Nafziger Economic Development (4th ed)

686 Part Five. Development Strategies

IMF studies suggest that demand-restraining monetary and fiscal policies reduce growth until the long lags associated with exchange-rate, interest-rate, resourceallocation (such as increasing agricultural producer prices), and other market reforms stimulate growth. The 1987 real exchange rate of countries undergoing Bank adjustments depreciated on average by about 40 percent from their 1965–81 levels. Changes in exchange rates and interest rates improved resource allocation and restructured the economy toward exportables and import substitutes, stimulating investment and growth (World Bank 1988a:18–36).

Simon Commander’s study finds commercial (especially export and importreplacement) farmers, their wage labor, and traders benefiting from exchange-rate and other adjustments. Public-sector employees, domestic-goods producers, and informal-sector workers tend to be hurt by adjustment (Commander 1989:239).

UNCTAD (1991:8) maintained that the economic performance of the twelve leastdeveloped countries with consecutive structural adjustment programs throughout the 1980s did not differ significantly from least-developed countries as a whole. Furthermore, Riccardo Faini, Jaime de Melo, Abdelhak Senhadji, and Julie Stanton’s (1991:957–967) study of 93 LDCs undertaking adjustment before 1986, controlling for initial conditions and external factors, found no evidence of a statistically better (or worse) performance for World Bank/IMF loan recipient countries.

UNICEF (1989:21) contends that

the common aim of these [World Bank/IMF economic adjustment] measures is to improve the balance of payments, repay debts and reduce inflation. Important national objectives – such as expanding and protecting employment, ensuring a minimum income for households and providing basic public services – have become secondary. Ironically, the result has often been an aggravation of the economic crisis and a parallel human crisis as unemployment rises, incomes of the most vulnerable groups fall, import-dependent industries cut production, public services are curtailed, and public discontent and political instability grow.

Another UNICEF study shows that from 1980 to 1985, during a period of negative growth resulting from external debt limiting social spending, child welfare deteriorated in most of sub-Saharan Africa; that is, rates of infant mortality, child death, child malnutrition, primary school dropout, illiteracy, and nonimmunization all increased (Cornia 1987b:11–47). The fall in birth weight occurring throughout the sub-Sahara also indicated declining welfare. Moreover, an ECA paper indicates that killer diseases such as yaws and yellow fever, virtually eliminated by the end of the 1950s, reemerged in the 1980s (Green 1990:3).

Frances Stewart (1990) uses World Bank data to ask whether Bank/IMF policies restore external equilibrium and internal balance as well as long-term development. She finds no difference in the fall in GNP per capita, 1980–87, between sub-Saharan countries undergoing strong Bank/Fund adjustment programs and those with weak programs. Additionally, during the period, real domestic investment and export earnings fell, the fiscal deficit remained large, debt continued to accumulate, and the

current account did not improve, despite falling imports, in sub-Saharan countries undertaking adjustment. When Stewart deplores that “after undergoing tough programs, many countries found themselves with reduced real income, increased poverty, deteriorating social conditions, reduced growth potential and often with no significant improvements in their external accounts,” she was describing the situation in Nigeria (before the 1989–91 oil price recovery), Zambia, and Tanzania in the 1980s. She concludes that, irrespective of the cause, Bank/Fund policies did not meet their short-run objectives and were undermining growth potential, 1980–87.

Paul Mosley, Jane Harrigan, and John Toye (1991:Vol. 1) and FAO (1991c:15) criticize methods for evaluating World Bank/IMF adjustment programs. Comparing performance before and after adjustment, although useful and informative, has a strong static bias, FAO pointed out. The questions to ask are: How would the economy have performed without the policy reforms? How does this performance compare with the actual performance? Moreover contrasting adjusting to non-adjusting countries ignores the conditions when adjustment policies were initially implemented, the different economic and political characteristics of the countries and the different policies.

Mosley, Harrigan, and Toye (1991:Vol. 1, 181–207) reject comparing LDC World Bank recipients with LDC nonrecipients; the results will be misleading because recipients are not representative of LDCs generally. For example, perhaps only the most desperate countries apply for Bank adjustment loans (ALs), or the Bank may eliminate from consideration economies that are too weak to undergo programs. For this reason, Mosley et al.’s comparisons were based on selecting recipient countries with similar characteristics to 1980–86 recipients. To illustrate, Coteˆ d’Ivoire was paired with Cameroon, Kenya with Tanzania, Pakistan with Egypt, and Thailand with Malaysia. Another problem, the linkage of Bank ALs to other finance programs, such as an IMF stabilization agreement, was disentangled by regression analysis, which holds other influences constant.

