Shuja Nawaz - IMF eLibrary...introduces selected excerpts from some of his speeches Rudolf Hablutzel...

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New World Bank books

WATER SUPPLY AND SANITATION —A NEW AND TIMELY SERIESThe United Nat ions has designated the 1980s as the Internat ional Drinking WaterSupply and Sanitation Decade. Its goal is to provide two ol ' the most fundamentalhuman needs—sale water and sanitary disposal of human wastes to all people.To help usher in this important period ol international research and cooperation,the World Bank is publishing three volumes on appropriate technology for watersupply and waste disposal systems in developing countries.

Since the technology for supplying water is more widely understood, the seriesemphasi/.es sanitation and waste reclamation technologies, their contributions tobetter heakh. and how they are affected by water service levels and the abil i ty andwillingness oi" communities to pay for the systems.

The first two volumes are described here. The third. Sanitation ami DIM-UWHealth Aspects of Excreta anil Wastewater Management, will be available in thelatter half of 1981.

All three books arc published for the World Batik bv I he Johns HopkinsUniversity Press and are available from booksellers: directly from the Press(Baltimore. MD 21218. U.S.A. or Ely House. 37 Dover Street. London W I X4HQ. U.K.) ; or from Press d is t r ibutors throughout the wor ld

APPROPRIATE SANITATION ALTERNATIVESA Technical and Economic Appraisal

John \l. Kulhermutten. DeAnne .V. Julia.',, anj l ' h a r i f \ (,. (iunni'r\i>n

This volume summarizes the technical, economic, e n v i r o n m e n t a l , heal th , andlociocultural findings of the Bank's research program on appropriate san i t a t ionalternames and discuses ihe aspects of program p l a n n i n g tha i an- iK-k:ess.ii> loimplement these I i r i d i n g s h is directed p r i m a r i l y tovva id p U n m i i t : officials andsector policy advisers for developing countries

The most important l i n d m g is (ha t there an- mam d i f f e r e n t k ind- ut technolnir.lhal can be satck and chcapK used on ,i w i n e scale T h r o u g h o u t , emph.iplaced on l i n k i n g improvements in environmental sanitat ion wi th p o i t m s . s ibenefi ts t o h v , i l i l i

Approximately 21)8 pages. Paperback I 'SSIMS.

A P P R O P R I A T E SANITATION ALTERNATIVESA Planning and Design Manual

John U. f^tilhernitiltcH, I>f Arm? S Julius. Cfiarlt"- (i (iiitiu,'r\tit>. tin,!I) Dliin tin \lura

Ihis manual presents guidelines. proLcdmes. ;md uvriiu)]ii(;ii:i h.isi'J i ' i i i l i cI t u n k ' s U\MI research; summan/es sclccled portions ul u i h i ' r p i i h ! k . , i l i . . r i s m:s a n i t a t i o n program pUnning . and descnhes ihe cngmcenri( i d e t a i l s ol , i l l i ; i i i j i i \ esan i i . i i ion lec l t i iDl i t . s i i t J s .md liuw shc> can hu upgraded.

I h..- r i u i L - i i . i l > t n t e i i d L - d l u r professionallj t r a i n e d project engineers ands t i enusLh and im i i - t l n u c i a i i s and t i e l d w o r k e r s who .ire k i m i l i u r w i t h ilk-par t icu lar fcogruphic and c u l t u r a l condiuori .s ;n uv.-n |'ion:ci .ircas

Approximatelj '--I p.igcs. I 'apeihaek U S S I S . I K . 1

EMPLOYMENT POLK V IN DEVELOPING ( OlM HIESA Survey of Issues and Evidence

/ i n St/iiirc

Low uitcs oi y i o w t h in industrial employment, high tatus ol unemploymentamong new entrants to the urban labor market, and low k- \ fb i> l lahoip i o J u i ' t i v n \ .UK! remuneration are the three ISMICS ,iddi(.^-.ud in this s t i u l - ,

