFA. As a result aconsiderable portion of world trade in textilesand clothing is managed, and thus not subjectto the normal forces of international trade.

Apart from textiles and clothing, steel isthe product category most heavily affectedby VERs. Since the first restraint in thissector was negotiated in 1968 between theUnited States and several European andJapanese exporters, about a quarter of thetotal trade in steel has come under VERs,affecting exports from nearly all the majorthird country suppliers to the United Statesand the European Community, as well asexports from the European Community to theUnited States. Exports of agricultural pro-ducts are also restrained by VERs, principallyfrom the more efficient producers, such asAustralia and Argentina, to the EuropeanCommunity. In automobiles and transportequipment, as well as in electronic productsand machine tools, Japanese exporters limittheir sales to both the European Communityand the United States, while in footwear anumber of OECD markets are protected byVERs with Korean exporters.

According to one calculation, in 1984 some10 percent of total world trade, and 12percent of non-fuel trade, was covered byVERs ("Export Restraint Arrangements" byM. Kostecki, World Economy, forthcoming).This study also estimated that in the sameyear approximately 38 percent of Japaneseexports to the European Community and 32percent of Japanese exports to the UnitedStates were covered by VERs. Other com-mentators estimate that in 1983 about 11percent of world trade in developing coun-tries' manufactured goods was restrained by

Finance & Development I December 1987 3


Major known VERs(excluding the MFA)1

Total:

Steel

99

39

Agriculturalproducts

Automobilesand transport

equipment

Textiles andclothing

Electronicproducts

Footwear

Machine toolsOther

17

13

11

7534

Restrained exporters(by number of arrangements)2

Japan (24), Korea (14), Brazil (4);ODCs (21); OICs (20); E. Eur. (16)

EC (4); OICs (12); DCs (12);E. Eur. (11)

DCs (6); ICs (6); E. Eur. (5)

Japan (11); Korea (2)

Korea (2); ODCs (9)

Japan (6); Korea (1)

Korea (3); Japan (1); Taiwan (1)

Japan (3)

Korea (3); ICs (1)

Protected markets(by number of arrangements)2

EC (S5)3; USA (32);(Canada, Japan, Norway (12)

USA (25); EC (14)

EC (16); Canada (1)

EC (9); USA (1); OICs (3)

USA (4); EC (3); OICs (4)

EC (6); USA (1)EC (2); OICs (3)

• EC (2); USA (1)EC (3); Norway (1)

Sources: GATT Secretariat, and M. Kostecki, "Export Restraint Arrangements.", World Economy, forthcoming.VERs known to be in place in late 1986.

2EC is the European Community; E. Eur. is East Europe; ODCs are other developing countries; OICs are otherindustrialized countries; DCs are developing countries; ICs are industrialized countries. The term "other" in ODC and OICrefers to countries other than those identified in the particular classification (e.g., OICs under "footwear" refer to all industrialcountries other than EC).

3lneluding 12 arrangements involving individual EC member states.

VERs. Further, the percentages appear tohave risen rapidly in the early 1980s. By oneestimate the share of exports of the newlyindustrialized countries of Asia and Japanaffected by VERs rose from some 15 percentin 1980 to about 32 percent in 1983.

The economics of VERsIn general, the effect of VERs is to reduce

the level of imports and thus increase theprice of the product in question in theimporting country. This will happen as thenormally low-cost, but now restricted, for-eign suppliers raise their export prices tocapture the rents created by the VER. Thehigher price will normally encourage anincrease in domestic output of the product.

However, even if the VER is set at thefree trade level of imports, in an oligopolisticindustry prices can rise because a VERfundamentally changes the nature of competi-tion in the affected industry. Given that theexporting industry (or country) administersthe VER, producers in the protecting countrybecome "price leaders" relative to those inthe exporting country: any increase in theprice by domestic producers must result inan appropriate rise in the price of theimported substitute if the VER is to beobserved. In these circumstances the profitsof both the domestic and foreign firmsincrease. Consumers will, of course, lose.Producers in the exporting country can beexpected to agree willingly to a proposedVER, particularly since it can increase theirshare of the importing country's market, if

the demand for the domestic product is moreresponsive to changes in the price of thehome product than to changes in the price ofthe imported substitute. The VER thenprotects domestic producers, by raising theirprofits, but does not protect domestic pro-duction.

These results become less tenable thelarger the number of firms in the industry.First, it becomes more difficult to persuadeall domestic firms to be part of the price-leadership role; some may prefer to increasemarket share by price competition. Second,if not all foreign firms are covered by a VER,they, too, may seek a larger market share.Thus the larger the number of firms in theindustry, the more likely that the VER willneed to be set at an import-reducing level ifthe domestic price is to rise and encouragehigher local production levels. However, theoligopolistic example does point to the impor-tant conclusion that, regardless of the numberof firms in the industry, a VER provides anincentive for collusion between firms, tochange the nature of competition. Thiscreates vested interests in both the importingand exporting country. A VER may encour-age, therefore, what anti-monopoly legisla-tion is meant to forestall.

Price rises due to VERs can be substantial.In a recent study of the impact of the VERon Japan's automobile exports to the UnitedStates ("The Cost of Trade Restraints" byCharles Collyns and Steven Dunaway, IMFStaff Papers, March 1987) it was estimatedthat the average price of a car sold in the

United States in 1984 was about $1,650, or17 percent, higher than it would have beenin the absence of the VER. Of this estimatedincrease about $1,030 reflected improve-ments in quality. Exporters under a volumeconstraint have an incentive to upgrade thequality of their product on the restrictedmarket in order to maximize profit per unitsold. Unrestricted foreign suppliers and do-mestic producers are likely to follow suit iftheir products are relatively close substitutesfor the improved, export-restrained, product.In the above study the pure price effect wassome $620 per car in 1984; this cost USconsumers a total of $6.6 billion.

VERs can distort trade and production in anumber of ways. First, in the importingcountry the market share of exporters notsubject to VERs can increase. The price ofthe product subject to the VER in theimporting country is likely to exceed theworld price; the latter may in fact fall,particularly if the importing country's marketis large and the VER well enforced. In thesecircumstances, non-restrained suppliers maydivert exports to the protected market, thusdistorting the pattern of trade. At the timeof the 1977 orderly marketing arrangementfor color television sets between Japan andthe United States, Japan accounted for some90 percent of US imports of such sets. Twoyears later Japan's share had fallen to about50 percent, while that of the Republic ofKorea and Taiwan, Province of China hadgrown significantly. Subsequently the DMAwas extended to Korea and Taiwan.

Second, there may be an incentive for newfirms in both the importing and other coun-tries to enter the affected industry, makinginvestments that might not have been effi-cient at the free trade level of imports. Third,the existing VER-affected firms in the export-ing country may seek to circumvent theirconstraints by exporting via third countries.Finally, foreign suppliers may take to export-ing, or increasing exports of, close substi-tutes for the VER-protected products to theimporting market.

If VERs spread so as to cover imports ofa product from all sources, the VER-systemthen resembles an import quota. The pro-cess, however, is quite different. A quota isnormally applied on a global basis; it isnondiscriminatory, usually being allocatedeither on a "first-come, first-served" basisor by quota-shares in accord with theprevious pattern of import shares. VERs arebilaterally negotiated, normally with one or afew suppliers. They are discriminatory, there-fore, with export volumes depending onnegotiating strength. They can bias thepattern of trade for the VER-covered productto the importing country against the more


Prevalence of VERs


efficient exporters and may create invest-ment signals for producers in third countriesthat could turn out to be wrong. As such,VERs can lead to larger efficiency losses thana globally applied quota of equivalent import-reducing volume.

As already indicated, VERs can—and have—spread from country to country and fromproduct to product. In this respect theirdemonstration effect can be important. More-over, as previously noted, a VER tends tolower the world price of the product,increasing demand in third countries, whichmight be satisfied by imports of the product.This effect could be reinforced to the extentthat the VER-covered exporters are able touse their rents from the protected market towin market share in nonprotected countries.These factors may help to persuade thirdcountries, especially those that manufacturethe product in question, also to negotiateVERs. Eventually, as in textiles and clothing,and steel, a VER network could effectivelyresult in a globally managed market-sharingarrangement.

VERs tend to create rents, which can besubstantial, for foreign producers. The OECDhas estimated that the annual transfer fromOECD countries to exporters of textiles andclothing in the newly industrialized countriesof Asia is at least $2 billion under MFAbilateral export restraint arrangements. Inthe above-noted study of the VER on Japan'sauto exports to the United States, it wascalculated that Japanese exporters, on pureprice effects alone, "earned" rents of $1billion in 1984; the total transfer to foreignsuppliers was $1.67 billion, indicating thatthird-country exporters not restrained by theVER may have benefited from it. M.Kostecki, using a VER tariff-equivalentmethod, has estimated that the rent transfersresulting from VERs worldwide in 1984 couldhave been as much as $27 billion.

Trade policymakers are not unaware of theeffects discussed above, in particular of theefficiency losses in the allocation of re-sources. This is one reason why VERs aregenerally negotiated to have a relatively shortlifespan. Nevertheless, VERs can be atempting form of protection. Once they arein place, vested interests may work againsttheir removal.

Do VERs work?The answer to this question depends on

• whether a VER serves its purpose ofsafeguarding employment and promoting adjust-I ment in the protected sector, and, if so, at

what price. These aims might not be consis-tent with each other. Modernization to regaincompetitiveness often entails switching to amore capital-intensive mode of production.

Similarly, if a VER implies a political con-straint to retain employment, adjustment bythe industry might be delayed. This mighthappen in any event as the VER, akin to otherforms of protectionism, reduces competitivepressures and makes it easier to continueproduction with outdated and inefficient tech-nology. The industry then retains low-qualitystaff, displacing potentially higher-skilledemployees who could make a greater con-tribution to raising real incomes.

More generally, by raising domestic profitsVERs can make resources available foradjustment. This appears to have happenedin the US automobile industry and in certainparts of the textile and steel industries in boththe European. Community and the UnitedStates. However, in these sectors the VERprotection has also afforded the exporters anopportunity to upgrade the quality of theirproducts. The domestic industries thus faceincreased competition in precisely thoseareas where they might otherwise have hada comparative advantage.

A recent GATT report shows that VERshave not prevented a loss of employment inthe textiles, clothing, and steel industries inthe protecting countries. In the period1973-84, employment in the steel sectors ofthe European Community and the UnitedStates declined by 42 percent and 54 percent,respectively; in textiles and clothing thedeclines were 46 percent and 43 percent,respectively, in the European Community,and 22 percent and 18 percent, respectively,in the United States. Modernization, gains inproductivity, and changes in macroeconomicconditions dominated the employment situa-tion in these sectors, as they did in the USautomobile industry where employment fellby some 250,000 jobs in the early 1980s. Itis possible, however, that employment inthese sectors would have fallen further in theabsence of protective measures. Thus, byone estimate between 40,000-75,000 jobswere saved in the US automobile industryduring 1981-84 as a result of the VER onJapan's car exports to the United States.Similarly it has been calculated that a 50percent relaxation in the VERs protecting theSwedish clothing industry would reduce cloth-ing employment in Sweden by about 6percent.

Job maintenance by VERs can be verycostly. Estimates for 1984 indicate that theannual cost, as a result of higher prices, toUS consumers under VERs on textiles andclothing amounted to $50,000 and $39,000,respectively, per position saved, as comparedwith annual average textile and clothingwages of $13,400 and $10,500, respectively.The OECD has calculated that each jobprotected under the orderly marketing arrange-

ment on Japan's color television exports tothe United States cost about $60,000 peryear.

Regulating VERs

The prevalence of VERs and their inherentdrawbacks, especially their tendency tospread and fragment the trading system intoa series of market-sharing arrangementsdominated by the major trading nations, hasled some commentators to suggest that theyshould be regulated and their use be sub-jected to strict conditions and multilateralsurveillance. This would encourage greateradherence to internationally agreed traderules. These observers also note that GATTalready sanctions certain departures from theprinciple of nondiscrimination as, for example,in its provisions for customs unions and freetrade areas. Others suggest that the principleof nondiscrimination is too vital to be furtherweakened by giving VERs official approval.Nondiscrimination in economic terms meansthat a given level of protection for domesticproducers can be achieved at minimum costto domestic consumers and the rest of theworld. It also protects the interests of smallertrading nations and helps to ensure the accessof new entrants to the international marketplace. Its role in GATT rules lends transpar-ency and predictability to international traderelations and to domestic decisionmaking. Inthis view, VERs would be controlled by afirmer commitment by trading nations tonondiscrimination in the formulation andpractice of their trade policies.

This issue is on the agenda of the recentlylaunched Uruguay Round of multilateral tradenegotiations, especially in the context ofGATT's safeguard provisions. The decisionsof the negotiators could have an importanteffect on the future of the international tradingsystem and by implication on the growth andemployment prospects of its member coun-tries. •

Clemens F.J. Boonekampa Dutch national, is withthe Fund's Office inGeneva. He completed hisgraduate studies at BrownUniversity and has taughtat the University of BritishColumbia (Canada). Hejoined the Fund staff in1980.



Helping Structural Adjustmentin Low-Income Countries

Concessional assistance from the Fund's new structural adjustment facility and Fund-Bankcooperation help countries undertake crucial medium-term reforms

Michael W. Bell and Robert L. Sheehy

Mn the first 20 months of its operations, theFund's structural adjustment facility hasprovided concessional financial assistance tosupport the balance of payments adjustmentefforts of 21 low-income member countries(see Table 1). Discussions are in progresswith a number of other eligible countries. Thestructural adjustment facility, established bythe Fund's Executive Board in March 1986,is financed by about SDR 2.7 billion expectedto become available during 1985-91 fromTrust Fund loan repayments. The Trust Fundhad provided concessional financing over1977-81, and was itself financed largely bythe sale of a portion of the Fund's goldholdings.

Most SAF arrangements have supportedpolicy reform programs that have also re-ceived support under other Fund facilities.Indeed, all but six of the SAF arrangementsthat have been approved to date have alsoinvolved the use of Fund resources underother facilities. In some of these cases, SAFresources were critical in meeting balance ofpayments financing needs; in others, the SAFresources facilitated the implementation ofadditional measures, such as a further libera-lization of import restrictions or an exchangereform that might not have been possiblewithout the greater balance of paymentssupport provided by the SAF. Thus, theresources made available under the SAF andother facilities have played mutually suppor-tive roles, with the relatively longer-termcommitment of resources under the SAFassuming special importance in enabling coun-tries to face structural issues requiring asustained commitment to policy reform.

This article reviews the background againstwhich the SAF was launched and the designof adjustment programs undertaken by low-

income member countries of the Fund thathave qualified for assistance under the facility.It also explains, in brief, the criteria foreligibility and the nature of the collaborationbetween the Fund, the World Bank, and themember country in developing an agreedpolicy framework for medium-term balanceof payments adjustment.

Conditions in the 1980sThe SAF was established in the context

of very difficult economic conditions facing thelow-income countries. Many had experienceda significant deterioration in their externalpositions and growth prospects in the late1970s and early 1980s, brought on bydiminishing net capital inflows following theonset of the debt crisis, a progressiveworsening in their terms of trade, and theslowdown in growth in the industrial countrieswhich affected their export possibilities. Thedeterioration was exacerbated in many coun-tries by inadequate domestic economic pol-icies. In responding to these difficult circum-stances, a number of countries undertookadjustment measures that reduced theirexternal current account deficits, but evenso, many of these countries faced a declinein per capita income that began to be reversedonly in 1984. In other countries, inadequateor inappropriate macroeconomic and struc-tural policies resulted in a substantial worsen-ing of their payments imbalances and madeadjustment even more difficult. In some ofthese cases, limitations in the institutionalstructure of the countries reduced the effective-ness of policy instruments, hampering adjust-ment still further.

The fundamental concept underlying theSAF is the notion that growth and adjustmentare mutually reinforcing. If a country's

balance of payments position is unsustainable,it will not be able to restore and maintainsatisfactory growth unless adjustment takesplace; conversely, a viable balance of pay-ments position can be sustained only in thecontext of adequate growth that enablesproduction and trade to expand to meet thedemands (and indeed improve the livingstandards) of an increasing population. TheSAF was designed to facilitate this process,both by the direct support that it wouldprovide to countries pursuing strong macroe-conomic and structural adjustment programsand also through its catalytic role in encourag-ing the flow of financing from other sources.

Programs supported by the SAF (which areoutlined in the policy framework papers—seebox) are intended to promote growth byfocusing investment on productive projects;by raising domestic savings and mobilizingexternal resources, particularly through non-debt-creating inflows; and by improving theincentives to efficient production through theestablishment of appropriate prices and theremoval of other structural impediments.These programs also aim at establishing aviable balance of payments position, to helpmeet external obligations in an orderly andtimely manner, and to avoid disruptions toeconomic activity arising from external con-straints.

SAP-supported adjustmentAlthough the revival of economic growth

in the context of a viable external position hasbeen and will continue to be a commonobjective of SAF-supported adjustment pro-grams, the design of programs in individualcountries is based on a case-by-case approachthat reflects the circumstances of the member(see Table 2). There were, however, many

Finance & Deoelofnnent I December 19876


common features. The economic programssupported by SAF arrangements thus fargenerally aimed to increase growth rates; inmost cases, the GDP growth target was 3-4percent. The desired path for the externalcurrent account reflected a number of factors,including the position at the beginning of theprogram, the availability of medium-termexternal financing on appropriate terms, andthe extent of liberalization of the tradesystem. However, in all cases, programswere designed to achieve substantial progresstoward external viability during the three-year period of the SAF arrangements.

All programs approved to date included,as an important objective, the containmentor reduction of inflation; in cases whereinflation had significantly exceeded the globalinflation rate, the programs generally aimedat a reduction to, or close to, the global rate.To this end, most programs included areduction in the rate of growth of domesticcredit aggregates. At the same time, somerestructuring in the composition of domesticcredit was generally expected, with privatesector credit growing in real terms anddomestic bank financing of the public sectordeclining, as less essential current expendi-tures were reduced to make room for higher

BangladeshBoliviaBurundiCentral African RepublicChadDominicaGambia. TheGuineaGuinea-BissauHaitiMadagascarMauritaniaMozambiqueNepalNigerSenegalSierra LeoneSomaliaTanzaniaUgandaZaire

ToW

Dale oithree-year

arrangement

Feb. 6, 1987Dec. 15, 1986Aug. 8. 1986June 1. 1987Oct. 30. 1987Nov. 26. 1986Sep. 17, 1986July 29, 1987Oct. 14, 1987Dec. 17, 1986Aug. 31, 1987Sep 22. 1986June 8. 1987Oct. 14, 1987Nov. 17, 1986Nov. 10. 1986Nov. 14, 1986June 29, 1987Oct. 30, 1987June 15, 1987May 15, 1987

Amountownrnittcd

182.657.627.119319,42.5

10.936.84.8

28.042.221.638.723.721454036.828.167.963.2

184.8

971.3

Amountdisbursed

57.518.18.56.1612.01

3.411.61.58.8

1336.8

12.27.56.7

42.6 '11.68.8

21.419.958.2

332,7

Source International Monelgry FundIncludes amounts disbursed under second-year arrangement

The policy framework approach

A major innovation of the SAF is the requirement that a comprehensivethree-year pobcy framevrork paper (PFP) be prepared by the nationalauthorities, with the joint assistance of the staffs of the World Bank and theFund. The PFP sets out the macroeconomic and structural pobcy objectivesof the authorities for the ensuing three-year period, the policy strategy andmeasures that will be employed, and estimates of the financingrequirements associated with the adjustment program. The paperidentifies, in particular, the principal macroeconomic and structuralimpediments to a better growth and external payments performance. Italso generally describes and assesses the public investment program anddiscusses financing requirements and, to the extent that information isavailable, the role of the major aid agencies. Finally, it analyzes the socialimplications of the program and describes the steps being taken by theauthorities to ameliorate the possible adverse short-term impact of theadjustment measures on vulnerable groups within the society. PFPs haveevolved in the 20 months of operation of the SAF and are increasinglyincorporating long-term development issues.

The PFP is updated at the beginning of each program year, within thethree-year pobcy framework. The main advantage of such a medium-termpolicy framework, updated regularly, is that it provides a continuity ofpolicies and analysis that is useful for both the authorities and theinternational institutions and agencies that provide support for the country'sadjustment efforts.

Bank-Fluid cooperation. Bank and Fund staff assist the authoritiesin the preparation ol PFPs. As a general rule, the Bank staff focusprimarily on longer-term issues and on analysis of the adequacy of sectorpolicies and of the public investment program and its sectoral priorities.The Fund staff focus mainly on the macroeconomic framework and

objectives and on measures to eliminate macroeconomic imbalances.Both staffs are involved in analysis of the structural policy reformsproposed by the authorities within their respective areas of expertise.Discussions with the authorities on the PFP are undertaken jointly bythe two staffs and the PFP is reviewed by the Executive Directors ofboth institutions. A summary of the views of the Bank's ExecutiveDirectors is made available to Fund Executive Directors for considera-tion prior to their own discussion.

Additional flowt. A key objective of the PFP approach is to serveas a catalyst to encourage the flow of additional financial resources toeligible countries from other multilateral and bilateral sources. Theresources of the SAF, even with the anticipated substantial enlarge*ment, are relatively modest in relation to the needs of eligible countries.It is important, therefore, that additional resources be made availablein association with the facility to ensure that countries undertaking thebroad policy changes included in SAF programs are assured of adequateexternal support. The information in the policy framework papersprovides bilateral and multilateral donors and creditors with acomprehensive and consistent policy framework and direction withinwhich individual agencies could provide aid to SAF-eligible countries.

This process can help to direct resource Hows to countries, and tosectors and projects within countries, that can use assistance mosteffectively. It can also help avoid overburdening the limited adminis-trative capacity of many recipient governments and ensure thatcountries do not receive conflicting policy advice. The latter considera-tion assumes special importance in light of the growing emphasis onpolicy-based lending by many aid agencies.

Finance & Development / December 1987

T«bl« 1Structural *d)u»tm«nl facility •rrang«m»nU,

•• of October 31, 1987(hi mitton* (X SOfe)

7


public and private sector investment. Tostrengthen private sector savings, mostprograms featured an active interest ratepolicy, usually aimed at achieving positivereal interest rates early in the programperiod.

The strategy for strengthening medium-and long-term growth prospects under theSAF arrangements approved so far generallyinvolved substantial increases in domesticinvestment, while short-term growth was tobe maximized by measures to increase theefficiency of the use of existing resources.The increase in domestic investment was inmost cases to be derived primarily from anincrease in private sector investment equalto about 2-3 percent of GDP. All programs

External sectorExchange rate systemImport liberalizationTariff reformDebt managementOther

Domestic pricesRetail price decontrolAgricultural producer prices

Fiscal sectorTax structureExpenditure controlPubltc sector investment

program/prioritiesOther

Public enterprisesRationalization of price

structureClosure divestiture/rehabi-

litationOther

Financial sectorInterest rale levels structureRehabilitation of state or

private banksInstruments of monetary

controlOther

Other sector policiesAgricultural policyIndustrial policyEnergyTransportOther

34792

65

1010

10e

7

104

g

5

54

97424

Source International Monelary Fund'Cowers arrangements conduced by February 6,

also emphasized the importance of thefinancial viability of public investment pro-jects. The aim was to direct public investmentto those areas of the economy with thehighest production potential and to projectsthat were efficient, cost effective, and finan-cially sustainable. In many cases, the WorldBank staff assisted the authorities in carryingout a review of the public investment programwith this objective, either before or duringthe design of the adjustment program.

To allow for the planned increase in totalpublic and private investment while achievingthe external current account targets, pro-grams stressed improvement in public fi-nances and increased private savings. Overallfiscal deficits generally were expected todecline substantially over the three-yearperiod of the arrangement. This was to beachieved in most cases by a reduction in thecurrent expenditure/GDP ratio, while reve-nues were generally projected to absorb aroughly unchanged or falling share of GDP.In most programs, the strategy to induce thedesired expansion in private investment andto improve its efficiency rested on: (1)increased domestic saving; (2) an improvedinstitutional and regulatory framework; (3) arelatively liberal exchange and trade system;and (4) an appropriate structure of relativeprices.

The maximization of economic growth inthe shorter run, within the constraintsimposed by the availability of external re-sources and the need to contain inflation, wasto be achieved primarily by redressing thestructure of incentives and relative prices,both within the economy and in comparisonwith those prevailing in the rest of the world.In many programs, this required modifica-tions of the key prices in the economy,including in particular the exchange rate,interest rates, external tariffs, and prices ofitems that had been under rigid systems ofprice controls. Programs also typically at-tempted to remove other structural distor-tions, serious deficiencies in infrastructure,and supply bottlenecks where these wereidentified as major constraints on growth inthe short run.

In most programs, structural policy re-forms focused in particular on the publicsector, including tax and public enterprisereform, exchange and trade system liberaliza-tion, and the pursuit of a realistic exchangerate policy. Programs have also typicallyincluded measures (frequently designed withthe assistance of the Bank staff) aimed atimproving the prospects for growth in theagricultural sector through better infrastruc-ture (e.g., feeder roads, irrigation systems)and removal of bottlenecks that have impededagricultural growth in the past; through

Access to SAF loans was limited initially tothe 60 countries that were eligible forassistance from the Bank's concessionalloan affiliate, the International DevelopmentAssociation, when the SAF was establishedin March 1986; subsequently, Kiribati andTonga were added by the Fund's ExecutiveBoard following the incluskin of thesemembers in the list of IDA-eligible countries(Table 1). China and India, the two eligiblecountries with the largest quotas, indicatedthat, because they did not anticipate acuteor persistent balance of payments need,they did not intend to avail themselves ofassistance from the SAF.

In order to qualify for SAF loans, eligiblecountries must face protracted balance ofpayments problems, and must develop apolicy framework describing their medium-term objectives and outlining a strategy andthe policies for achieving those objectives.A loan commitment under the SAF coversa three-year program of macroeconomic andstructural adjustment: annual disbursementsare made upon approval of annual adjust-ment programs within the overall three-year framework. The amount of resourcesavailable to a qualifying member country islimited to 63.5 percent of its quota in theFund, of which 20 percent is disbursed uponapproval of the first-year arrangement, 30percent upon approval of the second-yeararrangement, and the remaining 13.5 per-cent upon approval of the third-year arrange-ment. The amount of the third-year dis-bursement will be reconsidered during thenext review of the operation of the facility.

Loans under the SAF are made onconcessional terms similar to those of theoriginal Trust Fund loans. Interest ispayable semi-annually at a rate of 1/2 of 1percent per annum and repayments aremade in ten equal semi-annual installmentsbeginninR five and one half years andfinishing ten years after the date of dis-bursement.

improvements in services and regulatorypractices (e.g., better availability of seedsand other inputs and the elimination ofrestraints and controls on marketing arrange-ments); and through enhanced incentives andpricing policies to encourage full exploitationof production possibilities (e.g., higher pro-ducer prices).

Industrial policy measures featured in amajority of structural reform efforts, primar-ily to improve the environment for industrialinvestment, in general, and production oftradables, in particular. Measures to elimi-nate institutional or regulatory barriers to


Types of measures of country

MU»1Structural measures in

three-year program* supportedby the SAF In ten countries1

Eligibility for SAF assistance

8

1987


Member Fund quota1

AfghanistanBangladeshBeninBhutanBoliviaBurkina FaaoBurmaBurundiCape VerdeCentral African RapChadComorosDjiboutiDominicaEquatorial GuineaEtfitopiaGambia. TheGhanaGrenadaGuineaGuinea-BissauGuyanaHaitiKampuchea. DemKenyaKiribatiLao. P.D.H.LesothoLiberiaMadagascarMalawiMaldivesMaliMauritaniaMozambiqueNepalNigerPakistanRwandaSt Kitts & NevisSi LuciaSt VincentSao Tome and PrincipeSenegalS terra LeoneSolomon IslandsSomaliaSfi LankaSudanTanzaniaTogoTongaUgandaVanuatuViet NamWestern SamoaYemen Arab RepublicYemen. P. DR.ZaireZambia

Subtotal

China'India*

Subtotal

Total

8672875

31 325

90.731 6

137.042.74.5

30.430.645eo4.0

18.4706171

204560

57.975

49244 1250

142.02.5

29315.)71.366.437.22.0

50833.961 037.3337

54634384.57.54.040

85.157.9

5.0442

22311697107.038.43.3

99.69.0

17686.0

43.377.2

291 0270.3

4.191.8

2.390.92,207.7

4.598.6

8.790.4

Source International Monetary FundEach Qualifying member court ry is curmntty tlgfelB

10 recerve SAF resources equivalent to 63 5 percent ofus quota in tha Fund

'China and India have mealed lhat as trwy did noiXnpan scute or persistent balance ol paymentsneed, Itwy did not intend lo make use ol SoeoaiDisbursement Account resources, wilnin wtiicn meSAF a cufrently administered.

growth have included, for example, theelimination of labor codes that acted asdisincentives to new employment, reductionof quantitative restrictions on imported inputs,and streamlining of investment approvalprocedures.