Although both adjustment loan recipient and control groups grew more slowly in the early 1980s than in the late 1970s, the AL group had a significantly worse growth experience than the control group. Among the AL-assisted countries in which compliance with policy conditionality was high, growth was even more unfavorable compared to the relevant control group. Although the standard deviations were large, the AL countries had a greater fall in investment rates (from cutting the government development budget, from the multiplier effect in lowering aggregate domestic demand, and from the lesser constraints on spending on consumer import goods compared to project aid), but a more substantial improvement in current-account balance, a lesser decline in real export growth, and greater reduction in real import growth than non-AL countries (with all differences here and subsequently significant at the 5 percent level) (Mosley, Harrigan, and Toye 1991:Vol. 1: 181–207).

Mosley, Harrigan, and Toye’s (ibid.) regression-based results, which examine growth in all adjustment-loan countries, in sub-Saharan African countries, and in middle-income countries (with time lags varying from zero to two years) as a function

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of financial flows, compliance with Bank conditionality, and extraneous variables (weather and terms of trade), are consistent with their paired comparisons. Bank financial flows are negatively correlated but compliance with Bank conditions positively correlated with growth, so overall Bank program effects are nil (or perhaps negative, because the negative money effect is immediate, whereas the positive compliance effect, from price-based and other reforms, is lagged at least a year and uncertain to materialize). The authors explain the surprising negative effects of money flows by showing that they reduce pressures for policy reform and appreciate the real dollar price of domestic currency (as in “Dutch disease,” discussed in Chapter 13). The same study found that Bank financial flows have a strong negative effect and compliance with Bank reform a strong positive impact on export growth in the immediate period, but the relationships are reversed for a longer period (one or two years); the net effect of Bank programs on export growth is negative in the same and next years but positive two years hence. IMF standby credit, although positively related to middle-income countries’ growth, is negatively correlated with sub-Saharan growth. Both weather and terms of trade improvement have a positive effect on growth (Mosley, Harrigan, and Toye 1991:Vol. 1, 208–232.

FAO (1991:115–149), which examines the critical period after 1981–83, divided LDCs into healthy adjusters, who reduced internal and external deficits without jeopardizing growth, so savings and export earnings rose; unhealthy adjusters, who decreased the external deficit by restricting imports and investment, thus threatening the long-term capacity to expand; and deteriorators, whose internal and external deficits increased. Deteriorators appreciated their currencies in real terms, unhealthy adjusters’ currencies did not change, and healthy ones depreciated currencies, resulting in the most success in improving their trade balances. Income distribution shifts (for example, from urban to rural residents) following devaluation sometimes contributed to a recession, at least in the short run.

While savings rates declined from the 1970s to the 1980s, they recovered substantially after 1981–83 in the healthy adjusters, while falling uninterruptedly among unhealthy adjusters and deteriorators. LDC import and investment rates declined during the depression of 1981–83, afterward recovering unevenly and contributing to growth in the healthily adjusting Latin American countries but not recovering in any major African country grouping (FAO 1991:115–149).

The assessment of World Bank/IMF adjustment programs is mixed, with Bank studies indicating their effectiveness but several independent empirical studies failing to show the success of these programs. These studies, taken as a whole, show that the record of growth, external balance, and social indicators of countries with strong Bank/IMF adjustment programs was no better than those with weak or no adjustment programs. Moreover, Bank/Fund programs reduce investment and social spending. Yet, the World Bank and IMF could argue that these countries would have done worse with programs organized by national planners. Turning this statement on its head, many LDC leaders see no evidence that national planners do any worse than the Bank and Fund, but at least national adjustment plans provide indigenous people with experience and learning benefits. In the 1990s, the Bank and

Fund have put more emphasis on increasing recipient capability to plan adjustment programs. Future research needs to assess this new emphasis by the World Bank and IMF.

The Sequence of Trade, Exchange Rate, and

Capital Market Reform

Although price controls, exchange-rate misalignments, and government budget deficits contributed to the debt crisis, the immediate freeing of markets and contraction of spending may not resolve the disequilibrium. Many adjusting countries feel that the World Bank and IMF focus only on demand reduction. After 1981, the IMF emphasized shock treatment for demand restraint in low-income Africa, rarely providing financing for external adjustments, and cut programs from three years to one year. One year is not enough for adjustment. Demand restrictions, inflation deceleration, and currency depreciation do not switch expenditures to exports and import substitutes or expand primary production quickly enough to have the desired effect on prices and trade balance. Studies indicate that, even in DCs (for example, the United States, 1985–88), the current-account improvement from devaluation usually takes about two to five years, usually beginning with a worsening trade balance in the first year. The time for adjustment is due to the lags between changes in relative international prices (from exchange-rate changes) and responses in quantities traded. Lags involve time for recognition, decision (assessing the change), delivery, replacement (waiting to use up inventories), and production (Grubel 1981:349–388).