The a u t h o r u k n i i l u ' s i l u - more important dcterminmils t i l ktboi ,lem.iiul amis u p p h .UK! t i n i1 M e n t to w h i c h the growth ol labor tlem:imt has hccneiuisir . i inc,! and la hoi s u p p K . iJv.tncn! h> i n . i p p n ' p r i . i lc policies I '11 I hidemand side, i n d u s i n . i : n.nk- p u l i L 1 ) . agricultural j > i i > u i h . and the o p e M N . n i olcapi ta! n u t k e i s ate discussed; nn the MippK Mile, .mention is iodised u npopulat ion and education pohc\

\ lH ' !"M"i : i [cK 2()S pages Cloth I ' S S h - ' i ' - papcrbact I ^ ~ "I'hisi hook is p u b l i s h e d tor the World Hank tx ( K l o r d 1 I L I \ L - I M I \ 1 ' i essa iu l is

. U L i i l a h l e I n i i i i l iook-L-lkTs; d i r e e t l s Irom [ho | 'IL^S [21H1 M . n i r s o s i A ' - e t m e .New V - ' i k . ^^ HIOl l . . I .S.A. or Piess Koad. \-;r,,!L-r;. I n t i ihui \\\ 1C ! '! '[ '[ ' K . I : o r t i o n i ( ) \ lo rd blanches and d i s t r i b u t o r s ih ro ' . i i i t i om die w i i r l i i

©International Monetary Fund. Not for Redistribution

June 1981 /Volume 18/Number 2

Finance-A quarterly publication of the International Monetary Fund and the World Bank

William Clark 6 The McNamara yearsA personal view of Mr. McNamara's role as President of the World Bankintroduces selected excerpts from some of his speeches

Rudolf Hablutzel 10 Issues in economic diversification for the oil-rich countriesSignificant factors that govern the efforts of the Middle Eastern oilproducers to develop their domestic economies

Manuel Guitian 14 Fund conditionality and the international adjustment process:a look into the 1980s

The final article in a three-part series examines recent Fund policiesin support of member countries' adjustment efforts

G. Russell Kincaid 18 Conditionality and the use of Fund resources: JamaicaAn example of how the Fund attempted to work with a membercountry in a period of economic difficulty

Augustus W. Hooke 22 The Brandt Commission and international monetary issuesSome of the main issues are identified and examined against the evolutionof Fund policies in response to changes in the international monetarysystem

Enzo R. Griiii 25 Natural rubber: a better future?After the rise of oil prices, the economics of natural production havechanged for the better vis-a-vis petroleum-based synthetics

John Russell 30 Adapting extension work to poorer agricultural areasDo not transplant extension experience without taking into account thestate of local economic development and infrastructure

p.N. Kaul 34 Technical assistance from the Fund: Central BankingDepartment

Increasing demand for advice has shaped this important Fund activity

Alan Tait 38 Is the introduction of a value-added tax inflationary?Not really, according to data from 31 countries

2 Fund activityFirst quarter of 1981 marked by important developments; borrowingarrangement with and quota increase for Saudi Arabia; Trust Fundmakes final disbursements; new loan commitments; Fund transactions

4 Bank activityLoans for communications in Latin America and Caribbean region; firstloan to Zimbabwe; Bank loans and IDA credits

43 Book noticesThe Cruel Dilemmas of Development by Sylvia Ann Hewlett, reviewedby Jack Sweeney; Trade Relations Under Flexible Exchange Rates byRichard Blackhurst and Jan Tumlir, reviewed by Morris Goldstein; ResourceMobilization in Poor Countries—Implementing Tax Policies by Alex Radian,reviewed by Vito TanziOther books received