The majority of countries eligible for theSAF have not experienced acute debt-servicing difficulties, and the adjustmentprograms in these countries envisaged thatexternal debt would continue to be servicedon schedule throughout the three-year period.However, in some cases, there was a needfor rescheduling, including through the ParisClub. Where exceptional financing was judgedto be necessary, in some cases even beyondthe program period, the expectation was thatreliance on such financing would be elimi-nated, or at least substantially reduced,during the program period.

There have been some encouraging signsthat the PFP/SAF process has helped stimu-late the flow of additional resources to eligiblecountries. Paris Club creditors recentlyagreed to reschedule external debt serviceobligations of Mozambique and Uganda on thebasis of SAF arrangements (see article byThomas Klein in this issue). PFPs have alsobeen used by several countries in discussionswith bilateral aid agencies and some donorshave increased assistance to the countriesconcerned as a result of this information.Finally, the Bank has indicated that a SAFarrangement could provide the assurancesregarding the appropriate stance of macro-economic policies that it requires for itsstructural and sectoral lending programs.

Future role of the SAF

In addition to the 21 countries for whichcommitments of about SDR 1.0 billion hadbeen made under the existing SAF as ofend-October 1987, a substantial number ofother countries is expected to qualify for loansunder the facility during the last quarter of1987 and the early months of 1988. By May1988, the date by which operations under theexisting SAF will be reviewed, substantialadditional resources of the existing SAF mayhave been committed.

Only a limited amount of the financingrequirements of countries eligible for SAFassistance during 1988-90 could be met bythe amounts remaining under the existingSAF (see Table 3 for eligible countries andtheir Fund quotas). Even with generous ParisClub rescheduling, a continuation of growingbilateral aid flows, a rapid eighth replenish-ment of the Bank's IDA, and the realizationof other multilateral financing proposals, thefinancing needs of low-income countrieswould exceed current SAF resources.

Accordingly, the Fund's Managing Director

has proposed that the resources available tosupport policy programs adopted under theSAF be increased by SDR 6 billion, whichwould result in approximately a tripling of theamount originally available under the facility(see "Enhancing the Fund's Structural Adjust-ment Facility" by Charles S. Gardner, Fi-nance & Development, September 1987). Theproposal is based on an estimate of theresources that would be required during1988-90 to support strong growth-orientedadjustment programs of SAP-eligible coun-tries. The estimate was prepared on the basisof a country-by-country examination of financ-ing needs. The proposal was welcomed bythe heads of state and government of theindustrial countries meeting in Venice in June1987 and has also been supported in a numberof other international forums.

At its September 1987 meeting in Washing-ton, DC, the Fund's Interim Committeestrongly endorsed the Managing Director'sproposal and noted the complementaritybetween this initiative and those alreadytaken or under consideration elsewhere bythe international community. The Committeewelcomed the progress achieved thus far inexploring arrangements suitable to mobilizeresources on the scale envisaged and askedthe Managing Director and the ExecutiveBoard to proceed as quickly as possible tohold further consultations with potentialcontributors, with a view to concluding thesediscussions by the end of 1987. •

Robert L. Sheehy

a US citizen, is Assistant

Chief of the Development

Finance Division in the

Fund's Exchange and

Trade Relations Depart-

ment. He holds a PhD from

the University of Florida.

Michael W. Bell

from the United Kingdom,

is a Senior Economist in the

Development Finance Divi-

sion. His doctorate is from

the University of Aston

(UK) where he also taught.

Previously he was with the

Zambian Ministry of Fi-

nance.


Table 3Low-Income countries «llglbl« forih« structural adjustment facility

(In n*on» of 80R»

9


Debt Relief pot African Countries4 I V ^^^-•~~~^~--~.^J/\ j*

of

A new approach by official creditors in the Paris Club

Thomas M. Klein

"fficial debt dominates the external obliga-tions of most African countries. Only fiveSub-Saharan African countries—Congo, Coted'lvoire, Gabon, Nigeria, and Zimbabwe—owe more to commercial banks than to officialcreditors. Excluding these five countries, 80percent of the debt service of Africancountries that will fall due over 1987-90 tocreditors other than multilateral organizationsis owed to, or guaranteed by, official bilateralagencies. Since 1982, 23 Sub-Saharan Africancountries have renegotiated their officialbilateral debt through the Paris Club. TheParis Club's negotiating framework (see box),set up to deal with the debt-servicingproblems experienced by some Latin Ameri-can countries in the 1960s, has evolvedsteadily to address the more long-term debtdifficulties of many African countries.

Recently, the Paris Club has responded toone of these difficulties. Low-income Africancountries with large external debt burdenswere finding it very difficult to servicerescheduled debts on the Paris Club's stan-dard repayment terms (a maximum of ten-years' maturity and five-years' grace.) Inagreements with Mauritania, Mozambique,Somalia, Uganda, and Zaire signed betweenMay and July 1987, the Paris Club altered itsterms to provide longer relief. Creditorsagreed that Mozambique and Somalia couldrepay rescheduled debt over 20 years,including ten years of grace, and Mauritania,Uganda, and Zaire could repay over 15 years.

Further information on external debt and reschedulings is available in RecentExperience With Multilateral Official Debt Rescheduling by K. Burke Dillonand Gumersindo Oliveros, February 1987 (IMF); and World Debt Tables,1987 (World Bank), available respectively from the IMF Publications Services,Washington DC 20431, and World Bank Publications Services Unit,Washington DC 20433.

This article reviews the role of the ParisClub in the renegotiation of African debt andthe circumstances that have led to the needfor special treatment of low-income coun-tries.

The Paris Club and AfricaMost of the early work of the Paris Club

was with Latin American countries, as amultilateral forum for rescheduling exportcredits issued, guaranteed, or insured byagencies of the creditor country governments(see Table). Only a few low-income countrieshad renegotiated their external debts before1976. Each was treated as a special case, anddebts were rescheduled on highly conces-sional terms (see "Economic Aid ThroughDebt Relief by Thomas Klein in Finance &Development, September 1973).

The involvement of the Paris Club withSub-Saharan Africa began gradually. Between1976 and 1980, the Paris Club met four timeswith Zaire, twice with Sierra Leone, and onceeach with Liberia, Sudan, and Togo. But in1981 the Club had to deal with sevencountries, three of which had rescheduleddebt in 1976-80. It became evident thatfurther debt relief would be required for eachof these countries and that other countrieswould be likely to request debt relief soonthereafter.

To take account of the depth and intractabi-lity of the global debt problem in general andthe African debt problem in particular, by theearly 1980s, the Paris Club expanded thescope of its negotiations to cover all inter-governmental loans, concessional as well asnonconcessional, in addition to guaranteedexport credits. Interest was normally resche-duled along with principal. The basic periodof debt relief was about one year. If debt reliefwas extended for longer, it was normally

10 Finance & Development I December 1987


done through a series of separate agreementsor "tranches" of renegotiated debt.

African countries that sought debt relieffound the Paris Club willing to reschedule ahigh proportion of eligible debt service. In1981-82, the proportion consolidated forrescheduling ranged between 85 and 90percent. Between September 1986 and July1987, 11 of the 13 agreements consolidated100 percent of eligible payments. The non-consolidated portion was itself deferred,being payable in annual installments duringthe grace period of the consolidated portion.For low-income countries with poor balanceof payments prospects, the period over whichconsolidated debt could be repaid was ex-tended to approximately ten years, with afive-year grace period. (The terms of repay-ment in the Latin American agreements of the1960s were six-seven year maturities withone year of grace.)

Until the mid-1980s, a major principle ofParis Club negotiations was that the paymentterms of previously rescheduled debt would

be honored. After that, the Club amended itsoperations so that previously rescheduleddebt could be rescheduled again, if necessary,to finance the balance of payments.

A debtor country's request for debt reliefwas only considered if that country hadundertaken an adjustment program designedto address its payments difficulties. In prac-tice, creditors have generally required thatthe debtor have an upper credit tranchearrangement with the International MonetaryFund. The Paris Club, in effect, left responsi-bility for monitoring the economic per-formance of countries seeking debt relief tothe Fund. Meanwhile, the debtor countryundertook to secure comparable debt relieffrom other creditors.

The nature and extent of these agreementsvaried considerably. The chart shows theduration of debt-service payments coveredby Paris Club agreements between officialcreditors and Sub-Saharan African countries.Madagascar, for example, in its first agree-ment (signed in April 1981) rescheduled

arrears outstanding at the beginning of 1981and debt service due through June 1982.Debt service due from July 1982 throughDecember 1987 was rescheduled in foursuccessive agreements. Arrangements withsome other countries were more com-plicated. Debt relief for Zaire, from January1975 through May 1988, was achievedthrough nine agreements. The third debtrelief agreement for Cote d'lvoire was amulti-year agreement, one of the two agreedto date by Paris Club creditors. (The otherwas for Ecuador.) The agreement for Coted'lvoire rescheduled principal due over threeyears in three separate tranches, the propor-tion consolidated declining in each tranche.This was arranged parallel to a multi-yearagreement with commercial banks.

Repayment maturity

By the end of 1986, the very long-termnature of the debt service problems of someSub-Saharan African countries had becomeapparent. The balance of payments of the

Central African Rep.

Congo

Cite d'tvoire

Equal. Guinea

Gabon

The Gambia

Guinea

Liberia

Madagascar

Malawi

Mauritania

Mozambique

Niger

Nigena

Senegal

Sierra Leone

Somalia

Sudan

Tanzania

Togo

Uganda

Zaire

Zambia

Source VMbrtd Bank. Internationa] Finance DivisionNotes Lines indicate tne lengl n ol consoimalon periods Ooned line indicates potion of agreement cancelled Ar' indeaies arrears on tang-term debt consolidated Number tMkeMtt

nurnbor ol agreement Wsrteal bars indicate Separate tranche* Asterisks indicate rescheduling of previously rescheduled dam


D«l)t relief agreement* of Sub-Saharan African countrieswith otfteUI creditor*, 1976-July 1987


The Paris Club came into being in 1956. It is an informal official forum through which debtorcountries can seek debt relief on loans from governments and on export credits insured or

guaranteed by agencies of creditor country governments. Debt relief is extended only if the debtor

country demonstrates (normally through a Fund-supported adjustment program) that its balance

of payments situation, after the application of corrective policies, would permit it to meet itsexternal debt obligations.

While the French Treasury provides a secretariat and a senior official to act as the Club's

president, the Paris Club remains an ad hoc group without any fixed membership or organizationalcharter. Nonetheless, the participating creditor countries take careful note of precedents in dealing

with each new application for debt relief. The Club meets at the request of the country seekingto reschedule its external debt. Generally, in addition to the debtors and creditors, meetings are

attended by observers from the Fund, the World Bank, the Organisation for Economic Co-operation

and Development, and the United Nations Conference on Trade and Development.

The traditional common characteristic of creditors in Paris Ctub meetings is that each creditorcountry has a system of export credit insurance that has given rise (or threatens to give rise) to

claims on the debtor country in question. The industrialized OECD countries provide the coremembership, but other countries may be invited if they haw export credit insurance claims to be

resolved (e.g., Argentina and Mexico for the 1983 meeting on Peru, and Brazil in meetings forCosta Rica, the Dominican Republic, Gabon, Mauritania. Mozambique. Nigeria. Poland, and

Senegal).Interest as well as principal may be rescheduled. The consolidation period for debt to be

rescheduled is typically 12-18 months, and rescheduled debt is to be fully repaid in eight-ten years.

Equal semi-annual principal payments normally begin after a three-five year grace period. (As noted

in the accompanying article, grace and repayment periods have recently been extended for somelow-income debtors.) Paris Club debt consolidation periods now coincide closely with the timing

of Fund arrangements. The results of the negotiations are summed up in an Agreed Minute.After the Agreed Minute has been signed, debt relief becomes effective only when bilateral

implementing agreements have been negotiated with the individual participating signatory

countries. These establish the list of debts covered by the rescheduling and the interest chargeon rescheduled debt (the "moratorium interest rate").

Sub-Sahara"Africa

Lann Americaana irw Caribbean All o<nei All COunlne?

NO 0( No ol No ill No Ofagreements Amount agreements Amount agreements Amount agreements Amount

1956-651966-751976-87

(June)

Totals

04

66

72

0.5

19.9

20.4

75

25

37

1.21,2

18,6

21.0

213

19

34

0.736

38.3

42.6

922

112

143

1.95.3

76.8

S4.0

Source WorkJ Bank. International Finance Division

poorer countries seeking debt relief had notimproved quickly enough to enable them torepay debt rescheduled with a standardten-year maturity, even with five years ofgrace. The protracted nature of the debt-servicing problem facing these countriesreflected a variety of factors. Earlier borrow-ing—particularly when commodity priceswere strong—had often not been investedproductively and had left many countries witha burden and profile of debt that wasunsustainable. This was particularly so in anenvironment of declining commodity prices,

slow growth in world trade, and reducedcapital flows. In some cases, these problemswere compounded by the continued pursuitof inappropriate economic policies, in particu-lar inadequate agricultural production incen-tives, parastatal enterprises requiring largegovernment subsidies, and inappropriatepublic sector investments. A number ofcountries that had maintained, over a pro-longed period, programs of adjustment suffi-ciently strong to qualify for support underFund arrangements, still required virtuallycontinuous debt relief through the Paris Club.

Consequently, in 16 of the 29 follow-up ParisClub agreements signed between 1983 and1986 it was necessary to consolidate previ-ously rescheduled debt.

The June 1987 Venice economic summitmeeting of the leaders of the major industrialcountries recognized the need to improve theterms of debt relief for low-income Africancountries: "For those of the poorest coun-tries that are undertaking adjustment efforts,consideration should be given to the possibil-ity of applying lower interest rates on theirexisting debt and agreement should bereached, especially in the Paris Club, onlonger repayment and grace periods to easethe debt burden."

Paris Club agreements with Mauritania,Mozambique, and Uganda in June, and withSomalia in July reflected this new approach.An important breakthrough was the extensionof 20-year maturities with ten years' graceto Mozambique and Somalia. Mauritania andUganda received 15-year maturities (as didZaire, in May). Extended maturities are likelyto be given to other countries in a similarsituation—large debt-service obligations, poorbalance of payments prospects, and low percapita income. However, each country willbe considered eligible for exceptional treat-ment on a case-by-case basis. The Mozambique and Uganda agreements were alsoexceptional in that the Paris Club agreed toreschedule on the basis of an economicprogram supported by the Fund's new Struc-tural Adjustment Facility rather than an uppercredit tranche stand-by or extended arrange-ment.

Remaining problemsWhile the recent Paris Club actions are an

important development, many problemsremain for poor indebted countries. Longermaturities may not entirely relieve the debtproblems of a number of Sub-Saharan Africancountries. In these countries, the interestdue on rescheduled loans may need to berescheduled again for the foreseeable futureto reduce debt service to a level consistentwith the availability of external resources.Concessional loans are generally rescheduledat concessional interest rates, while commer-cial loans are rescheduled at market rates.The latter rates, currently averaging about8.5 percent per year, may cause the growthof debt to outstrip the growth of nominal GDP(in US dollar terms) in these countries, addingto the debt burden and discouraging adjust-ment and investment.

This problem is not amenable to a simplesolution. Creditor agencies are often fundedby market borrowing and do not have thediscretion of lowering moratorium interestrates. Budgetary transfers to these agencies


The Paris Club

ft ̂ ̂ ,• m ̂ fc t n ̂ i .iiM+_jftu.*iAM ni j—^* —••_*uwOQrapnicai oiBiriDuiion 01 PVD* rwivfby official eradttora, 1»9«-July 1987

(In Mkon* of US tJoHwi)


may be feasible in some countries, but maybe difficult to accomplish in most. If theresources came from existing aid budgets, itcould be at the expense of fresh economicassistance, leaving the low-income debtorcountry in a possibly worse position as fewerresources would be available to supportcurrent needs. Proposed solutions will needto take into account these constraints oncreditor agencies and governments.

Another issue is that of annual reschedulingversus bloc rescheduling (i.e., consolidatingdebt falling due in several years into a singlesum). Creditor country governments favoryear-by-year rescheduling for most countriesbecause of the need to assure appropriate andprompt domestic policy responses and be-cause of the added flexibility in adjusting theterms of the rescheduling to fit the needs ofthe country.

Debtor governments appreciate the flex-ibility of annual reschedulings but worry thatshort consolidation periods also mean shortplanning horizons and the need for virtuallycontinuous negotiations. Nearly one year is

required to negotiate the bilateral implement-ing agreements that must follow a Paris Clubagreement, and then the Club must beapproached regarding debt relief for the nextyear. Since debt relief is not assured, financialplanning must also be on a year-to-year basis.

Concluding observationsThe recent initiative by the Paris Club in

dealing with the debt of the poorer countriesis a major step in arranging debt relief onterms consistent with those countries' abilityto pay, given their difficult economic environ-ment. Since the Paris Club considers debtrelief on a case-by-case basis, it can introducefurther modifications in its procedures, asrequired. The basic approach of the ParisClub is to provide debt relief within aframework that will open the way for renewedflows of capital, including officially supportedexport credits, to developing countries—opportunities that, should they arise, mustbe used more prudently than in the past. Themajor problem in development finance todayis not solely to find solutions for unpaid debts

but also to accelerate the expansion of worldtrade. This requires an economic structurein developing countries that will enable themto respond to export opportunities, morerapid economic expansion in the industrializedcountries, and a rollback of protectionistpolicies that reduce the volume of interna-tiona

Thomas M. Kleina US citizen, is an Econo-mist in the InternationalFinance Division of theBank's International Eco-nomics Department. Edu-cated at the University ofMichigan and the LondonSchool of Economics, he

X joined the Bank staff in/ 1969.

Available for the first finfe

Social Indicators: "•*ofDevelopment 1987This comprehensive data set, available to the public for the first time,

provides the most current statistics available for more than 50 indicators ofpopulation, food, health, nutrition, the labor force, housing, education,

income, consumption, and poverty.

Data for 132 countries are listed for 1965, 1973, and the most recentestimates (usually 1986). Each country's figures are also compared with theaverage for countries with similar GNP per capita and with the next highestgroup based on GNP per capita.

New this year are two summary tables by region of average annual growthrates in population, GNP per capita, and private consumption, as well aschange in the agricultural labor force, infant mortality, calorie supply, andprimary school enrollment. These summary tables show how particularcountries compare with others in their region and how closely economicgrowth corresponds with social improvements.

Data are based on the World Bank's exclusive Social Indicator Sheets (SIDS)reporting system for 132 World Bank member developing countries. Recentreports from international agencies supplement the data. • • . ;

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INCTYI) VII:New Spirit in North-South Relations?

A report on the Seventh United Nations Conference on Trade and Development

Carlston B. Boucher and Wolfgang E. Siebeck

UJNCTAD VII took place in Geneva fromJuly 9 to August 3, 1987, under the chairman-ship of Mr. Bernard Chidzero, Minister ofFinance, Economic Planning and Develop-ment of Zimbabwe, and a former DeputySecretary-General of UNCTAD. Over 140countries were represented. The conferencewas addressed by a number of heads of stateor government. The statement by WorldBank President Barber B. Conable focusedon the requirements for renewed globalgrowth. The Fund's Managing Director,Michel Camdessus, also stressed the needto revitalize growth while providing forappropriate financing of heavily indebtedcountries.

UNCTAD conferences take place everyfour years. This meeting was held in a climateof heightened concern over the setback toeconomic recovery in most of the developingworld since the last conference in Belgradein 1983. In particular, there was disquietabout the extent to which the adjustmenteffort has been hampered by the continuingdownturn in commodity prices, stagnatingworld trade, inadequate capital flows, andpersistent debt problems in both low- andmiddle-income countries. But unlike theclimate of confrontation that characterized theBelgrade meeting, UNCTAD VII reflected aquieter, more constructive effort to identifycommon interests and to negotiate broadpolicy directions in a renewed spirit ofcooperation.

In a number of ways, UNCTAD VII brokewith tradition. It limited its agenda to foursubstantive items, and agreed on a consoli-dated conference document, the "Final Actof UNCTAD VII," in place of the variety ofseparate resolutions often adopted withoutthe full support of major industrial countries.In addition, by holding most of its committeemeetings (four committees were set up, eachdealing with one of the four substantive itemsof the agenda) in informal settings, individualcountries were able to participate actively;to some extent, this introduced a degree offlexibility to the discussion of issues thatwould not normally be possible under the rigidcountry-group approach of the UNCTADprocess. Traditionally, discussions withinUNCTAD have taken place among threegroups of countries—the developing coun-tries (Group of 77), developed market eco-nomy countries (Group B), and the socialistcountries of Eastern Europe (Group D)—andChina.

"The Final Act"

The results of UNCTAD VII are containedin the Final Act that represents the consensusof its participants. Under the new format fordiscussions, the conference aimed first atbroad agreement on an assessment of econo-mic trends and global structural change. Thiswas to serve as background against whichspecific issues could be examined and policydirections formulated. Views converged in a

number of key areas. Where agreementproved difficult, differences were identifiedand the need for follow-up consultations orrelated technical work indicated.

In reviewing the difficult problems facingthe global economy, UNCTAD VII underlinedthe growing need for adequate and wellcoordinated policy responses, especially fromthe major industrial countries, given theirweight in the world economy. While expres-sing concern with slower growth in the globaleconomy and the implications for orderlyimplementation of structural adjustment indeveloping countries, the Final Act recog-nized a number of positive developments.

Growth-oriented adjustment has been en-dorsed and the need for adequate externalsupport accepted. The major industrial market-economy countries have committed them-selves to enhancing macroeconomic policycoordination, most recently at the VeniceSummit. Japan has offered to channel aportion of its external surplus to developingcountries. There has been movement towardextending the maturities and grace periodsin rescheduling debts of low-income countriesin the Paris Club. Finally, the launching of theUruguay Round of Multilateral Trade Negoti-ations provides a major opportunity to restoreand enhance the principles of the internationaltrading system. All of these developmentswere welcomed as evidence of a growingconsensus that the revitalization of thedevelopment process should be a shared



objective of all countries, and should bevigorously pursued through renewed multila-teral cooperation.

While acknowledging the diversity of na-tional development experience and objec-tives, UNCTAD VII reflected a broad under-standing on the need for:

Major industrial countries to strengthencoordination of their policies, promote struc-tural adjustment in agriculture and industry,foster stable, sustainable, and non-inflation-ary growth, and adopt measures to enhancethe flow of public and private resources todeveloping countries; and for

Developing countries to sustain their struc-tural adjustment programs; in particular, toimprove domestic mobilization of financialresources, promote a suitable policy environ-ment for external financial resources, bothpublic and private, further enhance theefficiency of domestic and external resourceuse, and accelerate the development of theirhuman resources.

Four substantive issuesResources for development. Much of the

discussion in this area centered on the debtproblem, the adequacy of external financialresources, mobilization of domestic sav-ings, and related concern with the function-ing of the international monetary system.The incidence of net negative transfers offinancial resources in a number of develop-ing countries also received special atten-tion.

Participants took note of the far-reachingpolicy adjustment being implemented inmany developing countries, but cautionedagainst the heavy social and political costsof prolonged debt-servicing difficulties andfailure to recover growth momentum orcreditworthiness. They agreed that thedebt crisis was complex, and that anydurable solution must be sought within theframework of an integrated, cooperativegrowth-oriented strategy that takes intoaccount the particular circumstances ofeach country. Commercial banks wereencouraged to apply flexibility in restructur-ing debts and in promoting new loans toindebted countries. It was suggested thatthe debt-service burden of the poorestcountries that are undertaking structuraladjustment programs be eased throughlonger grace and repayment periods, espe-cially through arrangements within theParis Club, and possibly by lowering inter-est rates on existing debts.

No agreement could be reached, how-ever, on the appropriate forum to followup discussions on the debt problem. TheFinal Act reflected the divergence of views.It took note of the proposal by developing

countries to establish within the Interim andDevelopment Committees a Committee ofMinisters to examine the debt problem. Italso recognized the position, held mainlyamong industrial countries, that debt issuescontinue to be discussed constructively atministerial level within both of these Com-mittees, and that these efforts should beencouraged on the existing basis. Somedeveloping countries also argued for auniversal forum as the only framework inwhich an effective and equitable solution ofthe debt problem is likely to be found.

The Act underlined the consensus thatimplementation of structural adjustmentprograms requires adequate and sustainedlevels of external resources. With regardto official development assistance, it urgeddonor compliance with the recommenda-tions of the Fund-Bank Development Com-mittee's Task Force on Concessional Flows,and the internationally agreed target of 0.7percent of GNP for total ODA. Donorswere also requested to meet expeditiouslytheir commitments to the Eighth Replenish-ment of IDA and ensure that terms andconditions of IDA credits remain highlyconcessional. On nonconcessional re-sources, the Act called for a substantialgeneral increase in the World Bank's capitalto maintain the Bank's net lending at areasonable level, and for adequate reple-nishment of resources in regional develop-ment banks and the International Fund forAgricultural Development.

Underscoring the importance of policiesto enhance the mobilization of domesticresources, UNCTAD VII recognized that,while many developing countries haveadopted major policy reforms to expanddomestic savings and increase the effi-ciency of investment, efforts have beenhampered by an unfavorable external envi-ronment. It also agreed that further effortsare required by many countries to increasethe mobilization of domestic resources andimprove the quality of investments. Suchefforts would be facilitated, inter alia, byensuring an appropriate return to saversand a strengthening of institutions forinvestment finance, as well as an improve-ment in the external environment. It empha-sized the supportive role of human resourcedevelopment and the need for developingcountries to sustain investment in socialinfrastructure, particularly for health andeducation, and to safeguard the environ-ment in implementing structural adjustmentprograms.

Commodities. Developments in com-modity markets and the factors which havecombined to bring about the prolongeddownturn in commodity prices were re-

viewed. Among the measures to improvethe functioning of the commodity sector,the Conference discussed the role ofcommodity agreements, the Common Fundfor Commodities, including measures suchas diversification, processing, marketing,and distribution, as well as the need forimproved market access.

While urging measures to improve com-modity agreements, the Final Act warnedthat new ones, where they include pricestabilization mechanisms, should not try tostem long-term market trends. Followingup on UNCTAD's "Integrated Program forCommodities" (IPC) adopted at UNCTADIV in Nairobi in 1976, the Act called forpreparatory meetings on commodities notcovered so far by commodity agreements,leaving open, however, the specific formsuch future cooperation should take.

The centerpiece of the 1976 IPC is theCommon Fund. Though ratified by over 90countries (excluding the United States,which originally supported it), the associ-ated capital subscribed had, until now, fallenshort of the two thirds required to triggerimplementation. To operate its two win-dows, one financially supporting commodityagreements and the other commodity-related development measures (includingdiversification), the Common Fund, whenfully subscribed, is expected to have acapital base of $750 million. DuringUNCTAD VII (with considerable publicity)the USSR signed the Common Fund Agree-ment. With the signing and ratification by anumber of other countries, the CommonFund is now expected to come into effectsoon.

Although there are reservations, particu-larly among some industrial countries, onthe likely effectiveness of the CommonFund, broad agreement emerged on theneed for bilateral (including private invest-ment) and multilateral funds and technicalassistance to support diversification, pro-cessing, marketing, and distribution mea-sures in commodity exporting countries.Such assistance would be particularly rele-vant in the context of structural adjustment.

Regarding the question of improvedmarket access, the Final Act largely de-ferred to the Uruguay Round discussionswithin GATT on tropical products, resource-based products and agriculture, and man-dated UNCTAD to support these delibera-tions through related studies. It also re-flected the lack of consensus on the needfor a new compensatory financing facilitywhich has long been advocated by develop-ing countries, and which would complementthe Fund's facility and the European Com-munity's STABEX program.



International trade. In reviewing thecurrent situation, UNCTAD VII underlinedthe crucial role of trade in economicdevelopment and the need to expand tradeif structural adjustment is to be successfullymanaged. In its operative part, the FinalAct argued for improvement in the productscovered by the generalized system ofpreferences (GSP), while acknowledgingthat the GSP had not "fully achieved" itsobjectives.

The Act dealt at length with the potentialbenefits of the Uruguay Round of Multilate-ral Trade Negotiations (MTNs) in improv-ing market access. It restated severalcommitments from the Punta del EsteDeclaration on "standstill" and "rollback"(of tariffs and other trade restrictions), theeventual liberalization of trade in textilesand clothing and on agricultural trade andservices. In addition, it supported theproposed technical assistance contributionof the UNCTAD Secretariat to developingcountries in the MTNs in consultation withother relevant international organizations,and continuing work under UNCTAD'sexisting mandate in the field of services.Some major industrial countries, however,qualified their support for UNCTAD's rolein services, arguing that UNCTAD's man-date should not exclude others (implying inparticular, the GATT) from analyzing tradeissues in services, and that any workundertaken by UNCTAD should in no wayhold up services negotiations in the UruguayRound.