Trade liberalization in the midst of stabilization, even if politically possible, may perpetuate a government budget crisis. As Mosley, Harrigan, and Toye argue, given labor and resource immobility, early liberalization of external trade and supply-side stimulation in “one glorious burst” result in rising unemployment, inflation, and capital flight and the subsequent undermining of adjustment programs. This tradereform failure is consistent with the theory of the second best. An application of this theory suggests that trade liberalization while other prices are still controlled may be worse than having all prices distorted (see Chapter 17).

Mosley, Harrigan, and Toye (1991:Vol. 1) and FAO (1991:181–207) suggest the following trade, exchange, and capital market liberalization sequence: (1) liberalizing imports of critical capital and other inputs, (2) devaluing domestic currency to a competitive level, while simultaneously restraining monetary and fiscal expansion to curb inflation and convert a nominal devaluation to a real devaluation (McKinnon 1993:5), (3) promoting exports through liberalizing commodity markets, subsidies, and other schemes, (4) allocating foreign exchange for maintaining and repairing infrastructure for production increases, (5) removing controls on internal interest rates to achieve positive real rates, and expanding loans agencies to include farmers and small businesspeople, (6) reducing public sector deficits to eliminate reliance on foreign loans at banking standards without decreasing real development spending, and reforming agricultural marketing to spur farmers to sell their

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surplus, (7) liberalizing other imports, rationalizing the tariff structure,4 and removing price controls and subsidies to the private sector, and (8) abandoning external capital-account controls.

The eighth step recognizes the necessity of reforming internal capital markets before liberalizing international capital movements. Critics contend that neither World Bank nor IMF recommendations nor implementation bear much relationship to a sequence of reforms. Frequently, the World Bank asked for liberalizing trade early without limiting the imports that it should be applied to. For example, the foreign-exchange requirements associated with trade liberalization, the major component of the Bank’s first structural adjustment loan in Kenya in 1980, became unsustainable, so liberalization had to be abandoned. Additionally, import liberalization preceded agricultural export expansion based on commodity market liberalization, price decontrol, and export promotional schemes. By contrast, Ghana, under a World Bank sectoral adjustment loan beginning in 1983, allocated foreign exchange through an auction, and the goods eligible for entry to the auction expanded over time in line with the increased supply of foreign currency.

Moreover, recipients should implement IMF demand-reducing programs before the World Bank’s supply-increasing ones. If countries begin with supply reforms that take a longer time, the lack of demand restraint will contribute to inflation and an unmanageable current-account deficit. Still, adjustment loan recipients also need to avoid excessive initial demand restraint that depresses the economy; simultaneous devaluation, as in stage 2, could avoid this contractionary effect (Mosley, Harrigan, and Toye 1991:Vol 1, 110–16; FAO 1991:101–03).

Public Enterprises and the Role of Public Goods

Speaking broadly, a public enterprise is a government entity that produces or supplies goods and services for the public. Even in a capitalist country like the United States, government produces public goods that the market fails to produce. Public goods such as national defense and lighthouses are indivisible, involving large units that cannot be sold to individual buyers. Additionally, those who do not pay for the product cannot be excluded from its benefits. By contrast, quasi-public goods, such as education and sewage disposal, although capable of being sold to individual buyers, entail substantial positive spillovers and would thus be underproduced by the market. Government agencies in the United States produce part or all of the following public or quasi-public goods: national defense, flood control, preventive medicine, lighthouses, parks, education, libraries, sewage disposal, postal service, water supplies, environmental protection, gas, electricity, and police and fire protection (Case and

4Because they control currency convertibility, state trading agencies in socialist economies could simply refuse to authorize imports. Thus, McKinnon (1993:7–9, 93) stresses the importance of LDCs, especially those in transition from a state-controlled economy, converting implicit quota restrictions into explicit tariffs. “Once formally codified, the highest tariffs . . . can then be reduced toward zero over a preannounced fiveto ten-year adjustment period” (ibid., p. 9).

Fair 1996:313–315, 417–423; McConnell 1987:93–94). In most countries, however, the government sector supplies more than public and quasi-public goods.