•». •¥•• Nil •VJfc (SXDevelopment


Fundactivity The challenges facing the

International Monetary Fund

First quarter of 1981marked by important developments

The first quarter of 1981 was marked by anumber of notable accomplishments inmeeting the challenges currently facing theFund. In addition to the completion of thefinal loan disbursements from the TrustFund, the simplification of the SDR basket,and the decision to continue enlarged ac-cess to the Fund's resources, the Fundreached agreement in principle with SaudiArabia on a quota increase and on an ar-rangement to borrow resources to permitthe Fund to continue its lending operationswithout interruption and for the smooth func-

tioning of the recycling process. The in-crease in Saudi Arabia's quota will also re-sult in a substantial rise in the Fund'simmediately available resources in supportof the Fund's expanded level of operations.New loan commitments under stand-by andextended arrangements during the firstquarter of 1981 reached SDR 4.3 billion,compared with SDR 1.2 billion for the cor-responding period in 1980. Some of theseimportant measures are described briefly inthis section. For full texts, please see theIMF Surveys of March 23 and April 6, 1981.

Agreement with Saudi Arabia on quota increase andFollowing are excerpts from the Manag-ing Director Mr. Jacques de Larosiere'sstatement on the Developments in theFund's Financial Relations with SaudiArabia. The statement was released onMarch 27, 1981.. . . The Executive Board of the Fund hasunanimously approved today to recommendto the Board of Governors that Saudi Ara-bia's quota in the Fund be increased fromits present level of SDR 1,040.1 million toSDR 2,100 million. This will increase SaudiArabia's share in total quotas from 1.74 percent to approximately 3.5 per cent.

The increase in quota will become effec-tive following a vote by the Fund's Board ofGovernors.

The Executive Board supported the SaudiArabian request for an increase in quota asan exceptional matter. The Board judgedthat Saudi Arabia's quota was out of line atthe present time, taking into account therelative importance of Saudi Arabia in theworld economy. The Executive Board alsonoted the uniquely large-scale lending bySaudi Arabia to the Fund, both in the pastas well as prospectively, and not only in ab-solute amounts but also in terms of its quota.The increase in Saudi Arabia's quota will re-sult in a substantial increase in the Fund'simmediately usable resources, which can beused in support of the Fund's expandedlevel of operations at this time.

Table 1New loan commitments and other use of Fund resources: 1978-81

(In billions of SDRs)

Calendar yeat

1978 1979

1.3. New loan commitments understand-by and extended

1980

January-March

1980 1981

arrangements in period (including

1.b.

2.

oc t where applicable)Industrial countriesDeveloping countries

Purchases1

Industrial countriesDeveloping countries

Trust Fund loans disbursed(Developing countries only)Total (1+2)

1.90.11.80.70.10.6

0.73.3

2.2—2.20.7—0.7

0.53.4

7.2—7.21.0—

1.0

1.39.5

1.2—1.20.4—0.4

0.31.9

4.3—4.30.1—0.1

0.44.8

Source: IMF, Treasurers Department.Note: Details may not add to totals due to rounding. .1 Other than purchases under stand-by and extended arrangements (that is. credit tranche, compensatory financing

buffer stock, and oil facilities).

The nature and scope of the challengesfacing the Fund were examined by theFund's Managing Director, Mr. Jacquesde Larosiere, in remarks before the an-nual conference of the Association ofReserve City Bankers in Palm Beach,Florida. The three challenges facing theFund were described by the ManagingDirector as promoting balance of pay-ments adjustment, facilitating the recy-cling process, and working to improvethe international monetary system. Thefull text of the Managing Director'sspeech was published in the April 6,1981 issue of the IMF Survey.

borrowing arrangementThe increase in the Fund's usable re-

sources through the rise in Saudi Arabia'squota is timely and is in addition to the con-clusion of an important borrowing agree-ment reached in principle on March 24 be-tween the Fund and the Saudi ArabianMonetary Agency (SAMA).

. . . SAMA will make a lending commit-ment to the Fund of SDR 4 billion in the firstyear of the agreement and a further SDR 4billion in the second year. The Saudi Ara-bian authorities have also indicated their in-tention to enter into a further commitmentfor the third year if their balance of paymentsand reserve position so permits. Drawingunder these borrowing arrangements will beable to continue during a commitment pe-riod of six years, each call being subject toa notice period of 90 days. The Fund will un-dertake to draw down at least SDR 1 billionin the first year, and not more than SDR 4billion in any one year (without the furtheragreement of SAMA). The loans will be de-nominated in SDRs.