The Act did not endorse the proposal ofthe Group of 77 that UNCTAD shouldinitiate work on "a blueprint for a universal,non-discriminatory, comprehensive, stableand predictable trading system." On tradebetween the developing countries andcentrally planned Eastern European eco-nomies, it made a number of specificrecommendations to foster expansion, andcalled on socialist countries to take support-ive measures such as improving theirschemes under the Generalized System ofPreferences and providing credit on betterterms to developing countries.

Problems of the Least Developed Coun-tries. The Final Act recalled the commit-ments by both developing countries anddonor countries contained in the SubstantialNew Program of Action endorsed by theUnited Nations General Assembly in 1981,expressed disappointment that targets forgrowth and ODA flows had so far not beenmet, and urged donors to honor theircommitments. It welcomed the proposalby the Managing Director of the Fund toincrease significantly the resources of theStructural Adjustment Facility (SAF), which

together with the Eighth Replenishment ofIDA would enhance prospects for a sub-stantial increase in assistance to this groupof countries over the next few years.

Partly because of the limited adminis-trative capacity of the least developedcountries and their severe dependence onexternal concessional assistance, attentionfocused on measures to improve aid effective-ness and enhance aid coordination. The Actwelcomed the increasing cooperation be-tween the Fund and the Bank and othermultilateral financial institutions, althoughit cautioned against such cooperation lead-ing to cross-conditionality.

Special concern was expressed about thedeteriorating external debt situation in anumber of least developed countries. Theexpanded relief measures implemented bya number of creditor countries, such ascancellation of IDA debt or other equivalentmeasures, were welcomed. The Act calledon donors who had not yet done so toconsider related relief actions. It noted thatthe repayment of debt to multilateralinstitutions was part of the overall debt-service burden of the least developedcountries, and urged these institutions tocontinue to take account of such financialrequirements in their lending programs.

ConclusionsThe outcome of UNCTAD VII is encourag-

ing, particularly in view of the early uncer-tainty surrounding the Conference. Theunderstanding reached in favor of a moreflexible approach to the debt strategy was animportant development. Specifically, the Actunderlined the need for a cooperative debtstrategy which would take into account anumber of factors bearing on an individualcountry's capacity to repay its debts withoutunduly hampering growth or implementationof its structural adjustment.

On commodities, the Conference signif-icantly advanced the prospects for the imple-mentation of the Common Fund. It alsoadvocated structural adjustment in commodity-producing countries and increased investmentin diversification and processing. Such anendorsement may promote a more sys-tematic discussion of commodity problems(beyond the narrow confines of commodityagreements) within the broader context ofdevelopment policy.

There was also a discernible change in theperception of the relationship betweenUNCTAD and GATT. The new relationship,which would be based on complementarity,could alter the widely held view that GATTserves the interest of industrial countrieswhile UNCTAD promotes those of thedeveloping countries.

Many observers agreed that a majoroutcome of UNCTAD VII may well be theimpetus which the new modus operandiimparted to the development dialogue, andthe political will it fostered to make theUNCTAD process work. It was widelyrecognized that the system of discussions onthe basis of country Groups made consensusdifficult. Thus, the partial departure from therigid Group structure and the switch to asingle Conference document are two note-worthy features of UNCTAD VII.

Will the "spirit of UNCTAD VII" last?Much will depend on follow-up work inUNCTAD's committees over the next fewyears. In this connection, the recently estab-lished South Commission (a committee of 28members from developing countries ap-pointed to examine the future of North-Southrelations) may well influence the UNCTADprocess. The South Commission is expectedto provide intellectual and technical supportwhich in the past the Group of 77 soughtmainly from the UNCTAD Secretariat. Someobservers believe that, given the growingimportance of policy coordination in an increas-ingly interdependent world, this developmentcould ease UNCTAD's advocacy role andenhance its effectiveness as an intergovern-mental forum for examining interrelatedpolicy issues in trade, finance, and develop-ment. •

Carlston B. Boucherof Barbados, is an Econo-mist in the InternationalEconomic Relations Divi-sion of the Bank's StrategicPlanning and ReviewDepartment. He is a formerDeputy Special Bank Repre-sentative to the UN in NewYork.

Wolfgang E. SiebeckGerman, is the Bank's Spe-cial Representative to theUN in Geneva. He wasearlier a Division Chief inthe Europe, Middle Eastand North African Regionof the Bank, and ResidentRepresentative in Pakistan.



Adjustmentand the

Import Intensity of OutputContinued import compression in developing countries may slow down their economic growth.

Abbas Mirakhor and Peter J. Montiel

Afteter the onset of the international debtcrisis of the early 1980s, economic growth indeveloping countries slowed markedly, espe-cially in countries which are heavily indebted,which have borrowed extensively in privatefinancial markets, and have experiencedrecent debt-servicing problems. Once theaverage population growth rate of 2-3 per-cent a year is taken into account, it is clearthat real per capita incomes in these countrieshave failed to increase, or even contracted,thus far in this decade.

The challenge before the internationalcommunity is to help countries with debtdifficulties restore growth, while at the sametime promoting adjustment. The trade bal-ance of developing countries is of keyimportance to resolving these problems.Unfortunately, improvement in trade bal-ances usually has been brought about byreducing import volumes, rather than byincreasing exports. Continued reliance onimport compression promises serious reper-cussions for a country's short- and medium-term growth, unless reductions in its importintensity of growth—the rate of growth in theimport to output ratio—can exert an offset-ting influence.

Import compression for adjustmentFor capital-importing developing coun-

tries, adjustment has implied very abruptimprovements in their trade balances. As agroup, their trade balance increased from anegative $67.2 billion in 1981 to a positive

$9.9 billion just four years later. During thesame period, countries with the most severedebt problems also made impressive relativeadjustments: in particular, the 15 heavilyindebted countries increased their tradesurplus by $47.4 billion.

Trade balance adjustments of these magni-tudes became mandatory after mid-1982, asdeveloping countries faced a virtual dryingup of private capital inflows and massiveobligations on high-interest debts run up priorto 1981. An indication of the burden ofinterest payments in the adjustment processis the fact that in 1985 capital-importingcountries paid $79 billion in interest on theirdebt (14 percent of export earnings), of whichsum the 15 heavily indebted countries paidover half ($43 billion or 29 percent of exportearnings).

Factors both external and internal toindebted developing countries have workedto bring about heavy reliance on importcompression rather than export growth in theadjustment process. Chief among the exter-nal factors has been slow average growth inindustrial countries during 1982-85 and pro-tectionist policies limiting access to theirmarkets, which reduced the demand forexports. Internal factors concern chieflyinappropriate incentives for exports, includingovervalued currencies, commercial policiesdesigned to promote import substitution, andinefficient public investment.

For a significant number of developingcountries, the growth in export volume has

not kept up with its 1973-81 pace. Laggingexports coupled with adverse terms of trademovements in recent years have meant thatthe burden of trade balance adjustment hasfallen on imports. In fact, the volume ofimports for developing countries in theaggregate actually shrank during 1982-85.For the 15 heavily indebted developingcountries, imports contracted by an annualaverage of over 10 percent in real terms (seetable).

The prospect that the supply of externalfinancing will continue to be limited over themedium term implies that the large adjust-ment in the trade balance achieved by manydeveloping countries over the last four yearswill need to be sustained. Achieving thisobjective, of course, will involve some com-bination of stimulating the growth of exportsand continuing to restrain that of imports. Inview of the likely magnitude of the adjustmentin the trade balance that must be sustainedover the medium term and of currentprospects for growth in world markets, thereis little likelihood that the growth of importvolumes in indebted developing countries canbe sustained at pre-1982 rates in the foresee-able future. How, then, can desirable levelsof real income growth be restored in thesecountries?

Import intensity of growthProspective levels of economic growth in

developing countries over the next few yearscan be analyzed as the difference between



Growth rale ol GDP1

Developing countries

AfricaAsiaEuropeMiddle EastWestern Hemisphere

1967-72

6.1

5.85.26.29.55.9

1973-81

4.9

3.06.04.54.45.0

196245

2.6

0.76.62.3

-0.10.7

Growth rate cl import*2

1967-72

7.0

5.66.09.39.37.1

1973-81

8.7

7.29.64.5

15.46,2

1982-65

-1.6

-6.34.71.8

-4.5-9.1

By financial criteria

Capital importing countries 5.7 5.1 3.2 6.9 7.3 -0.5Market borrowers 6.5 5.1 1.5 8.6 8.4 -3.1Official borrowers1 3.2 3.6 2.2 2.8 3.4 -0.3Countries with recent debt-

servicing problems 5.5 4.5 0.7 5.9 6.2 -7.2Countries without debt-

servicing problems 5.8 5.6 5.7 7.7 8,4 3.8

By miscellaneous criteria

Fifteen heavily indebtedcountries 6.1 4.8 0.4 7.2 8.2 -10.1

Small low-income countries 3.0 3.5 3.2 1.2 2.4 1.0Sub-Saharan Alrica 4.6 2.4 1.4 4.7 2.5 -3.7

SOUIOB: International Monetary Fund. World Economic OuOoo*. April 1967.'Nominal GDP deflated By me GDP deflator'Nominal imports deflated by the import pnc* mdei-

two components: the rate of growth of realimports, that is, the degree of importcompression, and the rate of growth in theimport to output ratio, or the import intensityof growth. Analyzing growth from this per-spective is useful because the quantity of realimports is often perceived to be closely linkedto the level of real economic activity. This isso not only because developing countriestypically import a large proportion of inter-mediate and capital goods needed for currentproduction and future growth of productivecapacity, but also because higher real incomestypically result in increased demand forconsumer goods, including those producedabroad. Thus, continued import compressionin developing countries is likely to stunt theirshort- and medium-term growth, unlessreductions in the import intensity of growthcan exert an offsetting influence.

One way to assess the scope for such anoffsetting influence is to examine the histor-ical relationship between imports and growth.During the high-growth period of 1973-81,the rate of growth of imports for developingcountries exceeded that of output (see chart)by about 4 percentage points (see table).Furthermore, as illustrated in the chart,during these years the excess of importgrowth over output growth was, with theexception of 1975, fairly constant. This wouldsuggest that a stable relationship exists

between these variables and that the scopefor sustaining growth by reducing its importintensity may be limited.

Nevertheless, this period may have beenunusual. To assess whether this is so, it isnecessary to investigate the factors that mayhave affected the import intensity of growthduring the period. Economic theory suggeststhat the growth of import volume associatedwith a given rate of expansion of real outputdepends on a number of such factors, whichinclude the following.

Terms of trade. The more favorable acountry's terms of trade, the larger will beits domestic income. This will stimulateadditional consumer spending, which willbe reflected in larger levels of importedconsumer goods. In addition, greater profi-tability of domestic production may encour-age domestic investment, leading, in itsturn, to additional imports of capital goods.

Real interest rate. A decrease in thereal interest rate will tend to stimulatecurrent consumption, including that ofimported goods. At the same time, lowinterest rates encourage the purchase ofimported capital goods and are conduciveto the accumulation of inventories of im-ported intermediate goods.

Real exchange rate. Demand for im-ported consumer, intermediate, and capitalgoods depends on the price of such goods

relative to their domestically producedcounterparts. An appreciation of the realexchange rate is associated with a decreasein the relative price of imported vis-a-visdomestically produced goods, thus increas-ing the demand for such goods. Thestrength of this effect will depend, ofcourse, on the degree of substitutabilitybetween imports and domestically pro-duced goods.

During 1973-81, these three factorsbehaved in a way that stimulated importdemand, contributing to the "import bulge"of the period. Capital-importing developingcountries experienced very favorablechanges in their terms of trade during1973-74, an improvement which continueduntil 1982, despite a partial reversal atmid-decade. Similarly, international realinterest rates were negative during mostof 1976-79, achieving significant positivelevels towards 1981. The experience amongdeveloping countries with regard to realexchange rates was mixed. Many largecountries in Latin America and smaller onesin Africa underwent periods of significantreal exchange rate appreciation—an experi-ence which Asian countries, by and large,avoided.

Consequences of compressionThe severe import compression that has

been observed in developing countries since1982 can be attributed in part to a reductionof the rate of growth of real output and inpart to a drop in the import intensity ofoutput. The rate of growth of real imports forcapital-importing developing countries slowedfrom an average value of 8.7 percent per yearin 1973-81 to negative 1.6 percent during1982-85. This drop of 10.3 percentage pointsin the growth rate can be broken down to a3.3 percentage decrease in the output growthrate and a 7 percentage point drop in theaverage import intensity of growth. The dropin import intensity of growth is due in part toa reversal of the factors which had stimulatedan unusual increase in import intensity during1973-81. Terms of trade for capital-importingdeveloping countries had deteriorated during1982-85, with their terms of trade indexaveraging 4 percent below its 1973-81 level.International real interest rates have per-sisted at high levels, rising to an average of19.6 percentage points above their 1973-81level. In addition, in response to these factorsand to the international debt crisis, manydeveloping countries have sought to improvetheir competitiveness in world marketsthrough more flexible exchange rate policies,often with Fund and Bank support.

The combination of these factors, togetherwith the slowdown in output growth, would


Developing counlri*s: real growth of OOP and Import*, 1967-85|Av*rag* annual ptrunUg* ctitngt)


have contributed to an important contractionin import growth. But import compressionhas proceeded beyond what can be attributedto these factors. Import demand equationsincorporating these factors and estimatedduring the 1973-81 period, both for individualcountries and for groups of countries, do notproduce the expected results for 1982-85.They greatly overpredict imports, that is,they exhibit large negative residuals.

A possible explanation is that householdsand firms in developing countries have beenunable to satisfy their desired demand forimports, that is, they are no longer operatingon their "notional" demand curves for im-ports. This observation is consistent withevidence that quantitative restrictions onimports and on foreign exchange have becomemuch more severe in developing countries inthe period since the onset of the debt crisis,in spite of the well known efficiency costssuch restrictions are known to entail. Suchlosses have been judged to be less costly interms of output forgone than additionalreductions in aggregate demand. Nonethe-less, the cost of such measures is likely toincrease over time as inventories of importedmaterials are drawn down and as importedproducer and consumer durables wear out.Available evidence suggests that the draw-down on stocks has continued throughout theperiod. In 1985, for example, the contributionof stock building to growth of demand wassubstantially negative.

Other important effects

Since many of the imports of developingcountries are made up of intermediate andcapital goods, the severe import compressionof the past several years has been associatedwith reduced levels of investment and capitalformation. In fact, evidence suggests thatweakness of investment has been a mostdisturbing feature of the economic per-formance of recent years.

Retrenchment of investment, which is themain domestic counterpart to the adjustmentin the external current accounts, has oc-curred both in the public and private sectorsof developing countries. Private investmenthas been affected because import com-pression tends to reduce anticipated rates ofreturn. In addition, private investment hasbeen "crowded out" by increased pressureof public sector demand on domestic savingsto finance external debt-service payments.Public investment has been reduced primarilybecause of the political sensitivity to reduc-tions in some categories of current expendi-tures in the public sectors and, again, becauseof the massive increase in interest paymentson government debt.

The prolonged period of import com-

pression in developing countries, coupledwith the probable role that quantitativerestrictions and foreign exchange rationinghave played in producing this outcome, leadto the conclusion that a large unsatisfieddemand for imports currently exists in manydeveloping countries. Existence of thisdemand suggests that future reductions in theimport intensity of growth cannot be expectedto offset the continued slow expansion ofimport volume, thereby permitting the resump-tion of desirable levels of economic growthin developing countries. Although it wouldbe a positive step to replace quantitativerestrictions on imports and foreign exchangerationing by continued improvements in exter-nal competitiveness, such improvementscannot be expected, in the presence of asubstantial unsatisfied demand for imports atcurrent real exchange rates, to have asignificant favorable short-run impact on theimport intensity of growth under presentcircumstances.

Furthermore, realistic depreciation of thereal exchange rate in developing countriesmay not be sufficient to raise the market priceof foreign exchange to the price that is neededto clear the markets without controls. If thisis the case, then the import intensity ofgrowth is likely to increase in the short run ifquantitative restrictions and foreign exchangerationing are removed to enhance efficiencyin the allocation of foreign exchange.

Policy implications

In short, evidence that import compressionover the last several years has forcedhouseholds and firms in developing countriesoff their notional demand curves for importshas left these countries and the internationalcommunity in a policy quandary. The currentsituation has been sustainable over the shortrun to an important extent through adminis-trative controls. Because of the unsatisfieddemand for imports, relaxing these controlswithout very substantial improvement incompetitiveness could cause the short-runimport intensity of growth to overshoot itslong-run level, though the latter is more likelyto approximate the experience of the morenormal pre-1973 period than what occurredduring the "import bulge" period of 1973-81.

With this temporary overshooting of theimport intensity of growth, either the rate ofexpansion of import volume will have toincrease or the rate of economic growth mustcontinue at low levels. Increased importvolume will require some combination offaster growth in industrial countries, in-creased access to industrial country markets,or a marked reduction in international realinterest rates if import expansion in develop-ing countries is to be reconciled with only

• GrOMttl m GOP• GfWth .n .mpofts

Difference between growth rateof real output and real imports

Source International Mowlan, Fund. Waria EconomicOultoc*. Apnl 1987

marginal increases in indebtedness. If con-tinued slow growth in developing countriesis to be ruled out, the only remainingalternative is a significant expansion in thenet flow of resources to these countries fromthe international community. •

Abbas Mirakhora citizen of the IslamicRepublic of Iran, is aneconomist in the ResearchDepartment of the Fund.He has been a Professor ofEconomics at the FloridaInstitute of Technology.

Peter Montiela US citizen, has a PhD ineconomics from the Mas-sachusetts Institute of Tech-nology and did his under-graduate work at Yale Uni-versity. He is an economistin the Fund's ResearchDepartment.


Capital-importing developingcountries: growth rate of real

output and real Import*


Many consider the use of community participation inappropriate, or too difficult, in large-scaleinternationally funded projects. But in some fields it may be the key to success

Samuel Paul

^/ommunity participation—whereby peopleact in groups to influence the direction andoutcome of development programs that willaffect them—has been much discussed in thecontext of economic and social developmentwork, particularly in projects designed toimprove living standards for the poor. Somesee participation as an end in itself whileothers see it as a means to achieve ulteriorgoals such as efficiency. Whatever the goal,participation signifies the importance of the"voice" of the people in the activities thataffect them.

In this review of the World Bank's experi-ence with community participation (CP) indevelopment projects, CP is treated as aprocess by which beneficiary groups (peoplewhom the project is expected to serve)actively influence the direction and executionof projects with a view to enhancing their ownwell being. Though this is, perhaps, a limitedconcept of participation, it highlights twoimportant aspects. The first of these is thecollaborative involvement of beneficiaries inthe project. The second is the nature of CPas a process, or a force that helps to sustainthe benefits of the project after external aidstops.

ObjectivesCommunity participation can be used in

development projects to pursue four broadtypes of goals. These goals were representedin a sample of forty projects supported by theBank and using CP. These four objectivesform a hierarchy, but they may overlap inreal life.


To develop beneficiaries' ability and freedomto initiate action and thus to influence theprocesses and outcomes of development.Behind this concept of CP as a means of"empowerment" is the view that develop-ment should lead to an equitable sharing ofpower and should raise people's politicalawareness and strengths. When beneficiarieshave a decisive voice in project design andmanagement, they are moving toward empow-erment.

Only three of the projects had empower-ment as an objective, and in all of them,governments' active interest in this objectivewas critical. In the Zambia urban sites andservices project, and in a housing project inEl Salvador (through a nongovernmentalfoundation), the government was committedto a development philosophy of strengtheninglocal communities and institutions. In theseprojects, therefore, beneficiary groups (gen-erally from the poorer sections of thepopulation) were actively involved in deci-sions on project design and management.Evidence shows that CP was instrumental inforging solidarity among beneficiaries andstrengthening their ability to deal with avariety of public agencies effectively.

To build up beneficiaries organizationalcapacity. This is a more limited objective thanempowerment. Beneficiaries, for example,may be given responsibility for certain func-tions such as monitoring a project. Thisexperience may strengthen their capacity tomanage at least some aspects of the projecteven though their role in key decisions maybe limited. Beneficiaries may or may not

initiate action on their own in this case, but arole in decision making is implied.

Eight of the projects sought to build up thebeneficiaries' technical or managerial capac-ity, out of concern for the maintenance andcontinued viability of the facilities beingcreated. In Senegal, for example, the housingauthority made efforts to develop plot hold-ers' associations which were able to campaigneffectively for transport and municipal ser-vices. In the El Salvador projects, beneficiarygroups successfully maintained all the sitesunder the housing project and carried outsuch functions as the collection of dues. Insome of the population and nutrition projects,community members were organized intouser groups in order to educate themselvesand motivate potential users.

To improve the effectiveness of projects.Effectiveness refers to the degree to whichproject objectives are achieved. (For exam-ple, a project to provide urban housing maybe ineffective if it successfully builds thehouses but the prospective residents find thedesign so unfamiliar that they refuse to movein.) Even if beneficiaries are not involved indecision making, the project managementmay solicit their views on project design andimplementation. Such consultation is likely tolead to a better match between projectservices and beneficiaries' needs. (See "Lis-tening to the People" by Lawrence Salmen,Finance & Development, June 1987.)

Improving project effectiveness was anobjective of CP in ten of the forty Bankprojects. When the Tondo housing projectwas initiated in the Philippines, two local

CommunmnfinMcipation inWorld •ftS£»rojects


community organizations perceived the threatof relocation and displacement as a result ofthe new project. They sought and gained aconsultative role in the project, makingextremely useful contributions to the stra-tegies used to reorganize the slums. The fieldstudies of an experimental Indonesian nutri-tion project showed that active local organiza-tions and leadership stimulated better use ofproject services and nutritional improvementamong children. In all these cases, CP led tothe introduction of new and relevant servicesfor the beneficiaries and mobilized the re-sponse (demand) so that a better matchbetween demand and supply resulted.

To promote cost-sharing and efficiency ingeneral. CP may be used to facilitate acollective understanding and agreement oncost sharing and its enforcement. Timelycontributions from beneficiary groups canmake both the planning and implementationof projects more efficient. (Efficiency refersto the cost-effectiveness of achieving projectobjectives.) For example, sharing of informa-tion and interaction in groups may be used topromote a smoother flow of services and anoverall reduction of costs per unit of services.Information sharing and consultation withbeneficiaries are likely to be the main waysto enhance the project's efficiency. Cost-sharing was an objective in nearly half of theprojects, but it was achieved by very few.

The El Salvador housing project, whichwas successful in this respect, followed aneffective strategy to promote cost sharingwhich included the following elements:

• extensive dialogue with beneficiarygroups before implementation;

• hiring and training motivated field work-ers to follow up on individual beneficiaries;

• a monitoring system that kept track ofpayments and proposed action in case ofdefault;

• a system of investigation and negotiatedaction in cases of default;

• accessible field offices to assist benefi-ciaries with information and problem solving.

About half of the forty projects sought toimprove their efficiency (apart from costsharing) through the use of CP. Their aimwas to reduce costs by shortening oreliminating the delays in implementation thatcan arise from misunderstandings or conflictsbetween project staff and beneficiaries.

In some cases, efficiency became a concern__ because of the need for better operational

maintenance. Irrigation projects in the 1970sfocused initially on installing technology and

im hardware and did not take the participationof water users seriously until inequitable andpoor use of water and low rates of cost-recovery compelled them to do so. In thecourse of implementation, the National Irriga-

tion Authority of the Philippines, for example,realized the limitations of the purely technicalapproach and turned to the functions offarmer organizations and their development.Similarly, in the Jotlihur irrigation project inIndonesia, the initial focus was on thecompletion of civil works. It was the deteri-oration of the tertiary system of smallerdistribution channels that led the managementto set up water users' associations to improveefficiency.

Intensity of CPIt is also useful to distinguish between

different levels of intensity in CP, thoughdifferent levels may coexist in the sameproject.

By sharing information with beneficiaries,project designers and managers may facilitateindividual or collective action. In familyplanning or nutrition programs, for example,such information sharing can be critical to thesuccess of the project (see box).

When some beneficiaries are not onlyinformed, but consulted on key issues at someor all stages in a project cycle, the intensityof CP is higher. Beneficiaries can providefeedback which the project agency can takeinto account in the design and implementationstages.

Beneficiaries may have a decision makingrole, either exclusively or jointly with others,in project design and implementation. Thusslum dwellers might decide jointly withproject staff on the design for upgrading theirhousing.

When beneficiaries take the initiative inactions or decisions pertaining to a project—for example, when beneficiary groups identifya new need and decide to respond to it ontheir own, CP is at its most intense. Theirtaking the initiative is qualitatively differentfrom having the capacity to act or decide onissues or tasks proposed or assigned to them.

Projects may vary in the intensity of CP atdifferent stages in their life cycle. It iscommon to rely on information sharing andconsultation at the design stage, whenbeneficiary groups are yet to be formed, andthen to give beneficiaries a decision makingand managerial role during implementation.

Forms of organizationThe institutional devices appropriate for

achieving CP vary with the objectives at handand with the project context. They may begrouped into three categories.

Field workers of the project agency canbe used to mobilize and interact withbeneficiary groups. In agricultural andirrigation projects, field workers are oftenused to organize and interact with farmergroups. Field workers' training, orienta-

tion, and commitment to CP are keydeterminants of their effectiveness. If theysee themselves—and if beneficiaries seethem—primarily as agents of the govern-ment or donor, their ability to promote andsustain CP is likely to suffer.

Community workers or committees maybe used as mobilizers, either paid or unpaidby the agency, but with their selection androles influenced by the community. Theyare often more effective than project staffwhen more difficult objectives have to bepursued.

User groups, which entail an intenseform of participation, are viable when thenumber of beneficiaries is manageable.Whenever beneficiaries are expected toinitiate action or decision making, usergroups will probably be the most effectiveform of organization. On the other hand, ifthe only objective of using CP is to improveefficiency, field workers of the projectagency may be adequate to the task. Allinstruments and all levels of intensity cantechnically be used to pursue any of thefour broad objectives of CP describedearlier. Generally, however, the morecomplex the objective of CP, the greaterthe need for a higher level of intensity andmore powerful instruments.

Applications

The nature of the project, beneficiarycharacteristics, social traditions, the role ofelites in the community, and other relatedfactors must be assessed before decidingwhether to incorporate CP in a project.Moreover, it is worth noting at the outsetthat the use of CP in projects supported bythe Bank depends ultimately on borrowergovernments, who have the final say onwhether and how CP will feature in projectsthat the Bank supports. The Bank can act asa catalyst, influence decisions, or respond toborrower needs, but not decide for them.

This said, however, the Bank's experiencesuggests that there are four sets of circum-stances in which it is advisable to use CP ina development project.

When the main objectives of the project areto empower beneficiaries and strengthen theirorganizational capacity. CP will then benecessary in all phases of the project cycle.It should be noted, however, that localorganizations and voluntary agencies(nongovernmental organizations) may be ableto adopt and pursue these objectives morereadily than external donors. The formerhave greater and more continuous localpresence and acceptability, and are generallysmaller in scale and more flexible than largeexternal donors.

Finance & Development / December 1987 21


Health care. In an effort to bring basic services to whole populations,primary health care programs usually stress the importance ofcommunity participation so as to reach people more effectively at lowerunit costs or to stimulate a sense of involvement in and responsibilityfor improving and preserving health and well-being. Nongovernmentalorganizations have made considerable contributions in this regard,mainly by supporting and implementing innovative pilot projects andsmall-scale programs.

An impressive example is Project Piaxtla in Mexico. The projectbegan in 1963 with services provided by outside volunteers. It nowserves about ten thousand people in a hundred villages. Villagersoperate, direct, and supervise all services via a local project team in thecentral clinic and active health committees in the villages. Volunteerexpatriates organize the project and have trained local people, but thecurrent role of outsiders is now purely advisory. The project issupported by its own resources and raises funds through its own supportorganization, the Hesperian Foundation.

The use of CP can lower per-client treatment costs substantially, andcan lower overall costs through contributions of community labor andmaterials. For example, use of community volunteers in a nutritionproject supported by the World Bank in Indonesia resulted in a cost perchild served that was 60 percent lower than the cost for clinic-basedwell-baby services, and also reached a much higher proportion oflow-income people (73 percent vs 9 percent for clinic services). Onecomponent of a Bank-assisted nutrition project in Brazil providessupplementary feeding to children 4-6 years old through the regularschool system. By 1983 it covered 876,000 recipients and was largelyfinanced by the Ministry of Education. The program's costs perbeneficiary were found to be 33 to 55 percent lower than those in otherBrazilian school feeding programs largely because community coopera-tion sharply reduced food and facility costs.

Small farmers. Despite the drought affecting Zimbabwe, like therest of southern Africa, in the early 1980s smallholders managed toincrease their output of maize substantially. In 1984 they produced400,000 tons for market instead of the 150,000 expected by governmentplanners. This boost partly reflected the improved use of moderntechnology, but also was the result of the contribution of the widespreadsystem of farmer organization that had been built up, channeling inputsand extension advice to smallholders. In a district with poor soils andrainfall, there was a three-fold difference in output between membersand nonmembers. Throughout the country, farmers in farmer groupswere found to have higher yields, produce more, and sell more maizethan comparable farmers.