Arguments for Public Enterprises

Social profitability in excess of financial profitability provides major reasons for public enterprise. Public investment can create external economies, improve integration among sectors, produce social goods for low-income earners, and raise the capital essential for overcoming indivisibilities. Frequently, officials indicate that creating new jobs is the rationale for establishing state enterprises. Moreover, public firms can rescue bankrupt private firms in key sectors, or state initiative can substitute for private entrepreneurship when risk is high, capital markets are poor, or information is sparse. Finally, governments have noneconomic reasons for creating SOEs, including control of key sectors, wresting control from foreign owners or minority ethnic communities, responding to foreign donor pressure, or to serve other social and political goals, such as avoiding concentration of economic power among private oligopolists.

Definition of State-Owned Enterprises

State-owned enterprises (SOEs), called public enterprises, are common in transitional China, and market economies such as Taiwan, South Korea, and Brazil. Most SOEs are in large-scale manufacturing, public utilities (electricity, gas, and water), plantation agriculture, mining, finance, transport, and communication.

For this chapter’s discussion, a state enterprise consists of an enterprise (1) where government is the principal (not necessarily majority) owner or where the state can appoint or remove the chief executive officer (president or managing director) and

(2) that produces or sells goods or services to the public or other enterprises, where revenues are to bear some relationship to cost. Public enterprises that do not maximize profitability may still qualify if they pursue profit subject to some limitation assigned by the state (Gillis, Perkins, Roemer, and Snodgrass 1987:569). This narrow definition of state-owned enterprises differentiates public enterprises producing steel, palm products, electricity, and telephone, telegraph, banking, and bus services from public agencies that run schools, libraries, agricultural extension services, and police departments. The United States, with SOEs that include municipally owned public utilities, intracity transport, the post office, and the Tennessee Valley Authority, has fewer public enterprises than most DCs and LDCs.

Importance of the State-Owned Sector

The contribution of state-owned enterprises to GDP in developing countries increased from 7 percent in 1970 to 11 percent in 1978–91. The highest share was in subSaharan Africa with 14 percent (20 percent of formal-sector employment), followed by Latin America with 10 percent, and 8 percent in Asia (World Bank 1983i:49–50; Cook and Kirkpatrick 2003:213).

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Data on the size of government sector are incomplete and incomparable. In 1980, 13 percent of LDC nonagricultural employment was in nonfinancial public enterprises compared to 4 percent in the OECD. Public enterprise employees were 1 percent of the total population in LDCs compared to 1.5 percent in the OECD (Heller and Tait 1983:44–47). However, in the 1980s and early 1990s, output and employment shares in LDCs’ public sector fell, as IMF and World Bank lending to resolve external crises was usually linked to a program including privatization of public enterprise and SOE reform.

In the early 1980s, government employment as a percentage of total nonagricultural employment was 24 percent for OECD countries and 44 percent for LDCs – 54 percent in Africa, 36 percent in Asia, and 27 percent in Latin America (Heller and Tait 1983:44–47). In the 1990s, LDCs, under pressure from international financial institutions, reduced the share of employment and spending in the government sector. In 1995, the average size of government in Latin America and the Caribbean, as measured by public-sector expenditures, was 28 percent of GDP compared to 49 percent in OECD countries (Stein 1998:3).

In Brazil in 1985, a survey of the 8,094 largest incorporated firms indicated that SOEs controlled 48 percent of assets and 19 percent of employment (Baer 2003:221). Nigeria’s government spending as a share of GDP rose from the 1960s to the 1970s but fell in the late 1980s and early 1990s (Chapter 16) in response to World Bank programs emphasizing privatization, market prices, and reduced government expenditures (Nafziger 1988a, 1993).

Performance of Private and Public Enterprises

EFFICIENCY

Impressions of the superior performance of private enterprise often originate in anecdotes and informal case studies of Western businesspeople and aid officials. The British economist Robert Millward (1988:143–161) carefully examines studies comparing economic efficiency to test these impressions. Few studies measure precisely the performance of public and private firms of the same size, type, and product mix, and adjust for factor prices across enterprises that management cannot control (for example, the higher wage rates and cheaper capital that public enterprises face).

Studies comparing U.S. and British electricity and transport enterprises in private and public sectors indicate that productivity or cost effectiveness was as high in the public sector as in the private sector. Yet public firms, which charge lower prices, have lower financial profitability than private enterprises (ibid.).

The following three LDC studies compare public and private firms, while statistically holding other variables equal. W. G. Tyler’s (1979:477–495) analysis of the Brazilian steel industry indicates that if you control for size, whether a firm was privately or publicly owned had no significant impact on technical efficiency. K. S. Kim (1981:471–484) finds that government ownership had no significant effect on efficiency in Tanzania’s food and machinery industries. H. Hill’s (1982:1015–1023) study of automated weaving in Indonesia indicates that the higher productivity of