. . . As you know, our resources under thesupplementary financing facility are now vir-tually committed. It is thus most timely to beable to conclude this agreement and to havethe resources from the increase in quota.This will allow us to continue our lendingoperations, without interruption, for thebenefit of countries whose balance of pay-ments difficulties are pressing and for thesmooth functioning of the recycling process.These agreements reflect the growing roleof Saudi Arabia in the world economy. I be-lieve that they represent a most importantstep to strengthen the Fund and the inter-national monetary system.

Finance & Dci't'lopnient fitin' 19812


Final loans disbursedfrom Trust Fund

The International Monetary Fund, as Trustee,has completed the final loan disbursementsfrom the Trust Fund, bringing total disburse-ments to the equivalent of SDR 2,991 mil-lion. The disbursements were made in twoperiods. During the first period, from July 1,1976 to June 30, 1978, loans totaling theequivalent of SDR 841 million were madeto 43 developing members, and during thesecond period, from July 1, 1978 to Febru-ary 28, 1981, 53 members received dis-bursements totaling SDR 2,150 million.

The Fund has also distributed profitsto 104 developing members totalingUS$1,288.7 million from the sale of gold.

With the completion of loan disburse-ments, the Trust Fund was wound up onApril 30, 1981.

Increasing the usableresources of the Fund

Answering a question at a press confer-ence on March 27, the Managing Directorspoke on the Fund's usable resourcesand the effect on them of the borrowingfrom Saudi Arabia:

. . . We have two categories of resourcesthat we use in our lending—what we callordinary resources, and borrowed re-sources. Some of our lending is financedonly through ordinary resources. That is thecase, for instance, with a first credit tranchedrawing or for countries who wish to remainwithin the 100 per cent drawing limit, or forcountries who borrow under the compen-satory financing or buffer stock financing fa-cilities. But in many other cases, and moreand more so now, when you have a programthat goes beyond the 100 per cent—or 140per cent in case of the extended facility—we need to combine the ordinary resourcesand an amount of borrowed resources.Globally I can tell you that the arrange-ments, the programs, in high credit tranchesthat we are financing and will continue tofinance will comprise approximately onethird of ordinary resources and two thirds ofborrowed resources. This is not true in eachcase, of course, because much depends onthe position of the country in the Fund andthe exact amounts requested. But, generallyspeaking, the lending operations under Fundprograms will be financed one third fromordinary resources and two thirds from bor-rowed resources.

We have in the Fund now some SDR 20-21 billion of immediately usable currencies.This will contribute to the financing of all thecompensatory financing and first credittranche drawings (which are completely fi-

Table 2Selected data on Fund's assistance to members—disbursements and repurchases:

1978-81(In billions of SDRs)

Purchases under all Fund facilities(excluding reserve tranche purchases)plus Trust Fund loan disbursements


Of which Trust Fund loandisbursements

Repurchases1


Net purchases (+) andnet repurchases (-) (all members)

Of which repaid to lendersIndustrial countriesDeveloping countries

1978

1.90.11.8

(0.7)

4.82.82.0

-2.9(2.6)

-2.7-0.3

Calendar year1979

2.2—2.2

(0.5)

4.22.61.6

-2.0(2.8)

-2.40.5

January-March

1980

4.6—4.6

(1.3)

3.31.41.9

1.3(0.9)

-1.42.7

1980

1.0—1.0

(0.3)

0.70.40.3

0.3(0.2)

-0.40.7

1981

1.7—1.7

(0.4)

0.60.10.5

1.1(0.2)

-0.11.2

Source: IMF, Treasurers Department.Note: Details may not add to totals due to rounding.1 The first Trust Fund loan repayments are not due until July, 1982.