Rural banking. The Grameen (village) Bank of Bangladesh wasestablished in 1977 to encourage the generation of rural income andemployment. Supported by the Bangladesh Bank and seven othergovernment-owned commercial banks, by the end of 1981 the GrameenBank had extended its operations to 433 villages. By June 1982, it hadlent Tk 64 million (about $2.7 million) for over 200 different ruralactivities to about 3,000 male and nearly 2,000 female groups of thelandless, comprising over 15,000 and 10,000 members respectively.The loan recovery rate has been over 96 percent. Since lending beganin 1978, the Bank has mobilized over Tk 6 million as additional ruralsavings.

Grameen Bank workers carry on a motivational campaign to bring theBank to the people. They visit villages and explain the bank disciplineto the target population (landless and other very poor rural families)who are required to form groups of five people of roughly equal economicand social status. These groups elect their own leaders, and maintaingroup discipline through peer pressure; members can engage inindividual or group activities of their choice, but they are required tohold weekly meetings at which they are expected to deposit theirweekly installments as well as savings.

When the design of project services calls forinteraction among groups of beneficiaries as abasis for identifying their needs and prefe-rences. This is particularly relevant whenlittle is known about the type of service thatwould match beneficiaries' preferences andattributes. Examples are urban housing pro-jects and population and nutrition projects,which require collaborative actions and mutualreinforcement among beneficiaries.

When the nature of the project demandsfrequent dialogue and negotiation amongbeneficiaries and between project authoritiesand beneficiaries. The distribution of waterin an irrigation project is a good example of acase where the absence of consensus amongusers can lead to bottlenecks in the allocationand actual flow of water to the farms.Population and health projects require demandmobilization, which in turn may call forcommunity support. When beneficiaries areresponsible for cost sharing in housing pro-jects, a great deal of information sharing andnegotiation will be required.

When a part of the project operations willbe better managed by beneficiaries (with initial

external support) than by an already over-loaded or weak bureaucracy. A project mayperform better, for example, if beneficiariesare able to monitor operations or resolveconflicts. This is often evident in on-farmdevelopment, water allocation, and opera-tional maintenance in irrigation projects.

Governments and donorsWhat should governments, donors, and

other development-oriented groups do to

Samuel PaulIndian, is Adviser, Publicand Private Sector Manage-ment Division, in theBank's Country EconomicsDepartment. He was Direc-tor of the Indian Instituteof Management, Ahmeda-bad, and Chief TechnicalAdviser for ILO.

promote or foster CP, when the conditionsare appropriate?

In the context of poverty alleviation, thepolicies of many developing country govern-ments and donors have rightly emphasizedthe importance of increasing the access of thepoor to development services. It is necessaryto reinforce this concern by highlighting therole that community organizations can play inimproving the access to services of theweaker segments of the population.

Policies also need to be more explicit onthe important role of projects in developingbeneficiaries' abilities. The use of CP as ameans of sustaining project benefits, in avariety of situations, needs to be explainedand effectively communicated to donor staffas well as to borrower governments.

Governments and donors need to payspecial attention to the growing experienceof many countries with community participa-tion. Small-scale experiments are under wayin many parts of the world, at the initiativeeither of local communities or of NGOs whichact as catalysts in the process (see "Nongo-vernmental Organizations and Development"


Community Participation at Work


by Vittorio Masoni, Finance & Development,September 1985 and "Community Participa-tion in Northern Pakistan" by Graham Do-naldson, in this issue). The lessons learnedfrom these endeavors deserve to be dissemi-nated widely and the scope for scaling up oradapting the underlying strategies examined.

Even if governments and donors arepersuaded that CP is appropriate to theirprojects, they are unlikely to incorporate itin project design without guidance on how todo it. There is a need to develop anddisseminate sector-related guidelines rele-vant to specific country contexts, on the useof CP in projects.

Training can be a powerful instrument inthe dissemination process referred to above.Government training institutions could beused not only to disseminate the lessonslearned and methodologies or guidelines butalso to encourage public servants to play anactive role in CP. Government trainingstrategies could thus complement the training

efforts of NGOs and other organizations atthe grass roots.

Potential difficultiesIncorporating community participation in

development projects is not without risks.CP may raise the public's expectations, whichin some cases may be difficult to meet.Organizing beneficiaries is time-consumingand complex. Those who expect quick re-turns from this investment may be disap-pointed. Moreover, CP is apt to attract widerpublic attention than many other projectcomponents because of the emotional involve-ment it calls forth. Hence the consequencesof failure can be very visible.

To be effective, CP needs to be reinforcedby other elements in the project. Forexample, if project services are not availableto beneficiaries, perhaps because the tech-nology being used is inadequate or poorlymanaged, it is difficult to make full use of CP.Again, the benefits expected of CP may not

follow if the beneficiaries or their communityorganizers are not given the training andtechnical assistance they need.

Perhaps most important, in communitieswhere income and power are distributed veryunequally, the elites among beneficiaries tendto appropriate a disproportionate share ofproject benefits. In the design of projects, thelikely impact of inequality on CP and thepotential role of elites, if any, deserve specialattention.

CP takes time, money, and skills toorganize well and to sustain. For communitiesof the poor, the short-term opportunity costsof organization and active participation canbe quite high. For project agencies, the initialinvestment in getting CP under way meansan extra cost, though there is evidence fromthe field to show that such costs are not verylarge in relation to the total cost of a project.But where empowerment or building organiza-tional capacity are objectives, there is noother way to achieve them, regardless ofcost. •

: 4

Community Participation inNorthern Pakistan

Graham DonaldsonDivision Chief, Operations Evaluation Department, World Bank

1 he Aga Khan Rural Support Programme(AKRSP) was started in 1982 with thesupport and initial funding of the Aga KhanFoundation to foster the development of therural poor in the remote and mountainousNorthern Area of Pakistan. The project area(Gilgit, Chitral, and Baltistan) is surroundedby some of the highest mountains in theworld. It has been readily accessible by roadonly since the late 1970s, with the completionof the Karakorum Highway to China. It has apopulation of about 750,000 located in some1,030 villages. The villages are oases con-structed on river terraces, the "fans" of rivervalleys or scree from the mountains (oftenterraced), watered by ingeniously constructed

irrigation channels which tap streams flowingfrom glaciers, springs, and snow melt.

Purpose, precepts. The program's broadpurpose is to support the commercializationof subsistence villages, by creating villagelevel organizations, building productive phys-ical infrastructure, establishing deposits tofacilitate credit, and by providing produc-tion and marketing support systems andtraining. The intention is to double rural percapita incomes over a period of 10 to 15years without significantly worseningincome inequalities.

The community development model beingfollowed owes much to the work centeredon the Comilla Academy of Rural Develop-

ment in Bangladesh in the 1960s and early1970s. It has antecedents in the ruralcooperatives in nineteenth century Europeand in village organization programs in theRepublic of Korea, Taiwan (Province ofChina), and India in the 1940s and 1950s,and in Pakistan and in Sri Lanka in the1970s. It relies on the mass participation

This description of the community participationaspect of the AKRSP is drawn from "The Aga KhanRural Support Programme in Pakistan: An InterimEvaluation," a World Bank Operations EvaluationStudy, July 1987, available from the World BankPublications Sales Unit.



of villagers with relatively homogeneousresources, private ownership of cultivatedland, group management of irrigation waterand common grazing land, and cooperationfor the purpose of commercial activities.

Among its basic principles for action arethe following:

• small farmers in isolated communitiesneed a village organization to overcome thedisadvantages of small scale;

• village organizations can be used topromote genuine participation in planningand implementing development by villag-ers;

• villagers can be most effectively orga-nized initially around economic, rather thansocial, activities;

• a project to create productive physicalinfrastructure is an effective beginning forthe organization of villagers;

• in order to create such infrastructureefficiently and without exploitation, villagelabor employed should be paid;

• regular savings, however small, arean essential part of the discipline of col-lective management and finance of develop-ment;

• village organizations can be usedsuccessfully to promote formal savings andcredit by individuals and the group, pro-vided that control of the savings and creditremains with the group as a whole;

• members of village organizations canacquire the necessary organizational andtechnical skills to serve themselves and thecommunity, and for which other villagersare prepared to pay;

• the village organization following theseprinciples can take continuing responsibilityfor sustainable development of the re-sources at its disposal. A system ofcommunity participation makes it easier tofollow farming practices that are environ-mentally sound. Hill irrigation and alpinepasture management both depend on highlevels of cooperation between householdswithin villages if they are to be sustained.

Methods. The process AKRSP followsis to establish a village organization with allfamilies as participating members. Onceestablished, this organization enters intoformal partnership with AKRSP underwhich the latter provides technical andfinancial assistance in the form of programs.By late 1986, village organizations wereactive in half the villages in the programarea. Given the difficulties of terrain andseasonal conditions this is a tremendousachievement.

The VO's main function initially is thecollective planning and implementation of aproductive physical infrastructure projectfinanced by a grant but collectively chosen

by the organization. The infrastructuregreatly increases the financial return tosubsequent expenditures on the farm, andthus provides the very high incentivesneeded to encourage subsistence farmers'participation in the program. Most of theseprojects are irrigation channels or linkroads, but storage tanks, flood protectionworks, and pony tracks have also beenchosen. Engineering and costing is doneby AKRSP in conjunction with the villagers.The village organization is responsible forthe execution of the project and for payingvillagers wages for work on it.

The average grant made to these organiza-tions is about $9,000, paid in five progres-sive installments. The grant covers about40 percent of the imputed costs of theinfrastructure project, taking account of thevillage's labor contribution. (Only one grantis provided to each village; all subsequentactivities, including maintenance of theproject infrastructure, have to be financedby the village organization or throughcredit.)

All members of the VO must makesavings deposits at their regular meetings;in fact, a high proportion of wages fromwork on the infrastructure projects is beingsaved in this way. The accumulated fundsare recorded in individual passbooks but arebanked collectively. This "equity capital"is essential to the viability of the organiza-tion since it gives farm families access tothe formal rural financial system and itsvarious services at a cost well below thatof the informal credit system. The seriesof dialogues between project staff andvillage organizations to identify and plan theinfrastructure project ensures that planningis location-specific and agreed by members.In addition, through frequent meetings ofthe village as a whole, and through thepreparation of written records, the busi-ness of the village in relation to AKRSPbecomes public and open to all. In this waythe rights of less powerful members of thecommunity are protected and opportunitiesfor individuals or small groups to appropri-ate the benefits are minimized.

Originally the program had the goal ofestablishing separate women's organiza-tions independent of the VOs, but thevalidity of this approach gradually came toseem doubtful: since increased production,as well as most of the innovations beingintroduced under the program, implied anextra workload for women, there was adanger that the economic benefits from theinfrastructure projects would be limited byshortages of labor. The program now viewswomen's work as an integral part of thelocal economy and has begun to merge its

efforts for women into the overall develop-ment strategy of the village organization.In some villages, women now go freely tomeetings with men. In others, dealings arecomplicated by the purdah traditions of thedifferent sects, but the purdah problem isbeing overcome by using trained femaleAKRSP staff and training local women.

The longer-term benefit of most physicalinfrastructure projects comes only fromtheir employment as fixed capital in thebroader processes of farm production andmarketing. A whole system of productiveinfrastructure must be developed beforean investment in, say, irrigation channelsbecomes productive. The program is thusassisting technically with the on-farm devel-opment of the land and in agriculturalprocessing and marketing. It has alsoserved as intermediary between the banksand the VOs for the provision of credit forthis purpose.

Relations with government. AKRSP'saim is to leave in place local organizationsand institutions that will facilitate continuedprogress in the future. All its activities areintended to complement and enrich theactivities of government, not to duplicateor replace them.

The program's initial activities, however,are largely independent of the government.Through the combination of the VO and theinfrastructure project, and through thesequence of dialogues held between villag-ers and AKRSP management, local capacityfor self-help is built where the peoplebecome the prime agents of their owndevelopment. AKRSP catalyzes this pro-cess and offers not only a significantfinancial incentive early on, but also ex-pertise on organizational issues (how toconduct meetings, keep minutes, and main-tain accounts), technical matters (surveyingand estimating engineering work for chan-nels, link-roads and bridges), and accessto materials (opening supply lines forconstruction materials, tools, and equip-ment).

On completion of the infrastructure pro-ject, when the VO has reached a certainlevel of confidence and organizational skill,activities are begun that focus on humanresource development (training of livestockspecialists, plant production and protectionspecialists) and on the development ofsupply lines (for vaccines, pesticides, andfertilizers) that become closely linked togovernment agencies. Government officersare called upon to provide most of thetraining of village specialists in AKRSP'straining centers. This training significantlycomplements the work of governmentofficials without enough time or resources



to service remote communities. For exam-ple, AKRSP and the village organizationsrecognized the outbreak of anthrax nearGilgit in 1985 and 1986. Trained villagersrecognized the disease, AKRSP providedthe vaccine, and village livestock specialistsperformed hundreds of vaccinations underthe supervision of government veterina-rians. The government, an NGO, andvillagers cooperated in a previously impos-sible way to combat a very serious humanand animal health problem.

Program resources and costs. The pro-gram has one staff member for every 200households served, and one professional forevery 444 households. It employs 17 socialorganizers (all of whom are from theNorthern Areas and all of whom havemaster's degrees), supported by a centralteam of engineers, agriculturalists, econo-mists, and other subject specialists. Thesalaries of its 86 professional staff arecomparable to government salaries. Sup-port facilities, including jeeps, are moreabundant than in government.

The program's total funding for its firstfour years has been $8.3 million, receivedlargely in the form of grants from donors—the Aga Khan Foundation, Canadian Interna-tional Development Agency, the Nether-lands Government, Alberta Aid, US AID,the UK Overseas Development Agency,OXFAM, and the Ford Foundation. TheGovernment of Pakistan has also providedfunding.

The program's costs per beneficiary arewell within the range typical of most ruraldevelopment projects. Expenditures in thefirst four years amounted to about $192 perbeneficiary household.

Evaluation. An assessment by the WorldBank shows that after four years of opera-

tion, AKRSP is benefiting 45 percent of thepopulation in the project area. That theprogram works can be seen from the flowof apples, apricots, seed potatoes, andother produce moving down the roads andpresent in the market towns. The per-formance and achievements of AKRSP areimpressive. The attitudes of villagers havechanged from outright suspicion, alienateddisinterest, or guarded curiosity at best,to a combination of willing acceptance,enthusiastic cooperation, or unqualifiedendorsement. The achievements are largelyattributable to the effectiveness of theinstitution-building efforts at the villagelevel.

Several management principles are crit-ical to this effectiveness. First is theprinciple of primacy of the village organiza-tion, as the focal point of all AKRSPactivities. Though AKRSP is firm in keepingto the agreed conditions of the partnership,the village organization's activities aresupported but never undercut. Second isthe principle of continued attention toinnovations. For example, when one VOproposed building an irrigation tunnel ratherthan a much longer open channel it wasgiven the same support, despite the tunnel'sinherent difficulties and risks. Third, pur-suit of the first two principles is aided bythe flexibility of AKRSP as a small, indepen-dent, nongovernment organization, rela-tively free of fixed procedures, hierarchicalclearance, or internal constraints on itsactions. These features provide a degreeof flexibility and responsiveness to changingneeds that is a typical strength of NGOs.

Distinguishing features. AKRSP's10-15 year program horizon is much longer

than in more conventional rural develop-ment projects. Its early implementation

phases are institutional development, basedon popular participation, and infrastructureconstruction—and not, as in many com-parable projects, incremental productionfrom Year 2 or so. In some respects thefirst four years of AKRSP correspond to themissing years in many "delayed" ruraldevelopment plans, where there is frustra-tion as institutions are established andessential infrastructure is constructed, butproduction targets are missed. Its patientpursuit of much longer-term institutionaland social objectives may be compared withthe typical five-to-six year cut-off of se-cured funding in most other rural develop-ment projects —which can lead to frenziedconstruction of expensive physical infrastruc-ture, with too little emphasis on carefulintroduction of permanent institutional andsocial changes.

Second, village programs are plannedfrom the bottom up. The infrastructureprojects, which act as the catalyst forinstitution building, are identified by thebeneficiaries themselves with assistancefrom AKRSP. Later developments forwhich credit is supplied are similarly thevillagers' choice. Nothing is imposed on thevillage as part of an externally determinedmaster plan, and since villages have toimplement and maintain the infrastructureprojects, there is good assurance that theprojects chosen are of very high priority.This approach contrasts with that in manyother projects, which offer (or implementand then offer) a standard package of worksand improvements to rural communities,on what resembles a "take it or leave it"basis. With any insight into the nature ofhuman motivation, it is not surprising thatthe AKRSP approach has been so success-ful. •

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Determinants ofPublic Enterprise Performance

Why the economic and financial results of some companies are better than others

Mahmood A. Ayub and Sven 0. Hegstad

W hy do some public industrial enterprisesperform better than others? Why is it, forexample, that public enterprises in Brazilachieve generally better financial and econo-mic results than do their counterparts inGhana or Pakistan? Within Brazil, what is itthat makes the national iron ore company(CVRD) and the national petroleum company(PETROBRAS) much more successful than,say, the copper company (CARAIBAMETAIS) or, at the extreme, the railroadcompany? Why does India's Hindustan Ma-chine Tools remain dynamic and well-performing, whereas other public enterprisesin the same country and even in the samesubsector are far less successful?

There are two possible sets of explana-tions. The first consists of country-specificcharacteristics and accounts for differencesin performance of state industries fromcountry to country. These characteristicsinclude cultural, social, political, macroecono-mic, and institutional factors. The second setincludes factors that are specific to particularcompanies and accounts for variations inperformance of state firms within the samecountry. These variables include the extentof domestic and foreign competition, thedegree of autonomy, and the corporate andmanagerial culture.

This article is based on a study, Public IndustrialEnterprises: Determinants of Performance, pub-lished in 1986 as Volume 17 of the World Bank'sIndustry and Finance series. The study drew oncountry case studies of such enterprises in 13developing and developed countries.


The two sets of factors clearly overlap.This article, based on a study of developedand developing country public enterprises forthe World Bank (see box), deals only withthose influences on performance that arepeculiar to public firms and can be affectedby policymakers. It therefore excludes cul-tural factors, even though these can becritically important in determining the successof a public enterprise. Factors that affect theperformance of both private and publicenterprises are also beyond the scope of thediscussion. Examples would be the quality ofchief executive officers and other membersof top management, as well as the macroeco-nomic and institutional environment. Withrespect to the macroeconomic environment,this discussion assumes that governmentsintent upon improving the performance ofstate enterprises would adopt appropriatemacroeconomic policies.

To some extent, the reasons that publicindustrial enterprises generally do less wellthan their private counterparts lie in thedifferences inherent in their ownership. Theseinclude the fact that the directors of publicenterprises have no financial stake in thebusiness and probably take less interest in thedegree of its success than they would if thereverse were so. The easy recourse togovernment finance that public enterprisesenjoy greatly mutes the threat of bankruptcyand reorganization and potentially encouragescomplacency. Even when financial conditionsmight indicate cutting back payrolls, publicenterprises usually face political oppositionto such a move. Finally, decisions are a longertime in coming within public enterprises,where the decision-making process has been

made circuitous to ensure public accountabil-ity. Important as these influences may be,three other variables are equally important:the competitive environment, financial auton-omy and accountability, and the extent andmanner in which managerial autonomy andaccountability are ensured.

Degree of competitionAlthough it is impossible to make a

rigorous statistical analysis of the correlationbetween competition and performance, evi-dence from a sampling of countries stronglyindicates that those state industries that mustoperate within the more demanding, compet-itive environments tend to perform better.The biggest constraints on competition forboth public and private firms are inappropriatemacroeconomic, trade, and industrial po-licies. These include overvalued exchangerates, import quotas and bans, high tariffs,price controls, domestic content legislation(especially in automobiles and electronics),investment licensing, and regulations onentry and exit.

In addition to removing the obstacles tocompetition by changing such policies, gov-ernments can take specific steps to fostercompetition for state industries. Such com-petition can occur even among public enter-prises that are considered "strategic." A goodexample is the Heavy Mechanical Complex(HMC) in Taxila, Pakistan. The companyfaces competition from a privatized company,Ittefaq Foundry, in the production of roadrollers and sugar mills. In the construction ofcement plants it has to compete not only withimports, dutiable by 20 percent, but also withanother public enterprise, Karachi Shipyard.


In the manufacture of electrical towers,boilers, and overhead traveling cranes, itscompetition comes not only from privatefirms but also from the publicly ownedPakistan Engineering Company. In Brazil, thecompetition that the various petrochemicalsubsidiaries of PETROBRAS face is evenmore intense than that facing Pakistan'sHMC.

There is every reason to believe that LeonFestinger's social comparison theory, whichstates that people evaluate their own per-formance by comparing themselves to others,not to absolute standards, applies to publicenterprises as well. Central monitoring agen-cies should therefore make information oncomparative performance widely available.In countries where central monitoring agen-cies review performance targets for all publicenterprises, they could make a comparativeanalysis of performance available to all manag-ers of public enterprises and also widelypublicize the results. Apprehension of ad-verse publicity is an obstacle to this approach.This is obviously the case in Brazil andPakistan, where many managers of publicenterprises interviewed stressed their fearof unfavorable coverage in the national press.

Another way to subject public enterprisesto competitive pressures is to encouragethem to export. Of course, no amount ofencouragement or cajoling can make themexport if a country's macroeconomic frame-work is biased strongly the other way. Solong as the framework is appropriate, even asmall amount of exporting can make a bigdifference. The outstanding performance ofHindustan Machine Tools in India can belargely explained by the fact that, since therecession of 1966-69, it has placed greateremphasis on exporting, marketing, and profi-tability. While it exports only about 8 percentof its sales, this seems to be enough to givethe company access to new managementtechniques and new technologies.

In industries in which economies of scaleare not important, competition can be en-hanced by breaking up monolithic holdingcompanies or large enterprises. The break-upof Sweden's Statsforetag into smaller sectoralholding companies definitely increased com-petition and made public enterprises moremindful of efficiency. The present Boliviangovernment's efforts to break up the BolivianMining Corporation into several competingcompanies could be a useful experiment.Occasionally, breaking up large enterprisesdoes not necessarily produce better per-formance. For example, the break-up of theFertilizer Corporation of India in the early1970s made only a limited difference, mainlybecause the new smaller companies werehampered by the same inhospitable regula-

tions under which the large former parentcompany labored. This underscores the im-portance of the regulatory and policy environ-ment as companies try to improve theirperformance.

Financial autonomy, accountabilityOne of the main reasons that public

industry runs into financial and economicproblems stems from the fact that manage-ment and operations are not clearly separatedfrom political and strategic considerations. Inmany cases, such blurred separation resultsin diffuse and conflicting objectives, a loss ofthe managerial autonomy needed for efficientcommercial operations, and a civil serviceculture where chief executives are admini-strators rather than enterprising business-men. In such an environment, employment,investment, and pricing decisions are oftenmade without due consideration for theirfinancial consequences.

A prerequisite for improving the per-formance of state industries is to delegatemore decisionmaking to their managers. Themanagers interviewed in the study on whichthis article is based cherished financial auton-omy above all, in the sense of beingsubstantially free of the need to rely ontreasury financing. The two French steelcompanies, Usinor and Sacilor, have beenchronic loss-makers and, as a result, all majordecisions require prior approval by theirsponsoring ministry. By contrast, the essen-tially profitable companies of Saint-Gobain(now privatized) and Roussell have enjoyedthe greatest possible managerial autonomy.Similarly, in Sweden, the profitable tobaccocompany has had significantly more freedomthan the loss-making steel company, eventhough both are subsidiaries of the sameholding company, Statsforetag. Profitabilityalso largely explains the greater autonomy ofBrazil's petroleum company and iron orecompany as compared with its steel com-panies and the railroad company.

There are various requirements for finan-cial autonomy. They are greater marketdiscipline, sound financial objectives, clearsocial objectives, appropriate capital struc-ture, and greater discipline in financial rela-tions.

Greater market discipline. A combina-tion of more autonomy in financial mattersand greater exposure to markets normallycreates among public enterprise managersa stronger sense of responsibility and adeeper interest in the financial health oftheir company. In countries with robustprivate banking institutions and few implicitor explicit government guarantees, oneway of institutionalizing financial disciplineis to give state industries access to capital

markets. Independent bankers scrutinizeinvestment and financing decisions beforethey provide any loans.

Financial objectives and dividend po-licies. Sound financial management involvesspecifying a company's financial objectives,monitoring progress toward them, andholding managers accountable for the out-come. The main measures of performanceinclude return on assets or capital used,return on equity, dividend pay-out ratio,debt-to-equity ratio, and a specified levelof internal financing of large investmentprojects. In Sweden, officials of the agencythat oversees state industries argued thatthe establishment of broad financial objec-tives and enforcement of a clear dividendpolicy are even more essential in stateenterprises than in private firms. Theystressed that even though the dividendspaid by state companies are often small, theprinciple of paying them matters more thanthe amount paid.

Clear social objectives. Public enter-prises are often expected to pursue socialobjectives as diverse as redistributingincome, subsidizing particular regions of acountry, and creating or maintaining employ-ment. The problem is not in the fulfillmentof these objectives, which can often bedesirable. The problem is that multipleobjectives, together with the absence of asense of priorities, allow social goals tobecome an excuse for poor performance.When using state industries for socialpurposes, governments need to considertwo questions. Are the social objectivesbeing fulfilled? Are there no better ways ofachieving them?

There is evidence that using publicenterprises to pursue social objectives canproduce perverse results. One example canbe found in Zambia, where strict pricecontrols were imposed on refined oil andfats produced by Zambia's publicly ownedagro-based industries, which producemostly vegetable oil products, detergents,and soap. These controls were recentlylifted, but not before they had precipitatedlarge financial losses, severely undercutstaff morale, and shifted the product mixaway from oil and fats. This result wasprecisely the opposite of the government'ssocial priorities.

There are better ways of making socialchanges. A country could achieve regionallybalanced economic growth, for example,through investment encouragementschemes that consist of income and cor-porate tax credits and other measures. Alarge portion of the industrial growth of theeconomically depressed northeast regionof Brazil over the past two decades was



achieved with hardly any direct publicinvestment. Often it is more effective toallow public enterprises to operate oncommercial, profit-seeking lines and thenuse their profits to achieve such goals asincome distribution and employment crea-tion.

Appropriate capital structure policies.Several major benefits arise from using aproper mix of debt and equity, as opposedto using mostly or only debt in financingpublic enterprises. A mixture of debt andequity increases an enterprise's eligibilityto borrow in financial markets, serves as acheck against overexpansion, stimulates akeener awareness of profit, and streng-thens a company's ability to survive reces-sions.

Greater discipline and transparency infinancial relations. The accounts of themajor public enterprises in the study samplecontained a complicated maze of transfersbetween them and their central govern-ments. To improve financial discipline andto be able to record "true" financial results,governments should demand tax, duty,interest, dividend, and amortization pay-ments from public enterprises, just as theydo from private companies. Losses andnegative cash flow would then have to befinanced in a more transparent way throughnew equity loans, or other means.

If governments are to require financialdiscipline from their public enterprises,they must demonstrate the same quality intheir own financial management. They cando so in various ways. First, a governmentcommitment to pay in new equity capital aspart of a large investment project shouldconsider the risks involved and the govern-ment's own capacity to afford the capital.Second, when government payments topublic enterprises have been approved bythe appropriate ministries, they should notbe delayed and questioned by other mini-stries. Finally, surpluses from public enter-prises should not be used to financegovernment deficits. Instead, viable enter-prises should be allowed to decide how touse their surpluses, once an agreed upondividend payment has been made to thegovernment as the major shareholder.Managers who have made the profits arenormally better placed to decide upon theirproductive use than are bureaucrats moredistant from the marketplace.

Managerial issuesThe third crucial factor that distinguishes

successful public enterprises from poorlyperforming ones is a higher degree ofmanagerial autonomy and accountability in thetop performers. Experience has shown that

excessive control of and interference with theoperational decisions of public managers (ininvestment, product mix, pricing, hiring andfiring staff, wage-setting, and procurementpolicies) by the government unit with over-sight can suffocate managerial initiative andresult in a loss of accountability and costlyoperational inefficiencies. The problem ofexcessive control over operations is not onlythat the process is time-consuming for abureaucracy already stretched to the limit,but also that government officials lack thenecessary information, business perspective,and confidence to make correct and expe-ditious decisions.

Excessive political interference in theoperational matters of public enterprises canbe reduced by demarcating clearly the rolesand responsibilities of the government (own-ership role), the board of directors (strategicrole), and the management of enterprises(operational role). Further benefits will accrueby appointing professional directors withexperience relevant to their tasks and bydecentralizing appropriate powers to theboard of directors. Additional steps includeintroducing a management philosophy that isless control-oriented and procedure-bound,and more concerned with judging managerson the basis of enterprise viability and alimited set of indicators of performance.

The countries included in this study repre-sent a wide spectrum of organizationalstructures. The most decentralized are thosein Sweden and Norway. Intermediate onesare in Austria, Brazil, France, Israel, Italy,and Portugal, while highly centralized struc-tures are found in Ghana, India, Pakistan, andTunisia. A comparison of the two polarcases—Sweden and Norway on the one handand Ghana on the other—is instructive. InSweden, the Cabinet, the formal owner ofpublic enterprises, has delegated this respon-sibility to the Ministry of Industry. Within theMinistry, an operational unit, the Unit forState Participations (Unit 5), which is staffedby eight professionals, actually executes theownership role for the state industries, whichemploy 90,000 people. In Norway, wherestate industries employ 50,000 people, a staffabout the same size as Unit 5's in Swedenperforms the ownership responsibilities. TheUnit does not involve itself in the boards'decision making and does not maintain a databank of financial or operational data. The Unitdoes not keep a roster of managementcandidates, nor does it perform any manage-ment services. Executives of Unit 5 aredirectors on only a limited number of boards.They stress that in their role as boardmembers, they should not overpower theboard with their ownership role. Only in timesof crisis and when state financial support is

required does Unit 5 increase its involvementin decision making. Most public enterprisesin both countries are organized as limitedliability stock corporations and are regulatedby corporate law. Where a firm also hasprivate shareholders, the board reflects thefact.

Public enterprise managers in Ghana, bycontrast, have had little autonomy untilrecently. Their companies were responsiblefor about 60 percent of total industrialproduction in the country in 1975-81, buttheir performance has generally been poor.The Ghana Industrial Holding Company wasestablished in 1967. A central governmentbody, the State Enterprise Commission, withvarying responsibilities for development andcontrol of public enterprises, has been estab-lished and re-established three times, in1965, 1976, and 1981. In its current incarna-tion, its roles are to advise the governmenton issues involving performance, strategy,finance, and personnel, and to monitor andevaluate performance. The ownership role isvested in the sectoral minister. The lines ofresponsibility are then supposed to flowthrough the holding company's board andmanagement down to the board and manage-ment of the operating companies.

In practice, most control remains in theministries, with the sectoral ministers holdingthe key positions. For example, the Pricesand Incomes Board, which is a unit under theMinistry of Finance and Economic Planning,sets prices. The dismissal of five or moreworkers must be authorized by the Ministryof Labor (except in cases of proven criminaloffenses). Import licenses are allocated bythe Ministries of Trade and Finance, whileletters of credit for approved import licenseare the responsibility of the Bank of Ghanaand the commercial banks. Approval ofimmigrant quotas for foreign staff is handledby the Ghana Investment Center and theMinistry of Interior. Wage contracts need therecommendation of the Prices and IncomesBoard and the approval of the Ministry ofFinance.

It has been shown in state industries aswell as in large private enterprises that theworst repercussions of a poor organizationalstructure can be avoided by scrupulouslyadhering to the following principles:

• The roles and responsibilities of thegovernment, the board of directors, and themanagers of public enterprises should beclearly demarcated.

• Authority should be fully delegatedwithin the designated lines of responsibility.

• Professional directors and managerswith experience directly related to their tasksshould be hired.

• A management philosophy should be



introduced that judges managers on the basisof financial viability and a limited set of otherindicators.

Coordination within governmentOnce the government has decided how

much decision-making authority to delegate,the next question is how to organize its ownministries and specialized agencies to ensurethat decision making is effective. The multipli-city of government bodies involved in publicenterprises has frequently led to confusion,duplication, and excessive control. Super-imposed on this diffusion of responsibility isthe tendency for public enterprises to sufferthe extremes of political interference when-ever the government changes.

One way to coordinate decision making andto prevent excessive political interference isby establishing supervisory agencies of somesort. Some among such bodies perform thefull ownership role; the function of others ismore limited. Responsibilities of focal pointsperforming the full ownership role includeestablishing and amending the enterprise'scharter; hiring and firing the board ofdirectors; approving annual accounts anddividend payments; hiring auditors; and moni-toring performance. Responsibilities of suchagencies whose role is only supervisory oradvisory include defining financial and opera-tional objectives; reviewing multi-annual plansand budgets; monitoring performance on amonthly or quarterly basis; and providingtechnical assistance and training.

While it is true that one main characteristicof state industry management is excessivegovernment interference, it is equally

common to find a lack of effective control—a situation that creates uncertainty, misun-der-standing, and sometimes distrust, andthat frequently ends up in excessive interfer-ence. The dual purpose of supervisoryagencies is therefore both to protect thedirectors and management from undue polit-ical maneuvering and also to exercise effec-tive control over a limited number of vari-ables.

It is generally desirable to give supervisoryagencies some elements of the ownershiprole together with their supervisory func-tions. This is done in Austria, Italy, Norway,and Sweden. In Brazil, the success of theSpecial Secretariat for the Control of StateEnterprises (within the Ministry of Planning)depends partly on the fact that it has beengranted several powers that normally belongto the ownership role. There are strongreasons for requiring a supervisory agencyto report to more than one ministry. Theagency might be responsible to an intersecto-ral committee, for example, or operate as aquasi-governmental unit, or be attached tothe office of the prime minister or president.Such arrangements give the agency greaterstatus and ensure that it does not becomebeholden to the narrow views of a singleministry.

Establishing an institutional and policyframework that is conducive to good per-formance by state industries is a challengingtask. Because this is a relatively new area ofeconomic inquiry, and because institutionalissues loom so large, it is difficult to applystandard economic analysis. Prescriptions forthe problems of public enterprises vary

among countries, depending on factors suchas the level of economic development, theavailability of free markets, and the politicalphilosophy. In essence, however, this articlehas proposed a framework that stresses thedecentralization of decision making to thedirectors and management, and the strength-ening of their capabilities. It has not at-tempted to quantify the benefits of thisapproach. It has provided compelling exam-ples of how the performance of state indus-tries varies widely, with the variations oftenbeing attributable to the way the industriesare organized and run. •

Mahmood A. Ayuba Pakistani, joined theBank staff in 1976 and isChief of the End- User Com-puting Support Division. Hehas a BA from ManchesterUniversity (UK) and aPhD from Yale, and haspublished widely on econo-mic development.

Sven O. Hegstada Norwegian, is a SeniorIndustry Specialist in theBank's China Department.He holds an MBA fromHarvard. Before joining theBank staff in 1983, he heldexecutive positions with theSwedish private sector.

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The Decline of the IS Steel IndustryOnce dominant in the global steel market, the United States now produces about

10 percent of the world supply. A story of declining competitiveness

Lloyd R. Kenward

In the decade following World War II, theUS steel industry enjoyed a degree oftechnological superiority over its internationalcompetitors that made it the world's dominantproducer. In 1955 the United States suppliedroughly 40 percent of the world's needs andimported only 1 percent of its domesticconsumption. At that time, the steel industryprovided close to 1 percent of total civilianemployment in the United States.

By 1985, however, the US steel industryaccounted for only 11 percent of the world'ssteel; more than 25 percent of US consump-tion was imported; and the US steel industryprovided less than one-fifth of 1 percent oftotal civilian employment. This article era-mines these developments and some of thefactors that have altered the internationalcompetitive position of the US steel industry,and also reviews US trade policy on steel.

BackgroundFollowing two decades of rapid growth,

world production of steel deceleratedmarkedly in the 1970s, before falling byalmost 14 percent in 1979-82. Output in-creased a little in 1983, then rose sharply in1984 before slowing again in 1985. In 1985,however, world output remained well belowthe peak registered in 1978.

Several factors contributed to thesechanges. The annual growth of real GNP inindustrial countries declined from 5 percentin the 1960s to 3 1/4 percent in the 1970s,and to 2 percent during the six years ended1985. Also steel lost market shares to lighterweight, more malleable, and corrosion-

resistant products (such as plastics, alumi-num, and fiberglass), particularly in theautomobile industry, where efforts to im-prove the fuel efficiency of automobilesfollowed large increases in real energy pricesover 1973-84.

Since the early 1950s, trends in US steelproduction have diverged markedly from thatof worldwide production. From 1950 to 1970,production of steel by US firms increased atan average rate of 1 1/2 percent a yearcompared with average increases of 16percent in Japan, almost 10 percent for boththe developing countries and nonmarketeconomies, and 5 1/2 percent in the EuropeanCommunity (EC). As a result, the US shareof the world market fell from 47 percent in1950 to 20 percent two decades later (seeTable 1). Since 1970 US production hasdeclined by approximately 35 percent com-pared with growth in world steel productionof about 21 percent; the US share of the worldmarket fell further to 11 percent by 1985. Inthe domestic market US steel producers alsohave lost considerable ground to imports. In1955, imported steel accounted for 1 1/4percent of the apparent supply of steel in theUnited States, but this proportion has grownfairly steadily since then (see Table 2).

Trade policyAs the share of steel imports surged during

the 1960s, concern mounted in the UnitedStates regarding the impact of these importson the domestic industry. Policymakers andothers emphasized the importance of steelto the US economy, often noting its deep

sectoral linkages—both forward to othermanufacturing industries and backward to theraw materials sector—that gave it consider-ably greater prominence than the employ-ment figures, noted above, would suggest.In response to these concerns, in the summerof 1968, accord was reached with the FederalRepublic of Germany and Japan on three-year"voluntary restraint agreements," which werelater extended in a modified form for anotherthree years. While the voluntary restraintsoperated, the volume of steel imports (interms of tonnage) exceeded the ceiling in onlyone year (1971), but the restraints induced amarked change in the mix of imports towardhigh-valued products.

According to various econometric studies,the restraints lowered average annual im-ports of steel by somewhere between 3 and9 million net tons relative to the level ofimports that otherwise would have prevailed.The estimated range of price increasesassociated with the restraints is even wider—from 1 1/2 to 14 percent of domesticprices—while the estimated impact of therestraints on employment ranges from in-creases of 19,000-58,000 man-years annu-ally. Based upon the mid-point of theseranges, the estimates imply that the re-straints cost approximately $15,000 per job(in 1970 dollars) over the six-year period thatthey were in effect.

Following the end of the voluntary re-straints in 1974 and a drop in world demandduring the recession of the mid-1970s, importshare began to rise again. In response, importcontrols on specialty steel were imposed in



1976, followed in 1977 by the Carter Adminis-tration's Solomon Plan (named after UnderSecretary of the Treasury Anthony Solomon,who developed the plan), which attempted ina comprehensive way to reverse the deterio-rating prospects of the US steel industry.Although this plan suggested policy changesin several areas, its centerpiece was a"trigger price" mechanism designed to keepimported steel from being dumped on theUS market, while avoiding lengthy legalproceedings. The mechanism set a price floordetermined by Japanese costs (assumed tobe the lowest in the world) plus an 8 percentprofit margin; steel entering the US marketat prices below this trigger point was, inprinciple, subject to an immediate antidump-ing investigation.

By the late 1970s, however, US steelma-kers had become disillusioned with the triggermechanism and in 1981 began filing wide-ranging complaints against dumping and sub-sidies, alleging that producers in severalcountries would not be competitive in theUS market without significant governmenttransfers. Several of these complaints weresettled in the early 1980s through bilateralnegotiations with the EC, Mexico, and SouthAfrica. Also, in July 1983 the Presidentinvoked the "escape clause" provision toextend new protection to specialty steelproducers, increasing duties and implement-ing global quotas on certain products for fouryears.

In January 1984, US carbon steel produc-ers filed a new request for escape clauserelief. Following an investigation, the Interna-tional Trade Commission (a US body thatexamines trade complaints) recommendedthat tariffs be increased on a number ofproducts and that imports of other productsbe limited to their respective average marketshares in the 1979-81 period. The Presidentrejected the Commission's recommendationsand announced an alternative program thatsought to limit steel imports to 18 1/2 percentof US consumption, rather than the 25percent actual share in the first half of 1984.Voluntary restraints were to be negotiatedwith all major steel exporters except the EC(which was already subject to a voluntaryrestraint) and Canada. The President's planalso provided for continued rigorous enforce-ment of US laws on unfair trade, discussionswith trading partners to liberalize steel trade,and monitoring of the domestic industry'sefforts to adjust. Regarding this final provi-sion, US companies were required to reinvest"substantially" all of their net cash flow fromsteel operations in the modernization of theirindustry and to commit at least 1 percent oftheir net cash flow to retraining displacedworkers.

By December 1984, five-year restraintshad been negotiated with Australia, Brazil,Japan, the Republic of Korea, Mexico, SouthAfrica, and Spain; subsequently additionalagreements were concluded with Czechoslo-

UnitedStates

EuropeanCommunity Japan

Otherindustrialcountries

Developingcountries

Non-marvel

economies

(Percentage share)

1950

1960197019801985

47

26

20

14

11

2628231817

36

161615

4

5676

235

1012

19

31303638

Source American Iron and Steel Institute. Annual Sutistict/ Report

1955

1965

1975

1985

TOUI

1.210.4

13.5

25.2

Japan'

0.14.4666.2

EuropeanCommunity

0.8494.67.2

Developingcountries

0.20.65.3

Otntr'

0.30.91.76.0

1364 united Slates

TotalLaborOreScrapCoalOther energyOther

1980

TotalLaborOreScrapCoalOther energyOther

117441778

1526

3741355814454676

Japan

1021722

3141630

2866446—584276

Source: American Iron and Sleel Institute, Annual SisKiicil ReportIndustrial countries other man Japan and the EC, plus nonmarxel

Source Donald F Barren and Louis Schofscn.Sleet upheaval tn a Baste /ntfustry. Ballinger. Cam-Bridge. MA. USA, 19fl3. Tables 3-6

'Coid-roiied sheet is a typical product of integratedmils and has been the most important product (asmeasured by the value at shipments) ol the US steelindustry over the past three decades

vakia, Finland, Poland, and Romania. During1985, the United States and the EC extendedan earlier arrangement on finished steel andbrought it into conformity with the otheragreements. However, an understanding onEC exports of semi-finished steel was notreached, and the United States unilaterallylimited such imports in January 1986. TheEC retaliated, imposing quotas on US exportsof certain non-steel products. During thesummer of 1986 this dispute was resolved,with EC producers of semi-finished steelpermitted to export under quotas to theUnited States and with the EC eliminating itsretaliatory quotas on US exports.

Loss of competitivenessNumerous explanations have been advan-

ced to account for the decline in the UnitedStates' international competitiveness. Exces-sive wage settlements, inadequate invest-ment in new technologies, low expenditureson research and development, burdensomeenvironmental and other regulations, unfairforeign competition and, at times, unfavorableexchange rates have all been cited. Many ofthese factors probably have been reflected inthe relative cost structure of the US industry,as illustrated in Table 3.

In 1964 the operating cost of US steel millswas estimated to have been $117 per net ton


T.bl. 2Shar* of US Import* of mt«*l mill product*, by country

(Ac percent of apparent supply in the United Slates)

Tab(* 1World production of raw «to«l

T»bl« 3Comparison of ••ttmatod unit

cost of cold-rolled »h««t itool:1Unltod St*t«» and Japan

(US ooan per ion of output)


of output, roughly 15 percent above that ofJapanese producers. Allowing for the costsof entering the US market from Japan, thisdifferential was sufficient to leave US steel-makers with a small competitive advantage.This favorable position reflected the low costof raw materials and high labor productivitythat largely offset wage rates that wereapproximately five times higher in the UnitedStates than in Japan.

By 1972, the competitive position of USproducers had deteriorated to the pointwhere US unit operating costs were about40 percent higher than those of Japaneseproducers. A major improvement in laborproductivity in Japan had eliminated theearlier US advantage, and absolute declinesin the cost of iron ore to Japanese producershad reversed the competitive edge previouslyenjoyed by US steelmakers in their use ofthis input. However, abundant domesticreserves allowed US mills to retain a priceadvantage for scrap and coal, and a surge inJapanese wages during the 1960s limited theextent to which the United States' compet-itive position had been eroded.

Over the remainder of the 1970s, both USand Japanese producers experienced majorincreases in wage costs in the face of aslowdown in the growth of labor productivity.At the same time energy costs increasedmarkedly in both countries—an increase thatdirectly affected the relative cost of steel,which employs a highly energy-intensivetechnology.

Wage rates in the US steel industry, whichhave been considerably higher than those inJapan, are also high relative to those in othermanufacturing industries in the United States.In 1951, average hourly earnings for produc-tion workers in steel mills exceeded theaverage level for all manufacturing by almost25 percent; by the early 1980s this differentialhad widened to 65 percent. In response to asharp decline in steel demand, hourly earn-ings decelerated in 1982, before dropping 4percent in 1983 as a result of wage conces-sions negotiated as part of a special laboragreement. Despite this decline and relativelysmall increases during the following twoyears, in 1985 wages in the steel industrywere still almost 50 percent above theaverage for all manufacturing.

A counterpart to high wage costs has beena chronically low rate of profitability. Sincethe 1950s, the profitability of the steelindustry measured in relation to shareholders'equity has generally been below the averagefor manufacturing—in most years by a fairlywide margin. In 1982 85, US steel companiesexperienced net losses averaging almost 10percent of shareholders' equity, comparedwith net profits of 11 and 9 percent for all

manufacturing and the durable goods sector,respectively.

The slow growth of labor productivity insteelmaking in the United States relative toJapan to some extent reflects the investmentstrategies of these industries. During the1960s, investment in the basic oxygen fur-nace—a major technological advance in steel-making—proceeded at roughly the same ratein the United States as in the EC, althoughboth lagged behind Japan. The pace ofimplementation in the United States flattenedout in the mid-1970s at roughly 60 percentof the industry's total capacity. In compari-son, roughly 75 percent of steelmakingcapacity in the EC and Japan used that newfurnace technology after 1975.

The electric arc technology, which is usedto melt down scrap steel and features a morepowerful heat-creation capability than theopen hearth technology, was also introducedquite rapidly in the United States during the1960s. In contrast to the basic oxygen furnaceprocess, however, the rate of implementationof the electric arc technology was maintainedduring the following decade, probably reflect-ing the availability and low price of scrap steelin the United States and the enforcement ofantipollution legislation regarding open hearthfurnaces and other facilities that support basicoxygen furnaces.

By the early 1980s, the output of USsteelmakers using the electric arc approachexceeded that of both their Japanese andEuropean competitors. As measured by thecombined share of output accounted for bythese two advanced processes, the tech-nology of US steelmaking was at leastcomparable to that of the EC until 1975. Sincethen, however, the US steel industry hasbeen slow to shed its remaining inefficientmills and, in 1984, roughly 10 percent of USoutput still used the older, open-hearthtechnology. In contrast, the use of openhearth furnaces had been virtually eliminatedin Japan by 1970 and in the EC by 1980.

A major technological innovation in thesteel industry during the 1970s was theprocess of continuous casting, which elimi-nates intermediate products in the steelmak-ing process by pouring molten steel directlyinto a semi-finished stage. This reduceswastage, lowers energy requirements, andproduces more uniform quality. The US steelindustry was slow to adopt this new tech-nology, however. During the 13 years endingin 1984, supply capacity based on continuouscasting rose by roughly 90 million net tons inJapan and by some 80 million tons in the EC.By contrast, only 30 million tons were addedin the United States, of which roughly halfwas introduced during 1980-84. In 1984, only40 percent of the US steelmaking capacity

used continuous casting, compared with 89percent in Japan and 65 percent in the EC.

An important reason for the differencebetween the rates at which the United Statesand some of its competitors introduced moreadvanced technologies may be associatedwith the fact that since the 1950s the USindustry has tended to replace obsoletecapacity while other producers generally builtnew facilities. The significance of this differ-ence is twofold. First, installing replacementcapacity in an existing facility requires com-promises because the new capacity must fitinto an existing configuration. Consequently,the re-fitted facility is not likely to be asefficiently organized as a totally new one.Second, the financial performance of a com-pany that is replacing obsolete capacity aheadof schedule tends to be weaker than that of afirm that is building new capacity. In theformer case, debt-service costs incurred tobuild the obsolete capacity must still be meteven though the obsolete capacity is no longergenerating any income.

With these considerations in mind, it issomewhat surprising that in making long-terminvestment decisions since the 1950s, USproducers have generally opted to replaceexisting capacity rather than build totally newfacilities. The explanation appears to berelated to the difference between marginaland average costs; the marginal cost of a tonof output from an existing "inefficient" facilitygenerally appears to have been less than theaverage cost from a modern "efficient"facility. Investment decisions based on suchconsiderations would be viable over thelonger term if there is an expectation that thecost advantage of the efficient foreign produc-ers could eventually be offset by some othermeans, for example, by a protective tradepolicy.

"Mini-Mills"

While the steel industry as a whole in theUnited States has lost its dominance of theworld market, a highly competitive class ofnew firms known as "mini-mills" has emerged.These firms, which typically are relativelysmall and employ nonunionized labor, maybe differentiated from the traditional, inte-grated companies along three lines—tech-nology, markets, and products. In recentyears, the success of the mini-mills hasencouraged an expansion in their market andproduct line, which has tended to blur thedistinction between them and the older,integrated firms. Consequently, technologyis now their major distinguishing feature.

In general, the mini-mill technology useselectric furnaces to produce carbon steel fromscrap iron, which is then continuously castinto forms suitable for final products. By



contrast, the traditional firms use integratedworks—which include raw-materials facilities(such as iron ore and coal yards), coke ovens,and blast furnaces—to support basic oxygenor open hearth furnaces. The cost of thesefacilities constitutes an important share of thetotal investment in an integrated steel plant.

The markets served by mini-mills are oftenrestricted to local areas, well-endowed withconvenient sources of scrap, and sometimesinsulated by high transportation costs fromintegrated producers and foreign competition.Also the mini-mills have concentrated onrelatively simple, low-value commodities(such as wire rod and concrete reinforcingbars), leaving the more complex products—inwhich economies of scale may be significant—to the large, integrated producers.

Estimates for the cost structure in 1981 ofa major mini-mill product suggest that costsin the United States, Germany, and Japanwere approximately equal. At the same timethe costs of integrated producers in all threecountries were considerably higher, princi-pally because of higher unit labor costs. Onthis basis it appears that US mini-mills were

still competitive internationally in the early1980s and highly competitive relative to thetraditional integrated US steel producers.

Conclusion and outlookAfter dominating world steel markets

during the decade that followed WorldWar II, the US steel industry saw its globalinfluence diminish to the point where it nowaccounts for a small proportion of worldoutput. In addition, despite some form ofprotection virtually throughout 1969-86, for-eign producers have captured approximatelyone-quarter of the US domestic market. Toreverse the trends of the past three decades,the industry clearly faces major challenges.To be sure, some factors—such as the dropin the value of the US dollar since February1985—favor a substantial recovery in theinternational competitive position of the USindustry, at least relative to Japan and theEC. But the extent to which the industry—and especially the traditional, integratedproducers—will benefit from such factorsdepends ultimately upon its ability to convertthese gains into improved productivity and

reduced unit costs. For the traditional,integrated producers this probably meansfurther restructuring of their operations andoverall capacity. Without such adjustments,the older, inefficient producers will merelyfind that the form of their competition haschanged; low-cost foreign producers will havebeen replaced by efficient domestic firms,such as the mini-mills, that have successfullyexploited the opportunities open to them. •

Lloyd R. KenwardCanadian, is a senior eco-nomist in the North Ameri-can Division of the Fund'sWestern Hemisphere Depart-ment. He holds a PhD fromQueen's University,Canada, and earlierworked at the Bank ofCanada

New from the International Monetary Fund . . .

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Beyond their regulatory and monetary policy functions, central bankscan foster financial innovation and development

Anand G. Chandavarkar

M he rationale of central banking has beenargued too exclusively in terms of monetarypolicy and control of the financial system eventhough historically and logically its role in thedevelopment of the financial system precedescontrol. A central bank is commonly seen interms of its traditional functions as issuer ofcurrency, government's banker, banker'sbank, controller of credit, and a lender of lastresort. But it can also be viewed as adeveloper of the financial system and pro-moter of economic development. This articleanalyzes the developmental role of centralbanks and the problems of harmonizing it withtheir monetary, regulatory, and prudentialfunctions.

Central bank objectives may be broadlyclassified into (1) the tactical or conjuncture!objectives of short- or medium-term mone-tary stabilization, and (2) the strategic ordevelopmental objectives. Conjunctural ob-jectives are spelt out in central bank statutesin both developed and developing countries,whereas the developmental objectives nor-

This article is based on a longer paper presented to the Asian Seminar onFinancial Structure and Policies, February 8-20, 1987, Bombay. The completeversion is due for publication in The International Journal of DevelopmentBanking (published by the Industrial Credit and Investment Corporation ofIndia, Bombay).

mally are stated explicitly only in the statutesof developing country central banks. The USFederal Reserve Act is one of the fewdeveloped country exceptions. This Actenjoins the Board of Governors and theFederal Open Market Committee to "main-tain long run growth of the monetary andcredit aggregates commensurate with theeconomy's long run potential to increaseproduction, so as to promote effectively thegoals of maximum employment, stable prices,and moderate long-term interest rates" (Sec-tion 2 A. 1). It also requires that the Board ofGovernors should act "in furtherance of thepurposes of the Full Employment and Bal-anced Growth Act of 1948." In contrast, thestatutes of the two oldest central banks, theSwedish Riksbank (1668) and the Bank ofEngland (1694) do not specify any develop-mental goals.

The absence of statutory provision forpromotional activity has not inhibited centralbanks even in developed countries from usingmonetary policies to implement basic nationaleconomic goals. For instance, the SwedishRiksbank has been active in promotingprograms for priority sectors, such as hous-ing, principally through asset reserve require-ments. Similarly, the Bank of England which,historically, has taken a very broad view of itsfunctions as the "Curator of Financial Organiza-tion," pioneered in establishing specialized


Developmental Role ofCentral Banks


institutions like the Industrial and CommercialFinance Corporation, the Finance Corporationfor Industry, the Securities ManagementTrust, and the Bankers' Industrial Develop-ment Company. The central banks of Italy,the Federal Republic of Germany, Japan, andthe Netherlands have used various tech-niques such as asset reserve requirementsand lending (with or without interest sub-sidies) to priority sectors, for example,housing, agriculture, exports, small business,and underdeveloped regions. Such pro-motional techniques have been justified on thegrounds that these are typically the sectorswhich suffer disproportionately from creditrestrictions in deflationary policies.

The statutes of central banks and monetaryauthorities established in the 1970s and1980s, with the technical assistance of theInternational Monetary Fund, have specificprovisions for developmental roles (e.g.,Bhutan, Botswana, Fiji, Maldives, SolomonIslands, Swaziland, and Vanuatu). Centralbanks may, however, take a rather long timeto implement developmental objectives evenwhen they have the necessary legal mandate.For instance, the Statutory Report of theReserve Bank of India, issued in 1938,observed: "During a period of financialdevelopment such as exists in India today, itmay be desirable for Central Bank credit tobe made available in a larger number of waysand with less restrictions than when thefinancial structure is more complete...." (p.35). But it was not until the 1950s that theReserve Bank of India embarked on itsdevelopmental activities.

In addition to their role in promoting thedevelopment of the domestic financial sector,central bank operations also have a bearingon foreign borrowing by both the private andthe public sector in developing countries, thuscontributing to development by helping mon-itor and raise needed resources. While publicforeign debt is guaranteed and approved bythe ministry of finance in most developingcountries, there are instances where thesefunctions are shared with the central bank.Most private foreign borrowing is handledmainly through the central bank, but againthere are some cases where the bank sharesthe approval authority with the financeministry.

More than statutes and formal powers, itis the central bank's status, expertise, andinfluence which determine the efficacy of itspromotional activities as a regulator, innova-tor, participant, guarantor, and catalyst. Thevarious techniques of central banking likevariation of reserve ratios, open marketoperations, bank rate policy, rediscount andrefinance facilities, and selective credit con-trols can function concurrently as instruments

of monetary as well as development policy.Further, there is no one-to-one relationshipbetween monetary instruments and targetssince the same instrument can have multipletargets.

Even if a central bank adopts a passiveapproach to its developmental role, as is thecase in many developed economies, theneutrality of monetary policy is not assured.Consequently, even in the absence of formalcredit directives credit priorities will becreated. The large corporate business sectoreffectively functions as the preferred sectorfor credit in all industrialized countries evenwhen it is the primary target of creditrestrictions. Central banks in developingcountries, which have less developed financialsectors and are also more prone to financialmarket failures, need to take a more activerole in making up for these shortcomings.This can be achieved by the central bankthrough a coherent strategy of widening anddeepening financial intermediation and sav-ings mobilization, involving greater maturitytransformation, enlargement of portfoliochoices of savers and investors, reduction oftransaction and information costs, and theredress of sectoral and regional financialimbalances. These objectives cannot beachieved by the unaided efforts of the privatesector. In an underdeveloped economy thedevelopment of an adequate banking systemmust take place before it can serve as anefficient transmission mechanism for mone-tary policy.Modalities of developmental role

Financial liberalization. A liberal finan-cial system is essential for the develop-mental role of a central bank. This impliesthe elimination of "financial repression"defined as the cumulative effects of factors,such as interest rate ceilings, reserverequirements, and credit subsidies, whichtogether with inflation interact to reduceand misallocate scarce capital (see "Finan-cial Liberalization in Developing Countries"by Michael Dooley and Donald Mathieson,in Finance & Development, September1987). However, not all the instruments offinancial control are equally repressive insubstance. While interest rate ceilingsrepress savings by generating negativerates of return to savers and act asindiscriminate subsidies to borrowers, re-serve ratio requirements are a means ofprudential control of banks as well as beingone of the most efficacious traditionalinstruments of monetary policy in develop-ing countries. Developmental objectivescan also be achieved through the earmark-ing of reserves for assets of a develop-mental character (e.g., housing or publicutility bonds) or the prescription of regional

reserve requirements so as to promote thespread of banking. Non-interest bearingbank reserves may also function as animplicit tax on commercial banks and there-fore contribute partially to financial repres-sion. This drawback can, however, beremedied by payment of interest on re-serves by the central bank.