Table 3Summary of Fund operations in the General Resources Account,

January 1, 1978-March 31, 1981(In millions of SDRs)

Total purchasesReserve trancheCredit tranche

Of which, supplementary financingCompensatory financingExtended facility

Of which, supplementary financingBuffer stock

Total repurchasesNet purchases1

Fund borrowingGeneral Arrangements to Borrow2

Oil facilitySupplementary financing facility

Repayment of loansGeneral Arrangements to Borrow2

Oil facilitySupplementary financing facility

Net borrowing3

1978

3,744.32,535.5

421.0

(-)577.7174.0

(-)36.1

4,845.2-1,100.9

777.3——

1,142.11 ,422.6

—-1,787.4

1979

1,842.8147.1853.1

(205.4)572.0233.0

(101.5)37.7

4,215.3-2,372.5

——

306.9

587.92,218.3

—2,499.3

1980

3,752.7359.2

1,798.6(943.1)980.4614.5

(275.2)—

3,344.8407.9

——

1,218.3

—900.5—

317.8

January 1-March 31,

1981

1,505.7202.9

1,117.3(342.6)

19.4166.1(51.0)—

592.4913.3

——393.6

—243.2—

150.4

Source: IMF, Treasurer's Department.' (—) Indicates net repurchases.2 Includes Swiss National Bank.3 (—) Indicates net repayment.

nanced through ordinary resources) duringthe period, plus, of course, the part of themixed financing of programs which I re-ferred to. So we have to use this SDR 21billion over the period from now until theEighth General Review of Quotas, which Ihope will be completed by 1983.

Based on projected Fund lending for the

next few years, we will need in borrowedresources approximately SDR 6-7 billionannually in 1981, 1982, and 1983. So yousee that having reached an agreement forSDR 4 billion for the first year and SDR 4billion for the second, we have gone a longway toward meeting our needs for borrowedresources. . . .

Finance & Dei'clopment / June 1981 3


$83 million in loans for improving transportationin Latin America and Caribbean region

Haiti, Mexico, and Peru will benefit fromloans recently approved by the World Bankand the International Development Associa-tion (IDA) for improving communicationsystems.

Haiti will receive an IDA credit of approxi-mately US$11 million to expand and reha-bilitate the country's international port atCap Haitien and to build, or rehabilitate,seven other small ports. Cap Ha'itien servesan international traffic of cruise ships andcargo vessels vital to Haiti's economy. Thistraffic is currently endangered by the dete-rioration in existing port facilities. The IDAcredit will ensure the continuation of thistraffic, and of the labor-intensive activitiesengendered by it, thus safeguarding thejobs of the region's population.

A $14 million Bank loan to Mexico willhelp finance the preinvestment stage of aprogram to develop ports for four coastalareas of the country. Development of the

ports will help the Government to decen-tralize economic activity and growth fromthe central plateau and provide domestic in-dustries with direct access to internationalmaritime transport. The development will, inaddition, help to handle the recent increasein traffic coming to Mexico by sea. The ca-pacity of Mexican ports is no longer ade-quate for general cargo and nonpetroleumbulk commodities, and more than 2 milliontons of the country's imports and exports arebeing handled annually through UnitedStates ports, with extensive overland move-ment. The Government has estimated thatmore than $2.5 billion will be required forinvestments in infrastructure in the four portareas between 1980 and 1985.

In Peru, a $58 million Bank loan will go toa project for the improvement of three re-gional airports in the Amazon jungle andjungle highlands which currently have in-adequate transport links with the rest of the

Robert S. McNamara will retirefrom the World Bank, effectiveJune 30, 1981, after havingserved as President of the Banksince April 1968. He will be suc-ceeded by A.W. Clausen. Mr.Clausen's appointment be-comes effective on July 1.

country. The project also includes the con-struction of a fourth airport, technical assis-tance for another, and the provision of nec-essary aviation equipment. The lack ofadequate infrastructure and facilities has re-strained the growth of Peru's commercialaviation and reduced its efficiency. Airportsare frequently shut down because of pooroperating conditions and many cannot han-dle the most economical aircraft for existingtraffic volumes. The project attempts totackle these problems.