The label of financial repression applies,strictly, to the organized, relatively small,financial sector in the developing countries.The informal financial sector is beyond thepurview of the controls applicable to orga-nized banking but the central bank can playa substantial role in integrating the formaland informal financial sectors, making mon-etary and developmental policy more effec-tive.

The banking industry in most developingcountries does not enjoy great freedom ofentry, which is a necessary condition for aliberal system. Even if licensing of domesticbanking units is comparatively liberal thereare usually severe restrictions on the entryof foreign units into the financial servicessector. The organized financial sector inmost developing countries has compar-atively a high degree of concentration ofownership, leading to monopolistic andoligopolistic conditions. This poses prob-lems in maintaining an effectively compet-itive financial system. The maintenance ofa liberal financial system is, therefore, acontinuing task for the central bank.

Regulatory and prudential role

A central bank's traditional role as theregulator as well as the lender of last resortto the banking system should be supple-mented by promotional elements includingthe insurance of bank deposits and theinspection and supervision of banks to pro-mote the banking habit and financial inter-mediation by inspiring greater public confi-dence in financial institutions. Deposit insur-ance has been adopted in virtually all theindustrial countries and in some developingcountries. The rest of them rely on a lessefficient implicit policy of the central bank notto let financial institutions fail. Central banksshould, however, examine the merits andfeasibility of establishing deposit insurance forall financial intermediaries. Deposit insuranceitself has also to be flexible enough to covernew types of institutions and instruments andto ensure that coverage limits are adjustedfor inflation. From the prudential point ofview, it is far more important for a centralbank to ensure the viability of banks throughtimely and effective inspection and super-vision so that liquidity problems do not leadto insolvency.

There are other areas, too,, where the



prudential and developmental roles overlap,like the use of credit guarantees by the centralbank for specific types of lending by commer-cial banks. Many central banks have helpedto establish institutions to guarantee commer-cial bank loans to small enterprises inspecified sectors. Such guarantee institutionshave played an influential role in improvingthe access of small borrowers to organizedfinance by eliminating or de-emphasizingcollateral-based transactions. However, likeother central banking promotional activities,guarantee mechanisms also need to be keptunder review not only for appropriate mod-ification of their scope but, equally important,to hive off categories which no longer meritspecial treatment.

Advice, research, and trainingInsofar as a central bank functions as an

autonomous bureau, rather than as the agentof a principal (i.e., the government), itconstitutes a unique source of disinterestedtechnocratic advice to both the treasury anddevelopment agencies, a role most memo-rably phrased by Governor Montagu Normanof the Bank of England: "I look upon the Bankas having the unique right to offer advice andto press such advice even to the point ofnagging; but always of course subject to thesupreme authority of the government."

The advisory responsibility of a centralbank acquires an even sharper focus in adeveloping economy in regard not only to themaintenance of monetary stability by exertingits influence against governmental deficitfinancing but also in promoting an efficient anddynamic financial structure. But an effectiveadvisory role for central banks requires thatthe head of the research department haveindependent access to the governor and theboard of directors. The director of researchmay be allowed, for instance, to participatein the deliberations of the Board but withoutthe right to vote as is the case in the centralbanks of many countries. Such provisions helpsafeguard the quality of advice by notinvolving advisers in bureaucratic games of"second-guessing" the views of the powers-that-be. Unless the economic unit of a centralbank has the requisite independence inaddition to expertise, the credibility andinfluence of the central bank in its relationswith the treasury and the developmentagency can be seriously eroded. As aminimum, a central bank should have also_ effective channels of communication andrepresentation on joint organs of decision-making involving the treasury and the devel-g opment agency (e.g., for external borrow-ing). In federations it is equally important fora central bank to remain in close and constantcontact with the state governments, to

forestall and tackle problems such as therecurring overdrafts of State Governmentsto the Reserve Bank of India.

The focus of central bank research shouldbe on macroeconomic issues bearing ondevelopmental problems, as for instance, thefostering of an intermediate financial tech-nology, the regional impact of monetarypolicy, constant review of the instrumentslegislation to accommodate new financialinstruments, the scope for rediscounting oftraditional credit instruments (e.g., the hundisin India and the cek putih in Indonesia), andthe loan experience of commercial banks andcooperatives. This research could also iden-tify new techniques such as lease financing,project-related in place of collateral-orientedcredit, and development of efficient andeconomical clearing and remittance facilities.The central bank can play a positive role inoptimizing the choice of invoicing currenciesin foreign trade and payments. This choiceof invoicing currencies is made by individualsand may not necessarily be optimal from thecountry's point of view. For instance, acountry's exports may be invoiced in depre-ciating currencies whereas its imports andexternal liabilities may tend to be invoiced inappreciating currencies.

The training of financial manpower is alsoa special responsibility of central banksconsidering that this is a more criticalbottleneck in extending financial intermedia-tion than premises or equipment. Given thecosts and administrative difficulties of provid-ing such training, individual banks do not findit worth their while to offer basic training tofinancial personnel. Central bank trainingfacilities for financial personnel are an aptexample of the macroeconomic benefits ofinvestment in human capital. An importantrelated area of central bank research andpolicy is the impact of information technologyon the manpower requirements of the finan-cial sector.

Catalyst and innovatorThe promotional role of the central bank

should be guided by supply rather thandemand considerations, considering that thefinancial system, which is akin to a publicutility, is predicated on the dictum that"facilities create traffic." A central bank hasto be an innovator as well as a catalyst in itspromotional role for which there is a widevariety of techniques available (see table). Itis noteworthy that in some countries, notablyin Africa, central banks, which were initiallyassigned specific commercial and develop-ment banking tasks, are currently trying toseparate these functions, in the light ofexperience of conflict of interest with theeffective performance of basic central banking

functions of monetary policy. But a separationof functions need not preclude the centralbank's role in the creation of developmentfinance institutions through provision of partor whole of their equity or working capital andfostering the market for their securities.Although a widespread technique, it carriesthe risk that excessive dependence upon acentral bank's capital credit and profits, aswell as devices such as repurchase agree-ments for securities, are inflationary.

Development finance institutions are fre-quently financed from external sources, butconsideration should be given to providingthem with more domestic capital from genu-ine savings. Even if initially the whole or partof the capital of development finance insti-tutions is provided by the central bank,consideration should be given to the eventualdivestiture of the central bank's share in thecapital of such institutions. A good exampleof this approach is the gradual reduction ofthe Government of Bangladesh's share in thepaid-up capital of the Grameen Bank for thelandless poor from 60 percent (September1983) to 25 percent (July 1986) with acorresponding increase in the shares sub-scribed by the borrowers of the Bank.

The most favored promotional techniqueof central banks is that of preferential (i.e.,below market levels) rediscount rates andfacilities for officially approved categories ofcommercial bank credit so as to inducegreater lending to the preferred sectors orto reduce the cost of credit to sectors fromwhich the credit originates. However, the useof multiple preferential rates by the centralbank can seriously frustrate a restrictivecredit policy when such a policy is warrantedon macroeconomic grounds. Even with aunitary rediscount rate for eligible assets,banks may overextend credit to such sectors.

The subsidization of development credit,through preferential interest and rediscountrates and refinancing facilities to preferredsectors such as housing, export finance,agriculture, cottage industries, cooperatives,and small businesses, can distort the efficientallocation of credit and capital if theseschemes are open-ended and costly. Mostcentral banks do not seem to provide foreffective control and review of credit sub-sidies. Selective credit controls too raise theproblem of reconciling monetary policy withdevelopmental objectives since preferredcategories of borrowers are exempted fromcredit controls. The same trade-offs can arisein respect of open market operations whenthe requirements of credit policy may conflictwith the objective of fostering a continuous,wide, and active market for governmentsecurities through repurchase agreements,and so on. Nevertheless, as the experience



Savings policy units

Deposit insurance

Credit guarantee andinsurance schemes

Participation in capitaland management ofdevelopment institutions

Portfolio targets forpriority sectors

Differential interest rates

Preferential rediscountrates and facilities

Differential reserverequirements

Repurchase agreements

Allocation of Central Bankprofits

Open market operations

Target credit-deposit ratiosfor rural branches

Credit information bureau

Sources: National sourcesNote: The country information in this table is incomplete. It covers instruments that have been in use at one time or another.

and so on. Nevertheless, as the experienceof many developed and developing countriessuggests, it is feasible to implement aneffective credit policy while promoting thesecurities market.

Differentiated reserve requirements linkedto the composition of commercial bankportfolios or to the regional distribution ofcredit (rural or semi-urban branches) mayalso be used as a developmental device. Butthis technique, which historically has beenemployed in some Latin American countries,has not been used in Asia, Africa, or theMiddle East. An allied technique to redressthe urban bias in the financial system is thespecification of minimum credit-deposit ratiosfor rural or semi-urban offices of banks, as forinstance in Thailand where bank branches inthe undeveloped North-East region are re-quired to extend not less that 60 percent oflocal deposits for local credit and not less than20 percent for agriculture. In India a targetcredit-deposit ratio of 60 percent has beenset for branches in rural or semi-urban areas.The credit-deposit ratio, however, is not anunambiguous guideline unless further refinedto take account of population density (toestablish the ratio per capita), the man-landratio (per unit of land cultivation), and thedifferential credit absorption capacities of

regions. Moreover, such targets may notalways be attainable for reasons beyond thecontrol of the lending institutions.

ConclusionsAlthough the developmental rationale of

central banks is well grounded, it must takeinto account the possibility of failure inachieving the desired policy goals, or ofconflict between the allocation of credit andthe control of credit. In the event of suchconflict the control of credit should be its firstpriority. Central banks are also known tohave hampered financial innovation in theprivate sector through doctrinaire adherenceto legal forms. The promotional role, how-ever, needs to be critically evaluated, particu-larly the open-ended approach to creditsubsidies. Central bank profits or credit arenot substitutes for genuine savings for financ-ing development. Even when the leadershipof the central bank remains clear on itsprimary functions, it has often proven tooattractive to many governments to finance"development" objectives through the moneycreation powers of the central bank ratherthan explicitly through the budget. While astable and liberal monetary system andclimate are essential prerequisites for thepromotional role of a central bank, their

maintenance is, however, a continuing taskgiven the oligopolistic tendencies of mostfinancial systems. A central bank's pro-motional role is not merely one of passivelyadapting its techniques to suit the changingeconomic structure but of actively modifyingthe financial structure itself to promotedevelopment. The central bank is perhapsbest viewed as a catalyst and innovator, aPlatonic guardian and curator of the financialsystem rather than as a perennial participantin development finance. B

Anand G. ChandavarkarFrom India, tvas until hisrecent retirement Advisorin the Fund Treasurer'sDepartment. Educated atthe University of Bombayand the London School ofEconomics, he has pub-lished widely.


Rep. of SriInstruments Bangladesh China India Indonesia Korea Malaysia Nepal Pakistan Philippines Lanka Thailand

Promotional techniques of selected Asian central bancks


Foreign turren$J%osits in LDC§A review of this phenomenon and its implications for economic policymaking

MohamedA. El-Erian

Hn a number of developing countries, indi-viduals increasingly have been using foreigncurrencies instead of their national currenciesas a medium for current and future businesstransactions. This phenomenon, often re-ferred to as "currency or monetary substi-tution" or "dollarization," has attracted atten-tion because of its effects on the formulationand implementation of economic policies. Itsdeterminants, and some empirical estimatesof its extent, were discussed in Finance &Development earlier ("Monetary Substitutionin Developing Economies," by C.L. Ramirez-Rojas, June 1986). The present articlefocuses on the process through which anumber of governments have attempted tointegrate foreign currency-denominated do-mestic transactions in the formal economy:the introduction of officially-sanctioned for-eign currency bank accounts.

A detailed discussion of this topic is contained in anIMF Working Paper "Foreign Currency Depositsin Developing Countries: Origins and EconomicImplications" prepared by J. Dodsworth, MA.El-Erian, andD. Hammann.

The promotion of foreign currency deposits(FCDs) has tended to take place in anenvironment of widespread currency substi-tution which, in turn, has resulted from largeeconomic and financial imbalances. In suchan environment, officially-sanctioned FCDshave often been perceived by policy makersas a means of countering foreign exchangescarcity. Such deposits, however, have ap-peared to alter the structure of nationaleconomies in such a way as to affect the abilityof governments to implement fiscal, mone-tary, and exchange rate policies. This articleinvestigates these policy issues by discussingthe factors that influence the emergence ofFCDs, examining their macroeconomic implica-tions, and distinguishing their effects fromthose of widespread informal currency substi-tution.

The emergence of FCDsDeveloping countries that have experi-

enced a rapid growth in FCDs vary in termsof their economic characteristics and levelsof financial development. Such countriesinclude, for example, Argentina, Chile, Egypt,Mexico, Peru, Sudan, Uruguay, the YemenArab Republic, and Yugoslavia. In Argentina,FCDs as a share of total financial sectorliabilities to the domestic private sector rosefrom 2 percent in 1980 to 10 percent in 1985;in Peru, the ratio increased from around 31percent in 1980 to about 50 percent in 1984

while, in the Yemen Arab Republic, it rosefrom 5 percent in 1980 to around 47 percentin 1985. In Egypt, FCDs accounted for about40 percent of broad money in 1985, ascompared to some 25 percent in 1980. Asimilar trend took place in Yugoslavia duringthis period, with the share of FCDs in broadmoney in 1985 growing to 45 percent, ascompared to 26 percent at the end of 1980.

The FCDs introduced in various developingcountries have taken a number of differentforms, varying in such aspects as theirmaturity structure and the domicile of theirholders. For the purposes of this analysis,FCDs are defined to include demand, andtime and savings deposits held with thedomestic banking system by residents of thecountry, in accordance with rules governingthe source of such funds and their uses. Suchrules often place limits on the allowablesources of funds for opening and supplement-ing FCDs, as well as on the types oftransactions that legitimately can be financedby such accounts. The nature of these rules,as noted below, has a direct impact on thegrowth of FCDs, since the tighter theregulations on the flows and uses of thesedeposits, the less their attractiveness toindividuals as a store of purchasing power.

A review of country experiences indicatesthat the introduction of officially-sanctionedFCDs tends to follow increases in informal(often illegal) foreign currency holdings by



residents, domestically as well as abroad, ata time of official foreign exchange scarcity.In this context, it is important to distinguishbetween the effects of FCDs per se and theimplications of widespread currency substi-tution, which usually precedes the introduc-tion of FCDs. The preference of residents tohold substantial asset balances denominatedin foreign currency is most often the resultof inappropriate domestic policies which havegiven rise to strong inflationary pressures,and a weak external position. Such policiesare likely to be associated with growing fiscaldeficits, excessive injections of liquidity,growing exchange and trade restrictions,relatively low rates of interest, and, inparticular, overvalued exchange rates. Theseconditions lead to a reduction in the relativeattractiveness of domestic money, in termsof actual and expected financial return. In theabsence of suitable policies to tackle the majorimbalances facing the economy, the processof currency substitution accelerates, withforeign currency units increasingly replacingdomestic units both as a store of value andas a medium for commercial transactions.

In an environment of widespread currencysubstitution, a growing segment of theeconomy operates mainly in foreign currencyoutside the formal economy. As officialforeign exchange becomes scarce, this sec-ondary unregulated economy caters increas-ingly to illegal transactions-capital flight,smuggling, and false invoicing of exports andimports, among other things. With theovervaluation of the official exchange rate,even the savings of nationals working abroadare likely to be either increasingly divertedinto secondary illegal markets or kept ondeposit abroad. Against this background ofgrowing informal currency substitution, andusually in the absence of adjustment policiesthat would address the underlying economicand financial imbalances, governments mayattempt to integrate foreign currency trans-actions into the formal economy by legalizing,and even promoting, a system of FCDs. Thisaction is generally viewed as having twodistinct advantages: first, by diverting foreigncurrency transactions to the banking system,the authorities believe they can gain greatercontrol over the uses of available forefgncurrency holdings. Second, by reducing therisk to individuals associated with domesticholdings of foreign currency, governmentshope to encourage greater inflows of foreignexchange from migrant workers and res-idents with foreign money holdings, and toreduce capital flight.

The level of FCDsThe level of residents' holdings of FCDs

reflects not only the size of the foreign

exchange pool available (the notional supply),but also the perceived attractiveness oftransferring money into this new domesticbanking facility (which determines the effectivesupply). The notional supply depends on thestock of existing foreign balances held byresidents outside the formal domestic bankingsystem, both within the country and abroad,and new foreign exchange flows. This, inturn, is affected by the myriad economic,social, and political factors affecting thecountry's capacity both to earn foreignexchange and to utilize it. The effectivesupply reflects individuals' confidence in theliquidity and safety of FCDs, the relative yieldof these deposits, and the regulatory environ-ment governing their maintenance and utiliza-tion.

Since the willingness of individuals to holdFCDs depends fundamentally on their confi-dence in the domestic banking system, doubtsregarding the stability of the system, or theauthorities' commitment to maintaining theintegrity of FCDs, can weaken the induce-ment to transfer funds into these deposits.The attractiveness of the deposits dependson their yield relative to that on otheravailable assets, both domestic and foreign.Of particular importance in this respect arethe interest rates offered on these deposits,as compared to the returns obtained onalternative holdings of financial and physicaldomestic assets, and individuals' perceptionsof potential capital gains in local currencyarising from exchange rate devaluations. Thisfinancial assessment is supplemented by anevaluation of the liquidity of the deposits.Specifically, individuals' desire to hold foreignbalances in FCDs is reduced when there arelegal restrictions on their ability to transfercertain types of funds into FCDs and to usewithdrawals for various purposes; or whensuch restrictions are likely to be introduced.In some countries, for example, the author-ities have only allowed foreign exchangeproceeds obtained through officially mon-itored and sanctioned export transactions tobe placed in FCDs, and limited withdrawalsto finance imports judged to be in line withthe economy's requirements for essentialproduction inputs.

Macroeconomic implicationsThe macroeconomic impact of FCDs is felt

primarily through their effect on the extent,nature, and variability of currency substi-tution, that is, variations in the stock offoreign currency held domestically, changesin the process of financial intermediation, andtheir impact both on the pattern of creditextension and on the financial integrity of thebanking system. These factors are affectedcritically by the practices and procedures

governing the use of monetary balances,including reserve requirements, banks' pru-dential ratios, currency and maturity cover-age, and credit ceilings.

As noted earlier, residents' willingness totransfer foreign currency holdings into FCDsdepends on their perceptions of the relativereturns to such deposits (adjusted for risksand actual and expected valuation changes).The funds that are placed in these foreigncurrency accounts will be onlent by banks inaccordance with the regulatory environmentand their own prudential concerns. Thedistribution of such credit, in particularbetween the private and public sectors, willreflect the way in which credit regulationsand/or bank allocative procedures are applied.

Under regulatory systems based on aquantitative allocation of credit, such as thosethat prevail in a number of developingcountries, it is likely that the authorities'ability to influence the distribution of creditwill be greatly enhanced by the introductionof FCDs to the extent that they gain greaterinfluence over the process of intermediation

that previously occurred outside the bankingsystem. The resulting impact on the economywill depend on the extent to which the "new"credit is used for more productive operationsthan those financed earlier in the informalsector.

In addition to potentially affecting thepattern of use of funds, the introduction ofFCDs will have consequences for the portfoliostructure of the banking system. In thecontext of the new financial facility, banksshould not only strive to cover with foreigncurrency assets the deposit liabilities heldwithin the banking system-taking account ofboth maturity and currency compositionconsiderations—but they must also ensurethat the financial returns that they obtain fromonlending these deposits are large enough toservice the foreign currency liabilities. Thereare cases, for instance in Chile and Uruguay,where commercial banks have maintained abalanced position in foreign exchange bylending domestically in foreign currency butfound subsequently that borrowers wereunable to meet the loan repayment obligationsin foreign currency. In the absence ofappropriate maturity, currency, and returncoverage, the income position and balancesheet of the banking system will weaken, withpossible adverse effects on the public'sconfidence. This, in turn, could have unfavor-able consequences for the mobilization ofsavings and the efficiency of financial inter-mediation. This concern is highlighted by theimpact of a devaluation of the exchange rateon the banking system's balance sheet. Ifindividual banks have net liability positions inforeign currency, a devaluation will weaken



the banking system by causing domesticcurrency-denominated capital losses and wor-sening the banks' capital position.

Implications for economic policiesThe emergence of currency substitution

and the growth of a corresponding informalsector have been shown elsewhere in theeconomic literature to complicate the task ofmacroeconomic policy formulation. Specif-ically, studies on the policy implications ofwidespread and growing currency substi-tution have demonstrated that this phenome-non (1) adversely affects the fiscal stance bywidening the possibilities for tax avoidanceand reducing seigniorage (i.e., the commandover resources obtained by the governmentthrough the creation of high-powered money);(2) reduces the authorities' control overdomestic liquidity, both by enlarging thecomponent over which the authorities havelittle direct control and by reducing thestability of the demand for domestic money;and (3) lowers the efficacy of exchange ratepolicy by weakening the effectiveness of adevaluation designed to reduce domesticincomes and financial wealth.

The introduction of FCDs tends to bringthese policy difficulties into sharper focus.Thus, once FCDs have been introduced,foreign currency holdings by residentsbecome, in part, measurable, and theireffects on macroeconomic variables becomemore evident to both market analysts andpolicy makers. Because of their visibility,FCDs are often mistakenly identified as asource of these constraints on economicpolicies. In fact, the complications for policyformulation emerge out of the inappropriatepolicies that spawned currency substitutionin the first place, rather than as a result ofFCDs per se. In effect, the policy implicationsof the introduction of FCDs relate essentiallyto the nature and scope of the financial policiesassociated with their operation and theirimpact on the balance of resources within thebanking system.

Upon the introduction of FCDs, the author-ities may appear to have certain additionalpolicy instruments that were not availableunder a situation of informal currency substi-tution. For instance, interest rates on foreigncurrency accounts may be influenced by theauthorities, thereby supplementing the instru-ment of domestic interest rates in affectingthe mobilization and allocation of loanablefunds. In addition, in a number of countrieswith FCDs, the authorities have imposedvarious regulations determining legitimatesources and uses of funds, have accordeddifferent tax treatments for accounts, andhave implemented incentive schemes fordepositors. Notwithstanding this, however,

the ability of the authorities to affect the levelof FCDs may be limited. On the one hand,policy choices will be bounded by the need tooffer a risk- and exchange rate-adjusted rateof return that is comparable to that availableon alternative uses of funds, including thereturn to residents on deposits kept abroad.Clearly, if the FCDs are not competitive, thenfewer funds will be attracted. On the otherhand, the degree to which the authorities canpromote FCDs by making them more attrac-tive in terms of liquidity and rates of returnwill be constrained by the actual returnsearned from the use of these deposits by thebanking system or the government. Withinthese two limits, the authorities may be ableto vary the terms and conditions of theaccounts and thereby affect the level ofdeposits but still be unable to counteract thedifficulties caused by currency substitution,mentioned earlier.

The introduction of FCDs does create anadditional set of problems. These arise outof the impact of FCDs on the balance ofresources within the banking system. Byattracting foreign currency to the bankingsystem, the authorities are effectively increas-ing the gross foreign-currency-denominatedliabilities of the formal financial system.Although these liabilities are to residents, theservicing of the associated "indebtedness"and the potential requirement of repaymentof principal will be in foreign exchange. Insome cases where FCDs have been intro-duced the central banks of the countries inquestion have guaranteed the deposits. Inmost developing countries, however, thecentral bank cannot be regarded as automat-ically able to fulfill the role of lender of lastresort in foreign currency. Accordingly,governments need to pay special attention topreserving the integrity of the foreign cur-rency accounts and maintaining the confi-dence of depositors and foreign bank corre-spondents in the banking system. In particu-lar, as mentioned earlier, the funds whichbecome available through FCDs should effec-tively yield a higher return in foreign ex-

Moharned A. El-Erianfrom Egypt, is an economistin the Middle EasternDepartment of the Fund. Agraduate of Cambridge Uni-versity, he holds a doctoratefrom the University ofOxford.

change terms than the cost of servicing the"debt" to their account holders. In conditionsof foreign exchange scarcity, this will call forrestraint, in particular on the part of theauthorities, so that the resources are notused for consumption or to ease temporarilythe balance of payments situation. Moreover,it may be necessary to protect the bankingsystem against any loss of confidence bydepositors and foreign correspondents bytaking appropriate measures to ensure thatthe commercial banks maintain a balancedposition in foreign exchange, in terms of bothmaturity and currency composition.

ConclusionFCDs have been introduced in developing

countries following widespread, often illegal,currency substitution to enhance the author-ities' control over the mobilization and alloca-tion of the associated foreign exchangeresources. While the potential for growth ofsuch deposits depends on the existing cur-rency substitution and the prospects for thefurther accumulation of foreign exchangebalances by residents, the actual holdings ofFCDs will reflect the level of financial returnthat they offer, the regulatory environmentgoverning their utilization, and residents'confidence in their liquidity and safety.

While the introduction of FCDs has anumber of implications for economic manage-ment, it is important to distinguish betweentheir direct effects and those arising out ofother factors. FCDs, by affecting the struc-ture of the banking system's assets andliabilities, necessitate a corresponding adjust-ment in banking and credit practices as wellas in the regulations governing this system.However, the reduction in the effectivenessof policy measures in a number of other areas,which is often perceived to accompany theintroduction of FCDs, has other causes. It isprincipally a reflection of the deterioratingeconomic and financial conditions that spawnedcurrency substitution in the first place. Ineffect, FCDs serve essentially to rendermore transparent the changes in the underly-ing economic conditions resulting from thespread of currency substitution.

While possibly contributing to some in-crease in available foreign exchange byreducing the risk premia attached to theholding of such balances, the introduction andpromotion of FCDs is unlikely to help ineliminating the major economic and financialimbalances typically facing an economy char-acterized by widespread currency substi-tution. In fact, in the absence of fundamentalpolicy reforms, FCDs may ultimately aggra-vate foreign exchange difficulties by furtherdelaying and complicating the process ofeconomic policy adjustment. •



Alleviating Poverty underStructural Adjustment

Is there room for maneuver?

Tony Addison and Lionel DemeryOverseas Development Institute, London

^^an adjustment programs be implementedwithout inflicting undue hardships on thepoor? There are two responses to thisquestion. The first response is that anyattempt to tackle the poverty issue wouldwater down an adjustment policy package.According to this view, those hurt byadjustment can only be helped throughshort-run compensation schemes. The longer-run implications for poverty must be left tothe trickle-down effects of growth. Thesecond, more optimistic, view is that thereis potential for designing structural adjust-ment policies to assist in poverty alleviation.This can be achieved in two broad ways: first,by protecting the poor during the difficulttransitional period, and second, by safeguard-ing their interests over the long run.

Adjustment policies have profound effectson the course of economic development, andon future income distribution. A strong casecan be made for examining the distributiveimplications of adjustment policies in thelonger run.

In a recent article ("The Social Costs ofAdjustment" by Yukon Huang and PeterNicholas, Finance & Development, June1987), the short-run transitional costs ofadjustment were reviewed. This article ex-pands on this subject by tracing how adjust-ment policies can improve the welfare of thepoor over the longer run. The study on whichthis article is based identified a number ofcases in which concern about poverty allevia-tion was reflected in the design of Bank-supported adjustment programs. These exam-ples are seen as illustrative, rather thantypical, and not all these efforts fully met theirgoals. Moreover, the actions needed tosafeguard the interest of the poor duringadjustment clearly vary with the conditionswithin each country.

A policy framework

The key to achieving adjustment thatimproves prospects for the poor lies in theparticipation of the poor directly in the

adjustment effort. In so far as they areeconomically active, their primary incomes(derived from productive activities) can beraised by the adjustment process. This canbe approached in four ways. First, in thespirit of "redistribution with growth," accessto productive assets, such as land, irrigationand production inputs, can be improved.Second, rates of return on the assets of thepoor can be raised by dismantling marketdistortions, raising output prices, or loweringinput prices. Third, if the poor possess fewproductive assets other than their labor,increasing their access to employmentthrough improvements in the operation of thelabor market may be effective in raising theirincomes. Such structural measures are likelyto be sustained, and are to be preferred toshort-run emergency employment schemes.Finally, the human capital of the poor can beprotected by guaranteeing their access tohealth and education services through arestructuring of public sector resource alloca-tions. Although adjustment usually imposesgeneral fiscal restraint on government ex-penditures, it also provides an opportunity toreview and revise fiscal priorities.