Operations approved3

Borrowing countriesMember countries

World Bank

World Bank

Loan amounts1

Disbursements2

Operations approvedBorrowing countriesMember countries

International DevelopmentAssociation (IDA)

Credit amountsDisbursements

Table 1and IDA lending: fiscal years 1977-80

(Ending June 30)

1977

5,7592,636

16154

129

1,3081,298

Fiscal year1978 1979

(In millions of U.S. dollars)

6,098 6,9892,787 3,602

(Number)

137 14246 44

132 134

(In millions of U.S. dollars)

2,313 3,0221 ,062 1 ,222

1980

7,6444,363

14448

135

3,8381,411

(Number)

6736

117

9942

120

10543

121

10340

121

Source: World Bank Annual Report 1980.1 Excludes loans to International Finance Corporation of $20 million in fiscal year 1977. Includes amounts in fiscal

year 1977 lent on Third Window terms.2 Excludes disbursements on loans to International Finance Corporation.3 Joint World Bank/IDA operations are counted only once as Bank operations.

World Bank and IDA:lending to countries withannual per capita incomebelow $360.fiscal years 1971 -80(In millions of U.S. dollars)

Finance & Development I June 1981

Bank,activity

4


Table 2World Bank loans approved during third quarter of fiscal year 1981

(Ended March 31, 1981)

Country1

BahamasBarbadosBotswanaBrazilColombia (2)Guyana (2)Indonesia (2)Malaysia (2)Mexico (2)Morocco (2)Panama (2)PeruPortugalThailand (2)TunisiaTurkey (2)YugoslaviaZimbabwe

Total

Source: World Bank.

Purpose

Vocational educationPowerRoadsUrban transportRural roads, powerStructural adjustment, technical assistancePower, swamp reclamationRice development, rural developmentAgriculture, port developmentTourism, urban developmentOil exploration, development bankingAviationDevelopment bankingIndustrial development, development bankingVocational educationAgricultural exports, development bankingRural developmentManufacturing rehabilitation

Amount (In millionsof U.S. dollars)

7.0

6.0

17.0

90.0

118.015.5*

272.090.0

294.0136.026.558.0

100.038.926.080.087.050.0**

1,511.9

' Figures in parentheses are the number of loans approved for the respective country.• With an $8 million IDA credit." With a $15 million IDA credit.

Table 3IDA credits approved during third quarter of fiscal year 1981

(Ended March 31, 1981)

Country'

Bangladesh (3)

Burma (2)Egypt, Arab

Republic ofGuinea-BissauGuyanaHaiti (2)

India (3)KenyaMalawi (2)MaliNepal (3)

Pakistan (2)RwandaSenegalSierra LeoneSolomon IslandsSomaliaSudan (2)UgandaUpper VoltaYemen Arab

Republic (2)Zimbabwe

Total

Purpose

Technical assistance, port and rail development,development banking

Grain storage, wood industries

Fish farming developmentOil explorationStructural adjustmentPost-hurricane agricultural rehabilitation, port

rehabilitationIrrigation, telecommunications, tank irrigationEducationSecondary education, highwaysRoad maintenanceIrrigation, agricultural extension and research, rural

developmentVocational training, small-scale enterprisesCoffee productionForestryDevelopment bankingDevelopment bankingPrimary and secondary educationIrrigation (2 projects)Water supplyAgricultural development

Power, development bankingManufacturing rehabilitation

Amount (in millions ofU.S. dollars)

91.055.0

14.06.88.0*

14.2508.0

40.074.017.0

29.055.015.09.3

12.01.5

10.267.0

9.016.0

24.015.0**

1,091.0

Source: World Bank.1 Figures in parentheses are the number of credits approved for the respective country." With a $14 million Bank loan." With a $50 million Bank loan.