Poverty groups which cannot be drawn intothe restructuring of production can only behelped by well-designed and targeted incomeor consumption transfers. The discipline ofan adjustment program frequently requires arigorous review of state expenditures as aprelude to better targeting of resources tothe poor.

These, in principle, are the approachesthat can be taken to protect the poor duringan adjustment program. In practice, theemphasis will depend on which groups consti-tute the poor in the country concerned. Ifadjustment hits the rural poor hardest,especially the landless and agricultural small-holders, more emphasis should be given toenhancing access to, and returns from,productive assets. But if adverse effects arefelt mainly by the urban poor (including thosein the informal sector, or the "new poor"comprising retrenched public- and formal-



sector workers), more attention should bepaid to improving the operation of labormarkets in providing productive employment.It should be emphasized that we are onlyconcerned with the effects of structuraladjustment on poverty, and how theseprograms can reflect this concern. Theeffects of various other measures of povertyalleviation on the achievement of structuraladjustment objectives is not dealt with here.

Access to productive assetsImproving the access of the poor to

productive assets is a particularly effectivestrategy in agriculturally based developingcountries. It can be an extremely potent forcein raising the incomes of the poor and inachieving significant output gains in line withthe objectives of structural adjustment. Thechoice of which assets to distribute (land,irrigation, credit, electricity, fertilizers, andso on) obviously depends on the specificcountry situation. Our illustrations concernland reform, and its place in structuraladjustment programs. Land reform can be akey component of structural adjustmentprograms in selected countries in meeting theobjectives of both poverty alleviation andproductivity growth. Its main limitation isthat governments are faced with enoughdifficult political choices during periods ofadjustment, and are reluctant to take on thepolitically weighty challenges presented byland reform.

A measure of land reform was attemptedin Thailand, under the first and secondstructural adjustment loans (SALs) approvedby the Bank. Higher rice prices were animportant element of Thailand's adjustmentprogram, but the government was concernedabout their adverse impact on poor people inthe rice-deficit North-East region. Manyfarmers in the North-East were illegallycultivating land designated for forestry, andthe government granted some of these "rightto farm" certificates as part of its adjustmentprogram, in an effort to increase output andincomes. The effect of these certificates onproductivity was disappointing, however. Arecent study by the Bank concluded that theland reform did not go far enough. It did notconfer full legal tenure, which would haveprovided poor squatter farmers the collateralneeded to get access to institutional credit.However, the government is currently con-sidering further initiatives on this issue.

The potentially beneficial effects of landreform (on both poverty alleviation andproductivity) also underpin the land reformprogram of the Philippine government. Underits first two phases, over a million farmersand landless agricultural workers are likelyto benefit from a program that is considered

to be a key ingredient in the Philippineeconomic recovery plan. But the inclusion ofland reform in structural adjustment pro-grams is not always a popular option formember countries. Land reform was includedin SAL discussions between the Bank andsome other countries. But it was either notimplemented subsequently, or ran into polit-ical difficulties.

Enhancing returns on assetsBank-supported adjustment programs have

frequently sought to remove distortions inproduct markets, in order to generate a moreefficient allocation of resources. This libera-lization process has inevitably changed therates of return in different sectors of theeconomy, and the incomes they generate.Since previous policy interventions benefitedbetter-off groups (especially urban entrepre-neurs and traders with political influence),their removal has generally favored thepoorer sections of the community. In anumber of countries, especially in Sub-Saharan Africa, these progressive effectshave been noticeable. In Ghana, urbanincomes (on average, much higher than ruralincomes) fell by 40 percent in real termsbetween 1980-84, while real rural incomesheld steady. The urban-rural income ratio inC6te d'lvoire fell from 3.5:1 in 1980 to 2:1 in1985. Similar trends are found in otherdeveloping countries. Rural incomes haveincreased relative to urban incomes in Brazil,Chile, and Mexico.

But not all farmers benefit from these pricechanges. Some are poorly served by infra-structure services, such as irrigation andtransportation, and are not in a position toraise output in response to improved priceincentives. For these farmers, adjustmentcan often make matters worse, since itimposes fiscal discipline on governments, andreduces available budgets for such infrastruc-ture development. Other farmers producecommodities whose prices are not raised inthe general liberalization.

If the price changes brought about byadjustment do not favor poor farmers, anumber of courses of action are available.First, an assessment should be made of thepotential for raising prices of commoditiesproduced by the poor. If that is not possible,attempts should be made to encourage poorfarmers to shift production into commoditieswith higher rates of return. Thus, forexample, the poorer food-producing farmersof northern Cote d'lvoire could be encouragedto produce more cotton in line with theincreased price incentives. Finally, moredirect attempts can be made to raise productiv-ity levels of poor farmers and hence theirrates of return. In Zimbabwe, for example,

efforts to raise incomes of poor farmers havebeen directed to increasing agricultural exten-sion services in communal farming areas.

Access to employmentFor labor-abundant countries, reallocating

resources in accordance with comparativeadvantage should maximize employment inthe long run. However, there are two mainreasons why unemployment might increasein the short run as a result of adjustment.First, the process of resource reallocation isinevitably subject to time lags. Decliningsectors (mainly nontradables) respond fairlyrapidly to adverse market signals, but theexpansion of tradables may take longer. Withsome enterprises contracting rapidly andothers expanding slowly, a transitional unem-ployment problem is likely. This transitionmay be as long as five years or so before laborutilization begins to improve.

Second, if real wages cannot be reducedsufficiently, the contraction of aggregatedemand as well as public-sector retrench-ments will raise the level of unemployment.To the extent that macroeconomic equilib-rium can be gained through structuralchanges, placing less reliance on demandrestraint, the unemployment problem wouldbe short-lived. In practice, governments notonly find themselves dealing with the unem-ployment effects of their adjustment policies,but also with high unemployment ratesresulting from past events and policies.

The Bolivian government has establishedan Emergency Social Fund which financesprojects for employment generation andsocial assistance to help those most affectedby recession and adjustment. Small-scaleemployment projects will account for 95percent of the fund's disbursements andprojects are being implemented in the areasof food and export-crop production, ruralinfrastructure, erosion control, and municipalimprovements. Social assistance projectscover low-income housing, medical and nutri-tional assistance and vocational training.Proposals for funding are put forward bymunicipalities, nongovernmental organiza-tions, and other community organizationswho then supervise the work undertaken.Aside from government finance, the schemeis supported by donor agencies, including theWorld Bank which has provided an IDA creditof $10 million. The fund forms an effectivelink between the Bank and local organizations.

In the face of severe recession in the early1980s, unemployment in Chile peaked at 19.6percent in 1982 (or 33.8 percent if those inemergency work programs are included).Among a number of programs of povertyalleviation (including a schools food program),the government has implemented emergency



employment programs, administered by mu-nicipalities under central government financ-ing. A major limitation of the programs is theirtendency to become de facto systems oftransfer payment. Even in programs wherethe work discipline was maintained, theytended to emphasise non-traded activities.To this extent they did not sufficently supportthe adjustment effort. However, stipends forthis work have been low, so that they did notact as serious disincentives to counteract theresource reallocation required by adjustment.In a survey conducted by the University ofChile, 70 percent of those employed in theschemes were willing to work in another jobif one were available.

When adjustment incorporates major re-source transfers between sectors, a potentialexists for minimizing the resulting unemploy-ment by helping increase geographical andoccupational mobility, and by providing otherassistance, such as retraining schemes. InThe Gambia, for example, a major programof public-sector rationalization has entailedthe redundancy of about 2,600 workers. Theretrenched workers are mainly unskilled orsemi-skilled, and most received only smallseverance payments. The government hasestablished an "adjustment clearing house"which provides credit and training to selectedex-public employees to help them establishviable enterprises.

A word of caution must be sounded aboutsuch schemes. Recipients of employmentassistance are not necessarily among thepoorest in the community. There is a realdanger, especially in Sub-Saharan Africa, thattoo much attention will be given to assistingrelatively better-off groups—such as re-trenched civil servants—at the expense of thevery poor.

Expenditures on human capitalIn the process of revising their fiscal

priorities, some governments have increasedefforts to better direct social budgets towardthe poor. This was accomplished, for exam-ple, by the Government of Indonesia duringits adjustment to declining oil revenue. Its

five-year plan beginning in 1984 shiftedpriorities of the health budget toward thepoor, with community medicine, diseasecontrol and nutrition all receiving higherbudget allocations. The successful primaryeducation program, with its target of 100percent enrollment by the fiscal year 1986-87, has enhanced the human capital of thepoor.

In Brazil too, although aggregate healthspending declined in real terms, more re-sources per capita were committed to pro-grams benefiting the poor. Expenditure onprimary health care and basic nutritionprograms rose by 73 percent during 1980-83,and food distribution under nutrition pro-grams expanded by 40 percent. The govern-ment of President Jose Sarney (elected inMarch 1985) is committed to removinginequity in the health care system. Nutritionprograms have been further expanded, andservices have been moved to poorer regions,especially the Northeast. But, the recentre-emergence of high inflation, and therequirement for tighter monetary and fiscaldiscipline, will require careful planning offuture social commitments.

Income and consumption transfersInvolving the poor in supply-side adjust-

ments that increase their productivity willraise their primary incomes. It may not bepossible, however, to help some of the poor,either because they are economically inactive(mothers and children, for example) orbecause they are locked in low-productivityactivities. In Jamaica, for instance, attemptshave been made to cushion the impact ofhigher food prices on the poor throughnutrition support. The government's foodassistance program, initiated in 1984, con-sists of a school feeding program, a foodsupplementation program for pregnant womenand infants, and assistance for the very poorthrough a food stamps scheme. Around500,000 children benefit from the schoolfeeding program, 200,000 pregnant and nurs-ing women and infants are covered, and thefood stamps program is aimed at a group of

200,000 people (mainly the elderly and theunemployed). But while coverage is exten-sive, the assistance provided to the reallyneedy may not be enough. It has beenestimated that the value of food stamps, forexample, would have to be doubled to $40per month to guarantee an adequate nutritionintake for the target population.

Targeting nutritional programs at the pooris a difficult and, as yet, imperfect science.Clearly, better targeted nutrition support iscalled for—not only to aid the poor, but as amore efficient use of scarce public funds. Itis usually possible to reduce general sub-sidies, and use the resulting savings toprovide more effective interventions for thepoor. Direct food assistance programs areoften cost-effective. In some situations, foodcosts can be lowered by efficiencies inproduction and marketing. As argued by theBank in its recent report, Poverty andHunger (1986): "If the vulnerable group issmall, and easily identifiable, effective gov-ernment interventions can be targeted toreach them at reasonable cost."

ConclusionThis brief review has shown that efforts

have been made in various countries to helpmeet the needs of the poor during difficultperiods of adjustment. Two principles areillustrated by these experiences. First, pov-erty-oriented adjustment programs can andshould seek to maximize primary income-generating activities for the poor. This hasthe advantage of minimizing any conflictbetween adjustment and equity. Second, inobliging governments to reconsider thefundamentals of previous policies, adjustmentcan act as a catalyst in encouraging them toimplement more effective poverty alleviationmeasures.

Programs intended to protect vulnerablegroups may also help make adjustmentprograms politically acceptable. Our reviewshows that given the right policies, theconflict between adjustment and povertyalleviation need not be as severe as somesuppose. 0

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Do Outward-Oriented PoliciesReally Favor Growth?

A critical look at the World Development Report 1987

L.K.JhaChairman, Commission on Economic Efficiency, Productivity and Exports; India

Meople interested in the problems ofdeveloping countries look forward to theannual publication of the World DevelopmentReport by the World Bank with greatexpectation. The special feature of the 1987Report, the tenth in the series, is that it triesin Chapter 5 to argue that the tradeorientation of developing countries has beenthe principal factor influencing their industrialperformance. To prove this point, it classifies41 developing economies according to theorientation of their trade strategy over1963-73 and over 1973-85. At one extremeare the countries whose policies are said tobe strongly outward-oriented, while at theother end are those described as stronglyinward-oriented. In between, there are twoother groupings—moderately outward-ori-ented and moderately inward-oriented. TheReport compares the macroeconomic per-formance of these four groups, focusingattention on their average annual percentagegrowth in real GDP, both overall and in percapita terms, as well as other yardsticks ofeconomic performance, such as gross domes-tic savings, incremental capital/output ratio,average annual rate of inflation, and thegrowth of manufactured exports. The broadconclusion drawn from these comparisons isthat the more outward-oriented their tradepolicies, the better was the performance ofdeveloping countries.

A careful analysis of the methodologyemployed in coming to this conclusion givesrise to serious misgivings. Is it seriouslycontended that a policy which paid largedividends to island economies in whosenational income foreign trade made such alarge contribution would prove equally usefulin continental economies such as Brazil andIndia? One wonders why some other islandeconomies, such as Fiji, Seychelles, Jamaica,Trinidad, Mauritius, and Bermuda have notbeen included in the study. Further, is theinclusion of the Republic of Korea among theoutward-looking economies fully justified,

considering that the country's trade policieswent through many phases, some morerestrictive than others? In any event, theregulatory and developmental role of theState in various fields, particularly technolog-ical research, and the kind of political andeconomic support from the United States,among other things, have also unquestionablyhelped in the spectacular growth of Korea.Nor has its record of performance beenequally satisfactory all the time. At one stage,the annual rate of inflation was as high as 40percent. Indeed, there are a wide range offactors, differing from country to country,which influence the developmental potentialand performance of each. Therefore, ageneralization of the sort made in the Reportby looking at the average—and not atindividual performance—of different coun-tries, carefully selected and grouped, andcorrelating it with their trade policies, can bevery misleading.

Of the many factors influencing the growthperformance of a country, some are immu-table, such as natural resource endowment.Some, such as population growth, are ame-nable to change over a long period of time,through sociological rather than economicpolicies. Others include the nature of politicalrelations with developed countries whosecooperation can be particularly helpful inproviding resources, technology, and mar-kets for the developing country's industry.Then again, while external investment usuallycomes into export-oriented industries inisland economies with a small domesticmarket, in a large continental economy, it isthe size of the domestic market and the rateat which it is expanding that attracts foreigninvestment. In turn, foreign investors wantto be assured of a measure of shelter fromcompetition, both external and internal.

Then there are special factors which arepart of the national psyche. The absence of atradition of entrepreneurship, for example,often leaves an otherwise promising economy



in a state of poverty. Often restrictive tradepolicies which help minimize risks act as acorrective to it.

An objective study of the impact ofoutward- or inward-orientation of an economyon its industrial growth could have beenbetter made by comparing the performanceof the same economy at different periods oftime, under different trade orientations. Theresults of such a study might well have ledto very different conclusions. For example,in the case of India under British rule, theeconomy was open. There were no inhibitionsabout allowing private foreign investment inindustry. Import tariffs were low. Yet, therate of industrial growth in that period wasvery low. It was during World War II, whenimports were severely curtailed as a resultof short supply and shipping difficulties, thatthere was the first real spurt in the rate ofindustrial growth. This gained further momen-tum after independence. The experience ofmany other colonies, before and after inde-pendence, would tell a somewhat similar tale.

Yet another way of making an objectiveevaluation of the impact of trade policies onthe pace of industrial development would beto look at the historical experience ofdeveloped countries. Was the emergence ofthe United States as the leading industrialeconomy the result of outward-oriented tradepolicies or of other factors? Then, again,what about Japan? A 1972 OECD study, TheIndustrial Policy of Japan, has a very differentstory to tell. It says:

"Should Japan have entrusted its future,according to the theory of comparativeadvantage, to these industries [toys or othermiscellaneous merchandise and low-qualitytextile products] characterized by intensiveuse of labour? That would perhaps be arational choice for a country with a smallpopulation of 5 to 10 million. But Japan has alarge population. If the Japanese economy hadadopted the simple doctrine of free trade andhad chosen to specialize in this kind ofindustry, it would almost permanently havebeen unable to break away from the Asianpattern of stagnation and poverty, and wouldhave remained the weakest link in the free

world, thereby becoming a problem area inthe Far East.

"The Ministry of International Trade andIndustry decided to establish in Japan indus-tries which require intensive employment ofcapital and technology, industries that inconsideration of comparative cost of produc-tion should be the most inappropriate forJapan, industries such as steel, oil refining,petro-chemicals, automobiles, aircraft, indus-trial machinery of all sorts, and electronicsincluding electronic computers. From a short-run, static viewpoint, encouragement of suchindustries would seem to conflict with econo-mic rationalism. But, from a long-range pointof view, these are precisely the industrieswhere income elasticity of demand is high,

technological progress is rapid, and labourproductivity rises fast. It was clear thatwithout these industries it would be difficultto employ a population of 100 million and raisetheir standard of living to that of Europe andAmerica with light industries alone; whetherright or wrong, Japan had to have these heavyand chemical industries."

Turning once again to the area covered bythe 1987 World Development Report, a carefulstudy of the data presented can lead to verydifferent conclusions from those drawn in it.Thus, Figure 5.3 on page 86 furnishesinformation on the performance of individual

countries with different trade orientation over1963-73 and 1973-85. A closer study of theinformation presented shows that the rate ofincrease of real GNP per capita for Bangla-desh jumped up from about minus 2 percentin the first period to above 4 percent in thesecond period. Likewise, for India, the ratewent up from a little above zero to just below4 percent. Against this, the correspondingrate in Singapore and the Republic of Korearegistered a fall of 2 percent or more perannum. Considering that the rate of popula-tion growth in Bangladesh and India was somuch higher—a very important point whenassessing per capita growth rates—surelytheir performance cannot be judged to be toopoor, even though they pursued inward-looking policies.

Similarly, the average annual percentagegrowth of "real manufacturing value-added"shot up from near zero to about 10 percentin the case of Bangladesh, and from around 3percent to around 7 percent in the case ofIndia. The percentage rate of growth in"employment in manufacturing" between thetwo periods went up in the case of Bangladeshand India, while it recorded a sharp declinein the case of the Republic of Korea,Singapore, and Hong Kong.

Another point which emerges from a studyof the Report's data on the performance ofindividual countries is that Pakistan's rate ofper capita income growth was higher between1963 and 1973, when it was classified asstrongly inward-oriented, than between 1973and 1985, when it had moved into thecategory of moderately inward-oriented. In"real manufacturing value added" too, Paki-stan did not improve its performance by goingin for more liberalized policies. Moreover,"employment in manufacturing" in Pakistan,which showed an average annual growth ofaround 2 percent over 1963-73, had a growthrate of minus 3 percent over 1973-84.

Thus, the data presented in the WDR couldwell be used to argue that most of the poorerpeople of the earth have fared better withinward-looking trade policies. This is not theconclusion reached by the authors of theWorld Development Report 1987.

Rejoinder:Sarath Rajapatirana, leader of the WorldBank team that produced the World Develop-ment Report 1987, replies:

As Mr. Jha states, many factors influencethe growth performance of a country. Indeed,the first paragraph of the Report states precisely

I that. The discussion in Chapter 5 concentratedon the relationship between trade strategies andeconomic performance. It was based uponevidence from 41 developing economies that thebetter performance of outward-oriented eco-

nomies is the result of trade and industrialpolicies that do not discriminate betweenproduction for the domestic market and exportsnor between domestic and foreign goods. Thesepolicies lead to neutral incentives. Conversely,countries that actively discriminate againstforeign trade, by giving greater incentives toproduction for the domestic market, forgo thebenefits of efficiency, permit poor macroecono-mic policies to persist without correction, andincur costs associated with rent-seeking bythose in economic activities protected by quotas.

From his detailed comments, it appears thatMr. Jha either may not have read the Reportin its entirety or that he has misinterpretedsome of the data contained in it. I shall,however, attempt to answer each of his majorpoints, in the order that he raises them:

• Can we compare island with continentaleconomies? Whether a country is an island ora continental economy has no relevance to thedefinitions of outward- or inward-orientedtrade strategies. These definitions relate to thestructure of incentives. A continental economy



could have a small share of foreign trade in itsnational income and still reap the benefits ofneutral incentives. We did not include theisland economies that Mr. Jha cites becausewe did not have adequate data on their traderegimes and economic peformance to matchthose of the other countries in our sample.

• India may well have had an openeconomy and even neutral incentives underBritish rule. But the fact that it did not growrapidly cannot be ascribed to the neutralincentives. These incentives would have led toefficiency but could not have made up for lowinvestment, poor literacy, or lack of technology.

• In discussing the Republic of Korea, Mr.Jha implies that outward-orientation is equiv-alent to free trade. This is not correct. In oursample, Korea is classified as outward-oriented because it provides nearly neutralincentives for the domestic and foreign market.Providing incentives to some domestic indus-tries does not conflict with outward orienta-tion.

• Contrary to Mr. Jha's assertion that oursample countries were "carefully selected andgrouped," the group was not at all pre-selected.These were the developing countries on which

sufficient data were available. The two cate-gories—strongly outward-oriented and stronglyinward-oriented—correlate respectively withrelatively good and poor performance. No clearrelationship emerged for those in the "moder-ate" groupings. Our conclusions were basedon the robust results of the strongly outward-and inward-oriented economies in the sample.

• The reason we did not devote extensivediscussion to the performance of individualcountries with different trade policy orienta-tions over time is that we did not wish to repeatthe findings of numerous other studies, citedin the Report itself and elsewhere, of individualcountry experiences. See, for example, Little,Scitovsky and Scott (1970), Juergen Donges(1976), Bhagwati(1978), andKrueger(1978).Those findings show that, over time, countriesthat move toward neutral incentives improvetheir economic performance. The sample usedby our Report, which is 3-4 times larger thaneach of the sets of countries analyzed in thesestudies, confirms their findings.

• On Japan, Mr. Jha quotes a 15-year-oldOECD study. First, at the risk of repetition,one must not equate free trade with outward-orientation. Second, more recent OECDstudies (e.g., Costs and Benefits of Pro-

tection, 1985, Paris) acknowledge the highcosts of protection.

• Finally, Mr. Jha attempts to reinterpretour data in analyzing Figure 5.3 of the Report.He may have misread the bar charts. Eachvertical bar covers the range of individualcountry performances for each group of coun-tries. The location of the country name on thechart does not indicate its position on the scale.Bangladesh, for example, did not reach a 4percent growth rate in per capita GNP over1973-85, as stated by Mr. Jha. It was withinthe range that peaked at 2 percent, as clearlymarked by the vertical bar in the chart.Similarly, for the growth rate of real manufac-turing value added, Bangladesh and Indiaincreased by 7.5 percent and 4.6 percentrespectively over 1973-85, not by 10 percentand 7 percent, as Mr. Jha states.

• Contrary to Mr. Jha's interpretation ofour data, Pakistan's per capita income wasnot higher under inward-orientation. Again,he appears to have misread the bar chart. Evenif his point were correct, it does not demonstratethat high growth is associated with inwardorientation. It is well known that countriesmay be able to grow faster with increasedprotection, but they cannot sustain such growthover time. B

.LouN E W !

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World Development Indicator

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DISKETKS


External debt of developing countries, 1970-86

Data for 1986 are preliminary. Includes all developing countries reporting to the World Bank's Debtor ReportingService. Includes data for Poland from 1984-86 only.

'includes public and publicly guaranteed debt, private nonguaranteed debt, short-term debt, and use of IMFcredit.

2Public and publicly guaranteed debt only.Short term is defined as debt with original maturity of one year or less. Data were unavailable for 1970-74.

Chart 2Servicing the debt(In billions of US dollars)

1 Debt-service data do not include service of short-term debt. Source: World Bank, World Debt Tables, 1987.


.Chart 3' Debt by region

(In billions of US dollars)

Chart 1Total debt and selected components(In billions of US dollars)

LV1«] i\ Ml =!•(•] fl [•] iTATJ IJ i I ifil fl kl 11 [•] fl I


Richard Fortes and Alexander K. Swoboda

Threats to International Finan-cial StabilityCambridge University Press, Cambridge, UK, 1987,xviii + 307 pp. $42.50.

W.M. Scammel

Stability of the International Mon-etary SystemRowman and Littlefield, Totowa, NJ, USA, May 1987,viii + 162 pp., $29.50 (cloth), $11.95 (paper).

Robert D. Hormats

Reforming the International Mon-etary SystemFrom Roosevelt to Reagan

Foreign Policy Association, New York, NY, 1987,79pp., $4.

In turbulent times, there is a tendency toscrutinize the international financial andmonetary system and to devise ways oftinkering with it in the hope of salvation,even though the behavior of the policy-makers should really be the prime focusof attention. An ideal system is one thatpromotes efficiency in international mone-tary and financial relations and is able towithstand shocks and innovations. TheBretton Woods system, operating in a lesscomplex world, provided a stable base forthe international economy for about 25years. The current system—or "non-system" as budding wags call it—has hadto contend with major economic disloca-tions, innovations, and globe-swirling cap-ital flows of massive proportions. We livein an international economy where theimportant decisions are taken from anational perspective.

The Portes-Swoboda volume is basedon a conference of thinkers, doers, andsupervisors (i.e., academics, bankers, andofficials). It is an informative and wellbalanced collection that should be ofconsiderable interest to anyone concernedwith international financial issues. Fortes

and Eichengreen deal with the anatomyof financial crises. Notwithstanding theirclumsy epidemiological metaphor, the ana-lysis is stimulating and insightful. It com-pares the crisis of the 1930s with those ofthe 1970s and 1980s within the analyticalframework of the linkages between debtdefault, exchange market disturbances,and the instability of the banking system.The main lesson of the 1930s has been abetter understanding of these linkages.For a number of reasons, the latter-daycrises have not been as serious as theearlier ones. The critical role of publicpolicy in protecting the stability of thefinancial system and the macroeconomyis now recognized, but policy coordinationis a key to mitigating the effects of futurecrises.

Following up on the importance of therole of public policy, Baltensperger andDermine examine the motives, needs, andcharacteristics of regulatory systems, whileSchaefer discusses regulation and super-vision from a theoretical and practicalperspective. That theory has much tocontribute to this topic is suspect (althoughno subject is nowadays considered respect-able without the trappings of a theoreticalfoundation). Supervisory practice must befirmly grounded in each country's historyand traditions. Kane on competitive "rere-gulation" (a word used in a confusingmanner to denote any adjustment inregulatory instruments) is either codifyingcommon sense or saying something veryprofound.

Guttentag and Herring provide a lucidand informative paper on liquidity as-sistance for international banks and co-gently argue why such assistance, tradi-tionally accepted for domestic banks, mustbe extended to international banking,where both depositors and loan customersreside outside the bank's home base.More empirical references would havebeen interesting. (Some years ago a bank

in East Asia piled gold bars in its windowto stanch panic withdrawals by deposi-tors!)

W.M. Scammel's perspective is a broa-derone—the international monetary systemcovers international liquidity, exchangerates, and adjustment mechanisms,whereas international finance refers to thetransmission of savings. This is a reflec-tive, well written, and historically groundedbook whose compactness should make itall the more attractive. In spite of hissurprisingly intemperate asides on the roleof the IMF in adjustment, the author has athorough grasp of his subject. He observesthat, paradoxically, greater internationaleconomic integration has not enhancedstability. He emphasizes the now dominat-ing importance of capital movements; heis skeptical of the "market-can-solve-all-problems" approach; and he looks withfavor on target zones—a preference thatwould seem to be inconsistent with hisstrictures against the one-way speculativeoption provided under the adjustable pegsystem.

On the whole, Scammel is cautiouslyoptimistic about the international monetarysystem, remarking on its considerableadaptability and resilience. Indeed, theroutinely proclaimed demise of the systemhas been greatly exaggerated.

Finally, Robert Hormats, who is a thin-ker, a doer, and has been an official,provides a readable, breezy account of themajor international monetary develop-ments of the past 40 years. The one themecommon to all three works is succinctlyexpressed by Hormats when he says thatthe fundamental question for the future is"whether there can be a reform in attitudesof governments sufficient to ensure thatdomestic policies will be aimed to a greaterdegree at avoiding major internationaldisequilibria."

Bahrain Nowzad

Phillip Cagan (editor)

Deficits, Taxes, and EconomicAdjustments( American Enterprise Institute, Washington, DC, 1987,332 pp., $27.50 (cloth), $14.75 (paper).

This volume is the latest in an annualseries on contemporary economic prob-

lems launched by the American EnterpriseInstitute in 1976 under the direction of thelate William Fellner. The new volumecontains ten essays addressing a widerange of current issues facing the USeconomy.

Given the diversity of topics addressed,one might expect this book to be a

handbook of the latest information on themost pressing policy issues of the day, butthat is not what the volume turns out to be.Some of the most pressing and long-standing issues are dealt with obliquely ornot at all.