First loan to Zimbabwe

The World Bank recently approved twoloans to Zimbabwe, totaling US$103 mil-lion, to assist in the rehabilitation of themanufacturing sector and to produce morecoal for use in power plants and for export.The two loans constitute the beginning oflending operations to Zimbabwe since thecountry became a member of the Bank inSeptember 1980.

About $65 million will be provided by theWorld Bank and its soft-loan affiliate, the In-ternational Development Association (IDA),to support the rehabilitation of the manufac-turing sector.

The loan will finance the import of rawmaterials, spare parts, balancing equip-ment, and components. Only those goodsneeded to increase utilization of the existingmanufacturing capacity will be eligible forfinancing under this program. Consumergoods and capital items will be excluded.Expanded production of export goods is es-timated at $50 million and the goods for do-mestic consumption are valued at $300 mil-lion in foreign exchange saving. About 8,600additional jobs are expected to be createdas a result of an increase in the utilizationof capacity of the manufacturing sector.

A loan of $38 million will help finance anopen cast coal mining project at Wankie, tobe implemented by the Wankie CollieryCompany Limited, the only coal and cokeproducer in Zimbabwe. The loan will be pro-vided by the International Finance Corpo-ration (IFC), the Bank's affiliate that pro-motes and assists private enterprises indeveloping member countries, with partici-pation by a group of commercial banks.

This new facility is of high national priorityand will produce a minimum of 3 millionmetric tons of coal per year. Part of this coalwill be supplied to a new thermal power sta-tion, currently under construction near themine, which is needed to prevent a seriouspower shortage in the mid-1980s.

Zimbabwe's immediate economic priorityis to rehabilitate its economy. The Govern-ment is attempting to mobilize substantialamounts of resources very fast to removecritical bottlenecks in the economy createdby the prolonged war of independence andthe economic sanctions imposed on thecountry (formerly Rhodesia) by the interna-tional community after 1965. Both the warand the sanctions, along with increases inoil prices and two droughts, resulted in asignificant decline in economic activity be-tween 1975 and 1979. With the attainmentof Independence and the end of the warover a year ago, the economy once againbegan to grow.

Emmanuel d'Silva

Finance & Development I ]une 1981 5


The McNamara yearsA personal note introducing selections from speeches by Mr. McNamara.

William Clark

Robert S. McNamara is retiring from the World Bank in June1981, after 13 years as its President. During his tenure, there hasbeen a sea change in the quality as well as the quantity of theBank's lending operations and the development policies that itpursued. Bank lending during Mr. McNamara's presidency hasgrown from US$1 billion in fiscal year 1968 to $11.5 billion in1980, so that today the Bank is supervising more than 1,600 proj-ects in 100 countries. But these statistics show us only one aspectof the McNamara years at the World Bank. They do not reflectthe unique vision of development that Robert McNamara broughtand implemented during his tenure. Nor do the statistics onlending adequately reflect his managerial ability and remarkablecapacity for absorbing and using the vast amount of economicand social data produced by the Bank to shape the Bank's policiesto serve his vision.

Early on, even before he had come to the World Bank, Mr.McNamara had recognized as "the central historical event of ourtimes" the need to speed up the development of the poorestcountries that made up the Third World. He clearly felt that de-veloping countries need to devise policies and investment pro-grams to assist the poor in their societies to become more pro-ductive and to ensure an equitable distribution of basic servicesto them. In response to these needs, Mr. McNamara sought toshape the policies and programs of the Bank to improve the lotof the poorest. He had a vision that saw the Bank as a key in-strument for restructuring the world's economy so that the ma-jority of its population—the poorest two thirds—could enjoy afair share of the earth's resources. He saw this as the Bank'smission, one that could be accomplished by fashioning Bank pro-grams and policies in consultation with, and in response to, theneeds of member countries. But he also saw the Bank's role asa pioneer in the field, providing leadership in this direction fornational and international agencies.