Thus Jacob Dreyer's, Gottfried Haber-ler's, and Kenneth M. Brown's reviews of


I :{•!•] ft:!


issues in exchange rate behavior, policycoordination, and protectionism give valu-able restatements of familiar and generalthemes, but readers seeking enlighten-ment, for example, on the role of theexchange rate in solving the balance ofpayments problem will have to look else-where. John Weicher's discussion of thefederal budget confines itself to "domestic"expenditures, which it defines as thebudget exclusive of defense, interest, andspending for international affairs, withvirtually no mention of far more compellingglobal fiscal issues. The paper by MarvinKosters and Murray Ross on determinantsof the growth and distribution of real wagesin recent years studiously avoids explicitdiscussion of the closely related topic ofproductivity growth. Eugene Steuerle'sdiscussion of the economic effects of the

recent US tax reform covers the oppor-tunities to broaden the base of individualincome taxation that were missed by thetax reformers. Somehow, however,Steuerle avoids all mention of one of themost important, the mortgage-interest de-duction. He also omits any mention ofowner-occupied housing in his treatmentof the productivity-enhancing value of themore-nearly equal effective tax rates ondifferent assets that emerged from the taxreform. Such omissions, plus Steuerle'sflawed macroeconomic analysis, make hisessay the one disappointment in the book.

These problems aside, there are anumber of useful and even novel elementsin the volume that make it worthwhilereading. Hendrik Houthakker explains theinefficiency of fixed tariffs in oil, comple-menting the more general presentation in

Kenneth Brown's essay. Houthakker's pro-posal of a variable tariff on oil will be newto many readers, and merits consideration.Phillip Cagan reports econometric resultssuggesting that much of the shift in moneydemand resulting from the financial dere-gulation of the early 1980s can now beexplained, and this too should be usefulinformation for policymakers. Cagan's re-sults suggesting a surprisingly small con-tribution of the dollar appreciation of theearly 1980s to the domestic disinflation ofthat period are provocative. The same canbe said of Brown's figures that belie thewidely held view that the US economy isbecoming more heavily concentrated inthe services sector.

Frederick Ribe

Martin Feldstein (editor)

The Effects of Taxation on Cap-ital AccumulationThe University of Chicago Press, Chicago, IL, USA,1987, viii + 490 pp., $55.

The 14 papers that make up this bookwere prepared as part of an ongoing studyof the effects of taxation on capital accu-mulation in the United States. Publicationof the study is timely because tax reformproposals, which would involve significantchanges in the incentives to save andinvest, have either been implemented orare being considered in many countries.The book deals with the recent experiencein the United States where the interactionof frequent changes in tax legislation andvariable inflation rates caused importantchanges in the incentives to save andinvest, particularly beginning in the 1980s.The broad message from the studies isthat capital formation is quite sensitive totax policy. Whereas some of the researchin the book confirms earlier findings, otherstudies provide fresh insights and, inparticular, reveal the pitfalls of taking apartial approach to tax reform. The con-tribution of Martin Feldstein and Joosung

Jun, for example, suggests that tax incen-tives that were introduced in the beginningof the 1980s significantly stimulated netfixed business investment. However, two-thirds of this positive effect was offset bythe adverse impact of rising interest rates,which were partly attributable to the effectof the tax incentives on the fiscal deficit.

Patric Hendershott's study provides ano-ther illustration of the importance of adopt-ing a comprehensive approach to taxreform. Advocates of the recent tax reformin the United States have argued that thistax reform would enhance the overallefficiency of the tax system by reducing thedistortions implied by differential taxationof business investment. Hendershott'spaper suggests, however, that the new taxlaw hurts overall efficiency by worseningthe distortion in the resource allocationtoward owner-occupied housing.

In view of the importance of taking acomprehensive approach to tax reform, itis somewhat disappointing that none of thestudies in the volume examines how taxesaffect the accumulation of human capitaland intangible assets. Although the re-cently implemented tax reform in theUnited States may discourage the expan-

sion of capital-intensive industries, thesignificant reduction in marginal tax rateson personal labor income may encouragethe development of labor-intensive andresearch-intensive industries.

Despite this criticism, the book is timelyand useful, not only for those concernedwith US tax policy but also for all thosewho are concerned with fiscal policyworldwide. The empirical results in a paperby Boskin and Gale, for example, indicatethat the US tax structure significantlyaffects the international allocation of invest-ment. Therefore, policymakers in othercountries cannot ignore the consequencesof tax reform in the United States. At thesame time, the international coordinationof fiscal instruments may become animportant policy issue.

In sum, the studies in the book confirmthat the efficiency of fiscal instruments isimportant for growth and that both savingand productive investment are sensitiveto the choice of fiscal instruments. Thisfinding has important implications not onlyfor tax reform proposals now under consid-eration but also for the design of growth-oriented structural adjustment programs.

Lans Bovenberg

Sebastian Edwards and Liaquat Ahamed (editors)

Economic Adjustment and Ex-change Rates in DevelopingCountriesUniversity of Chicago Press, Chicago, III., 1986, xi +443 pp., $48.

Since 1971, developing countries haveincreasingly used exchange rate policies

to deal with external disequilibria. Thisdevelopment has given rise to manyquestions regarding the macroeconomicimpact of such policies. The 11 impressivepapers contained in this volume bringrecent developments in macroeconomictheory to bear on these questions. Origi-nally presented in 1984 at a conferencesponsored by the National Bureau of

Economic Research and the \Aforld Bank,the papers fall into three categories:macroeconomic models focusing on theeffects of particular adjustment policies;analyses of alternative financial regimes;and case studies.

Leading off the first of these groups,Sweder van Wijnbergen describes supply-side mechanisms through which a devalua-



tion has a contractionary effect, and showsthat the presence of a foreign debt inten-sifies such an effect. Michael Mussaexplores the ways in which the realexchange rate can be altered by commer-cial policy, capital controls, fiscal policy,and a combination of harmonized mone-tary and exchange rate policies. JacobFrenkel and Joshua Aizenman develop acomplex model that is used to deriveoptimal rules for wage indexation, mone-tary policy, and exchange rate policy asalternative means of dealing with exo-genous shocks. Rudiger Dornbuschargues the case for using multiple ex-change rates as a means of minimizing thecost of adjusting to transitory disturbances.Arnold Harberger, presenting a textbookexchange-market analysis to deal withvarious policy issues, argues for definingthe real exchange rate as the nominal

exchange rate deflated by a generaldomestic price index rather than the ratioof traded to nontraded goods' prices.

Guillermo Calvo and Maurice Obstfelddeal with problems arising from financialliberalization. Calvo analyzes the implica-tions of a liberalized banking system withfree international capital movements in asmall country. Obstfeld examines theimpact of changes in an officially controlledexchange rate depreciation both with andwithout international capital mobility.

The four case studies lend welcomebalance to a heavily theoretical volume.Sebastian Edwards shows that increasesin coffee prices have been associated withhigher rates of base-money creation andinflation in Colombia. William Bransonuses a macroeconomic model of Kenyato argue that as a means of externaladjustment, reduction in government spend-

ing is less contractionary than devaluation.Louka Katseli presents evidence that dis-crete nominal devaluations produce fasterprice adjustments—and therefore lessimpact on the real exchange rate—than acrawling peg. Jorge de Macedo analyzesadjustment behavior of countries in theWest African Monetary Union.

The papers and comments are of thehighest quality. This is not surprising,considering the distinction of the confer-ence participants. Nevertheless, the manydifferent models and partial analyses ofexchange rate policies in developing coun-tries may simply add to the bewildermentof some readers. International economistsare clearly still groping for a generallyaccepted theoretical framework in analyz-ing the issues addressed in the book.

Anthony Lanyi

Susan Joekes

Women in the World EconomyOxford University Press, New York, 1987, ix+ 161 pp., $19.96

No better book has been published on thesubject since Ester Boserup's study,Woman's Role in Economic Development,appeared in 1970. Women in the WorldEconomy contains some interesting hy-potheses and useful information, but fallsshort of providing a comprehensive andsystematic framework to study women'semployment in developing countries.

The question posed early in the book iswhether international trade since WorldWar II has reinforced sexual divisions thatemerged with early monetization of agri-cultural communities in which women wereconfined to the household and subsistencesectors while men participated in commer-cial activities. The general conclusion isthat international trade favored women'semployment in developing countries andthat traditional segmentation patterns werenot reinforced. However, Joekes contendselsewhere in the book that women'senhanced opportunities consisted mostlyof dead-end, low-skill jobs that replicated"the worst features of the traditionalsegmentation of occupation by sex."

The study's main point is that thesuccess of developing countries—mainlyEast Asian—in export-led growth has de-pended upon their comparative advantagein labor-intensive manufactured products

made by cheap female labor. Conse-quently, there appears to be a shift inwomen's employment opportunities fromagriculture to industry within developingcountries; and from developed to develop-ing countries in general. It is the socialcharacteristics of women—for example,their reproductive role and low educationlevels—that make them the cheapest labor.The role of multinational corporations inincreasing women's employment is consid-ered important, as these companies, unfet-tered by cultural inhibitions, began realiz-ing the potential profits from hiring low-costfemale labor.

In the agriculture sector, the employ-ment picture for women is not so bright.Joekes argues that the tasks allotted towomen—for example, tending and harvest-ing of crops—are most amenable tomechanization. Although employmentopportunities for Asian women increasedwith the enhanced output from new high-yield crop varieties, Joekes asserts thatmechanization displaced more female thanmale labor. However, firm evidence is notprovided to support this view. In Sub-Saharan Africa, falling international priceshave had an adverse impact on womenfarmers, who account for the majority offood producers.

In Latin America, the proportion of thefemale labor force employed in the ser-vices sector—mainly domestic services—is63 percent. In Africa and Asia, this propor-tion is much smaller. In general, trends in

the services sector are found to beunrelated to international factors. A signif-icant drawback of the study is the lack ofcomprehensive cross-country comparisonsto pinpoint why women's employment insome countries has fared better than inothers that had an export-oriented indus-trial growth strategy. For example, howimportant are differences in levels ofeducation and skills? Is there a greatercomparative advantage in hiring cheaperfemale labor when there are surpluses inthe male labor market? Given the likelytrends in technology and trade, what arethe future trends in women's employment?These issues are barely touched upon.

The last part of the book summarizes theprevious sections. Policy recommenda-tions in the final chapter are clearlyspecified, although they are not ade-quately supported by the main analysis.One important policy proposal is thatreversals in women's gains resulting frominternational trade should be preventedby training women in improved industrialand agricultural techniques.

The author also recommends that econo-mic adjustment programs take the genderdimension into account. Nevertheless, thebook does not look very closely at theimplications of structural adjustment pro-grams on women's employment, nor at theeffects on women of specific policies ofprivatization and reliance on market forces.

Masooma Habib



H.W. Arndt

Economic Development

The History of an IdeaUniversity of Chicago Press, Chicago, 1987, viii+ 217pp., $20.95.

This new retrospective of developmentthinking brings to mind George J. Stigler'sdictum that "it remains the unfulfilled taskof the historians of economics to show thattheir subject is worth its cost."

In an earlier publication, Arndt hadtraced the evolution of public attitudestoward economic growth in developedcountries. The present offering attempts asimilar treatment for development, a vastlymore ambitious undertaking given theheterogeneity of developing countries andthe growing diversity of thought abouteconomic development, an idea which has"come to encompass almost all facets ofthe good society, even/man's road toUtopia."

Despite the scope of the undertaking,Arndt's approach is minimalist. Innocentof empirical findings, neutral in tone, andmodest in intent, the book does little toevaluate the progression of thought withinthe discipline, its evolving assumptions,models, concepts, and criteria of evidence.It shies away from economic analysis andpolicy prescription. And it neglects to

trespass into the politics and sociology ofdevelopment which characterizes the bestwork of Joseph Schumpeter or A.O.Hirschman.

What Arndt does (and does rather well)is to relate the major strands of develop-ment thinking to their historical origins andto intellectual trends. The focus is onmainstream attitudes as reflected in aca-demic writing and public debate. Espe-cially valuable is the inquiry into theintellectual antecedents of developmenteconomics—from Adam Smith's "naturalprogress of opulence" to Sun Yat-sen's"reactive nationalism." In nontechnicalprose, Arndt expertly weaves the views ofpostwar academic economists with thoseof 19th century colonial theorists andnationalist leaders of the left and theright—from Marx to Mao and from Gandhito the Ayatollah Khomeini.

The account of the major themes andleading issues of development economicsfrom the late 1940s to the mid-1970streads familiar terrain. Initially, develop-ment was largely identified with growth andstressed capital formation, industrializa-tion, and a leading role by the State indirectly productive activities. Arndt chartsadequately the subsequent changes inperceptions about the neglected role ofhuman capital and technical progressfollowed by the sudden shift of develop-

ment thinking during the early 1970stoward employment creation, poverty alle-viation, and basic needs.

Arndt's panorama of the changing intel-lectual framework of development pro-vides a serviceable introduction to thetopic. But it fails to bring to life the animatedcontroversies of the post World War IIperiod. Emphasizing intellectual fashionover professional analysis, its relativisticstance inevitably equates ideological rhe-toric with competent assessments of devel-opment policy. Inexplicably, the inquiry isnot sustained through the late 1970s andearly 1980s. Therefore, the book providesno clue about the resurgence of neoclas-sicism in development economics. It doesnot describe the emerging consensusabout the benefits of outward trade ori-entation or the increasing realizationamong practitioners that institutionalchange and policy reform must hold centerstage in an interlocked global economy.As a result, the book sheds little light onthe predicaments faced by policymakersin developing countries today.

To tell the story of development from the1950s to the 1970s without describing itslogical culmination—adjustment in the1980s—is like telling a joke without givingthe punch line. This is why this bookultimately falls flat.

Robert Picciotto

BOOKS in brief

Robert Cassen & Associates

Does Aid Work?Report to an Intergovernmental Task Force

Clarendon Press, Oxford, UK, 1986, and Oxford UniversityPress, New York, 1987, xv + 381 pp., $45 (cloth), $15.95(paper).

This report, commissioned for the Bank-FundDevelopment Committee by 18 governmentsand written by an international team of con-sultants, answers its own question thus: "Mostof it, yes; however...." (An overview of the reportwas published in this journal's March 1986issue.) While reaching "a well educated assess-ment" that most aid works, the broad conclusionof the various studies in this compilation ofexperience in seven countries, together withassessments of the role of aid and donoragencies, is that the aid process needs to be" improved. A more open discussion of thefailures of aid would help prevent future prob-lems from arising and sustain public support for| development assistance. An important findingof the consultants was that in the combinationof aid and domestic policies in recipient coun-tries, the role of the latter was more important.No matter how well documented and presented,

no report can be expected to alter radically thebehavior of donors or aid recipients. But, thisclear presentation of facts and opinions identi-fies critical issues in the aid process and shouldserve as a sound basis for future discussionson improving aid coordination and use.

Dick Wilson

A Bank for Half the WorldThe Story of the Asian Development Bank1966-1986

Asian Development Bank, Manila, the Philippines, 1987,392pp., $25 (cloth), $8.50 (paper).

This commissioned volume provides a welldocumented look at the origins and growth ofthe ADB. With the non-regional developedcountries taking only a 40 percent share in theinitial capital of the institution, the ADB becamethe first regional development bank that wasdesigned as "an international partnership." Thebank has lent almost $20 billion since its birth,mainly for projects, leaving policy-based lendingto its larger cousins such as the World Bank. Ithas also provided technical assistance tocountries in the region and to other regional orsmaller multilateral institutions, such as the

Islamic Development Bank. The author providesa wealth of information on the personalities andactivities that marked the ADB's first 20 years.The critical comments are guarded, and prob-lem projects are treated with polite brevity. Inthe end, the book serves primarily to report,often the ADB's official view, with little outsidecommentary or analysis by the author that mightoffer the reader a preview of the next 20 years.

Merrie Gilbert Klapp

The Sovereign EntrepreneurOil Policies in Advanced and Less AdvancedCapitalist Countries

Cornell University Press, Ithaca, NY, 1987, 244 pp., $27.50.

This book is an interesting contribution to thetheory of the state and international bargainingtheory. It applies these theories to the patternof state control in the oil industry. The mainquestion addressed is: Why did governmentscreate state-owned oil companies? It then goeson to show the extension of the state's role inthe crucial oil sector. Klapp also compares statepolicies and control over oil companies duringthe period 1960-85.



LETTERS

English law or judges?In his review of Thomas G. Weiss's bookentitled Multilateral Development Diplomacyin UNCTAD (March 1987 issue of Finance& Development), Sir Joseph Gold observesthat "the anthropologists of the law havetaught that in primitive societies law is oftensecreted in the interstices of procedure."Surely, the latter part of that statement isattributable to an English judge of the lastcentury—and he referred to English law.

David J. AppaduraiLondon

Sir Joseph Gold responds:I relied on my recollection of the source of thestatement. I thought it had been one of SirHenry Maine's conclusions about primitivelaw, but you may be right. (Perhaps we areboth right.)

Listening to the PeopleI read with interest Lawrence F. Salmen'sarticle, "Listening to the People," whichappeared in the June 1987 issue of Finance& Development. As a marketing academic forthe last 17 years, I have always told mystudents that listening to the market is aprerequisite for market success. In fact, thewhole field of marketing is based on thephilosophy of understanding and trackingmarket dynamics, i.e., buyers, in order tooffer to the market a better product (service)relative to competition.

The news that the Bank first supported theuse of participant-observer assessment onan experimental basis in 1982 came as a shockto me. I urge Dr. Salmen to convince theBank to hire more marketing consultantsbecause their business is, in fact, "listeningto the people."

Over the years as a consultant, I have useda version of the qualitative research techniquewhich you describe as participant-observa-tion. In marketing, we call it the "focus-groupinterview" in which groups of up to 10 peopleare interviewed (or a single individual at atime). Such interviews rarely last over twohours which is considerably less than the timeframe Dr. Salmen reports in his article.Frankly, I find the six and a half months'average period cited in the article to be rather

I lengthy. Of course, I have never interviewedthe rural poor in developing countries, but Ihave some experience in interviewing therural and urban poor in Canada.

I realize that the participant-observationmethod has a very different time frame thanthe focus group method. Business firmswhich use focus groups are generally veryeager to see the results from such marketstudies as soon as possible. Based onexperience, I don't think a firm would wait sixand a half months. Of course, the motivebehind such studies is different in the WorldBank than in a private firm. But is it reallythat different?

In any case, I really enjoyed your articleand I'll make sure to read your book. I findapplying research skills to such worthwhilecauses to be very necessary. Without hesita-tion, I would welcome such a challenge, andI'm sure many of my marketing colleagueswould, too.

Dr. Robert D. TamiliaUniversity of Quebec at Montreal

Mr. Salmen responds:I share your amazement that the World Bankdid not support extensive work in participantobservation of development projects before1982. I believe, however, that no other majorinternational development institution has his-torically supported this kind of work either.

The development community has notaddressed the cultural aspects of its workadequately for two major reasons. Manydevelopment professionals are economists, farmore comfortable with abstract, deductivethinking than the grounded, inductive modeof analysis of this approach. Second, the socialscientists whose training most closely fits this"listening to the people" skill—anthropologists and sociologists —haveestablished a reputation for producing work ofa largely descriptive nature which often haslittle utility for decisionmaking. Perhaps whatis needed, as you suggest, is to bring moremarketing people into development.

Regarding time frames, individual inter-views, in fact, average close to one half hour.Focus-group interviews, as you indicate, arelonger, but seldom exceed two hours. The sixand a half months' duration for the averagebeneficiary assessments conducted to datebreaks down as follows: one and a half monthsfor finding and training field personnel, threemonths for field work, and two months forreport preparation. While this time may be cutby a month or two, it is not too long for purposesof development managers. Problem-specificinquiries, still using qualitative methods,could, of course, be done in shorter periods oftime.

Participatory approach advocatedI found the article by Gottfried Ablasserentitled "Issues in Settlement of New Lands"in the March issue of Finance & Developmentquite interesting. In the last paragraph, hediscusses the handing over of the project tolocal authorities after the grant period. Withregard to turnover, I would like to say thatour experience has shown that it should bethe residents or project beneficiaries whoshould be trained to take over managementof the project when it ends. Governmentagencies are not likely to be very interestedbecause of budgetary constraints or increasedwork loads. Furthermore, because the bene-ficiaries are the actual resource managers, alot of the responsibilities would be turnedover to them. A participatory project ap-proach thus would be the most attractive formof project management so as to ease theturnover shock.

Sol L. EbarleDumaguete City, the Philippines

Procedures as obstaclesI read with interest the article entitled"Fostering Enterprise Development" in theMarch 1987 issue of Finance & Development.I agree with the authors that to fosterenterprise development, it is necessary tocreate first a positive business environment.The policy to help entrepreneurs is encour-aging, but procedures adopted to help themmay be discouraging and thus the entrepre-neurs face difficulties in putting their projectsinto action or making them profitable.

RaviR. Singh MehtaPunjab and Sind Bank

Photo credits: Photographs on pages 5, 9, 19, 33, 37, and 40by D. Zara; pages 13, 22, and 29 by M lannacci; and on page16(Siebeck)byC. Berger.



INDEX 1987 VOLUME 24Articles

Gottfried Ablasser, Issues in Settlement of NewLands, March p. 45

Tony Addlson and Lionel Demery, Alleviating Pov-erty under Structural Adjustment, December p. 41

Bijan Aghevll, In-Su Kim, and Hubert Nelss, Growthand Adjustment in South Asia, September p. 12

John Akin and Nancy Blrdsall, Financing of HealthServices in LDCs, June p. 40

Mahmood Ayub and Sven Hegstad, Determinantsof Public Enterprise Performance, December p. 26

Michael Bell and Robert Sheehy, Helping StructuralAdjustment in Low-Income Countries, Decemberp. 6

Clemens F.J. Boonekamp, Voluntary Export Re-straints, December p. 2

Carlston Boucher and Wolfgang Slebeck, UNCTADVII: New Spirit in North-South Relations? Decem-ber p. 14

Anand Chandavarkar, Developmental Role of CentralBanks, December p. 38

J. de Larosiere, Progress on the International DebtStrategy, March p. 10

The Debt Problem of Sub-Saharan Africa, Marchp.14

Graham Donaldson, Community Participation in North-em Pakistan, December p. 23

Michael Dooley and Donald Mathleson, FinancialLiberalization in Developing Countries, Septemberp. 31

Michael Dooley, Market Valuation of External Debt,March p. 6

Sebastian Edwards, Sequencing Economic Libera-lization in Developing Countries, March p. 26

Mohamed EI-Erian, Foreign Currency Deposits inLDCs, December p. 42

Bruce Fitzgerald, Countertrade Reconsidered, Junep. 46

Alexander Fleming and Mary Oakes Smith, RaisingResources for IDA: the Eighth Replenishment,September p. 23

Charles Gardner, Enhancing the Fund's StructuralAdjustment Facility, September p. 6

Manuel Gulttan, The Fund's Role in Adjustment, JuneP. 3

Nagy Hanna, Strategic Planning and the Manage-ment of Change, March p. 30

Barbara Herz and Anthony Measham, MaternalHealth and Development, June p. 44

Peter Hopcraft, Grain Marketing Policies and Insti-tutions in Africa, March p. 37

Jocelyn Home and Paul Masson, InternationalEconomic Cooperation and Policy Coordination,June p. 28

Yukon Huang and Peter Nicholas, The Social Costsof Adjustment, June p. 22

L.K. Jha, Do Outward-Oriented Policies Really FavorGrowth?, December p. 44

Omotunde Johnson, Currency Depreciation andExport Expansion, March p. 23

Omotunde Johnson, Currency Depreciation andImports, June p. 18

Lloyd Kenward, The Decline of the US Steel Industry,December, p. 30

Mohsin S. Khan and Nadeem Ul Hague, CapitalFlight from Developing Countries, March p. 2

Thomas Klein, Debt Relief for African Countries,December p. 10

Malcolm Knight and Paul Masson, Transmission ofthe Effects of Fiscal Policies Among IndustrialCountries, March p. 41

Harlnder Kohli and Anil Sood, Fostering EnterpriseDevelopment, March p. 34

George Koplts, Turkey's Adjustment Experience,1980-85, September, p. 8

Anthony Lanyl, Issues in Capital Flows to DevelopingCountries, September p. 27

Augusto Lopez-Claros, The European Community:On the Road to Integration, September p. 35

Constantino Michalopoulos, World Bank Lending forStructural Adjustment, June p. 7

Abbas Mlrakhor and Peter Montiel, Adjustment andthe Import Intensity of Output, December p. 17

Shuja Nawaz, Why the World Current Account DoesNot Balance, September p. 43

Young C. Park, Evaluating the Performance ofKorea's Government-Invested Enterprises, Junep. 25

Samuel Paul, Community Participation in World BankProjects, December p. 20

Guy Pfeffermann, Economic Crisis and the Poor inSome Latin American Countries, June p. 32

A. Premchand, Managing the Budget, Septemberp. 39

Sarath Rajapatlrana, Industrialization and ForeignTrade, September p. 2

Recent International Borrowing by DevelopingCountries, March p. 12Lawrence Salmen, Listening to the People, June p. 36Marcelo Selowsky, Adjustment in the 1980s: An

Overview of Issues, June p. 11Nils Borje Tallroth, Structural Adjustment in Nigeria,

September p. 20Vito Tanzl, Fiscal Policy, Growth, and Stabilization

Programs, June p. 15trade Liberalization In Chile, September p. 16Rachel Weaving, Measuring Developing Countries'

External Debt, March p. 16World Bank Reorganization, September p. 46World Economy in Transition, September p. 48Miranda Xafa, Export Credits and the Debt Crisis,

March p. 19

Books

H.W. Arndt, Economic Development, reviewed byRobert Picciotto, December p. 51

Henri Bourguinat, Les vert/ges de la finance Interna-tionale, reviewed by Paul Masson, June p. 50

Ray Bromley, editor, Planning for Small Enterprisesin Third World Cities, reviewed by FriedrichKahnert, June p. 53

Phillip Cagan, editor, Deficits, Taxes, and EconomicAdjustments, reviewed by Frederick Ribe, Decem-ber p. 48

Chris C. Carvounls, The Foreign Debt/NationalDevelopment Conflict, reviewed by BahramNowzad, March p. 49

Wilfred David, Conflicting Paradigms in the Econom-ics of Developing Countries, reviewed by SumanBery, March p. 50

Sebastian Edwards and Liaquat Ahamed, editors,Economic Adjustment and Exchange Rates inDeveloping Countries, reviewed by Anthony Lanyi,December p. 49

Sebastian Edwards and Alexandra Cox Edwards,Monetarism and Liberalization, reviewed byClaudio Loser, September p. 49

Gerald Faulhaber et al., editors, Services in Transi-tion, reviewed by J. Paljarvi, June p. 51

Martin Feldstein, editor, The Effects of Taxation onCapital Accumulation, reviewed by Lans Boven-berg, December p. 49

O.K. Fieldhouse, Black Africa, 1945-80, reviewed byGeoffrey Lamb, June p. 51

Stanley Fischer, Indexing, Inflation and EconomicPolicy, reviewed by Michael Dooley, June p. 50

Gordon A Fletcher, The Keynesian Revolution and ItsCritics, reviewed by Bahram Nowzad, Septemberp. 50

Irving Friedman, Toward World Prosperity, reviewedby Anthony Lanyi, September p. 49

Robert Hormats, Reforming the International Mone-tary System, reviewed by Bahram Nowzad, De-cember p, 48

Susan Joekes, Women in the World Economy,reviewed by Masooma Habib, December p. 50

George Kaufman and Roger Kormendl, editors,Deregulating Financial Services, reviewed byCharles Collyns, March p. 51

Khushi M. Khan, editor, Multinationals of the South,reviewed by Sanjaya Lall, September p. 51

Robert Klltgaard, Elitism and Meritocracy in Develop-ing Countries, reviewed by Stephen Heyneman,September p. 50

Peter (Corner, Gero Maass, Thomas Siebold, andRalner Tetzlaff, The IMF and the Debt Crisis, reviewed

by Bahram Nowzad, March p. 49David F. Lomax, The Developing Country Debt Crisis,

reviewed by Bahram Nowzad, March p. 49Robert E. Looney, The Political Economy of Latin

American Defense Expenditures, reviewed byShuja Nawaz, June p. 52

John Loxley, Debt and Disorder, reviewed by BahramNowzad, March p. 49

Morris Miller, Coping Is Not Enough!, reviewed byBahram Nowzad, March p. 49

R. Fortes and A. Swoboda, editors, Threats toInternational Financial Stability, reviewed byBahram Nowzad, December p. 48

A.E. Safarlan and Gilles Y. Berlin, editors, Multina-tionals, Governments, and International Tech-nology Transfer, reviewed by Sanjaya Lall, Sep-tember p. 51

Karl Sauvant, International Transactions in Services,reviewed by J. Paljarvi, June p. 51

W.M. Scammel, Stability of the International MonetarySystem, reviewed by Bahram Nowzad, Decemberp. 48

Frances Stewart, editor, Macro-Policies for Appropri-ate Technology in Developing Countries, reviewedby Graeme Donovan, September p. 52

Thomas Wslss, Multilateral Development Diplomacyin UNCTAD, reviewed by Joseph Gold, March p. 51

Finance & Development / December 1987 53


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