He was under no illusions about the difficulty of the task, onethat later was exacerbated by massive disruptions in the worldeconomy. But he was impatient with those who held that it wasbeyond the competence of the Bank to provide leadership to thisend. To those on his staff and to many more outside who calledfor cautious prudence because "even the World Bank is only abank," he replied in the opening of his first speech to the Gov-ernors by saying: "I have always thought of the World Bank assomething more than a bank, as a development agency."

Early on, he asked his senior staff why no loans had beenmade to several important developing countries (such as Egyptand Indonesia) and to very many of the most underdevelopedcountries (in, for example, the Sahelian zone). The reply was (inpart) that there were severe financial constraints on the amountof money the Bank could raise in the markets. "Then give me alist of all projects which you would undertake if there were nofinancial constraints." That was the origin of the Five-Year Planto double Bank lending, which he announced in his first speechto the Governors in 1968.

That speech was to serve as McNamara's manifesto. It pro-claimed his belief that poverty could be eradicated and tha t the

power to do so was at hand if the will was there. As he put it:"The parable of the talents is a parable about power—about fi-nancial power—and it illuminates the great truth that all poweris given to be used, not to be wrapped in a napkin against risk."

To act when the power lay to hand was a moral duty, and for13 years Mr. McNamara sought to fashion in the World Bank themost effective practical instrument for such action on develop-ment. If it continues to be used as he intended, it will be theliving proof that his vision of a cooperative, progressive, anduniting world was valid.

Mr. McNamara saw that the power of this instrument mustdepend primarily upon the volume of resources made availableto it by the industrialized economies, and he was confident itcould be so provided. By diversifying its sources (to the FederalRepublic of Germany, first of all, and then to Japan and theMiddle East) the Bank successfully raised its borrowings in 12years from under $1 billion to over $7 billion.

But it was always clear to Mr. McNamara that this developmentinstrument must be not only powerful but also precise. He there-fore concentrated on improving the quality of Bank loans—directing them more precisely to break the constrictions ongrowth and development. This required an effort far more sub-stantial than that needed to double and quadruple the financialresources of the institution. Into the Development Policy Staffand the Central Projects Staff he recruited the ablest experts—oneconomics, agriculture, transport, education, and so on—thatcould be found in the Bank's member countries. Their task, inconjunction with the operational staff, was to devise individualprojects that would be precise, efficient, and economical.

In his early speeches, Mr. McNamara dwelt with great em-phasis on the numbers of poor people in the developing worldand on the population explosion that was multiplying thosenumbers. It was the billions of poor people that forced him tomobilize multibillions of dollars to finance economic projects toimprove their lot. On the other hand, he was to learn from in-tensive travel in the Third World, not just to capitals but to therural areas of some of the poorest countries, that this develop-ment assistance never adequately trickled down to the rural poor.

From these firsthand observations he devised, over a periodof time, a comprehensive attack on "absolute poverty"—a phrasehe coined and to which he gave a clearly defined meaning. Theessence of this attack on poverty was to use development assis-tance to make the poor more productive; in particular to helpmillions of small farmers produce enough to feed themselvesadequately and to have a surplus to sell to the cities.

This program of self-sufficiency in food was required to pro-vide the solid base on which member countries could hope tobuild real growth. In addition to Bank help, there remained ob-ligations for the governments of the developing world: to ensurethat the state's social services (pure water, health clinics, edu-cation, and so on) were directed to the poor masses whereverthey were and not just to the privileged (and usually urban) few.In this approach, resources were to flow directly to the poorest,and their basic needs were to be met earlier and more extensively

Finance & Development I June 19816


than they could be by a strategy of generalized growth in nationalproduct. More important, from Mr. McNamara's point of view,such a program could have a decisive effect in reducing fertil i tyrates—so that the planet's population might stabilize earlier andat a lower figure.

The planning and refinement of this broad strategy, the fash-ioning of an instrument to give it effect, and the continuous mon-itoring of the projects in place to carry it out—all these wereextensively discussed by the Executive Directors, in the Presidentof the Bank's speeches to the Governors, and in the Governors'responses. But there was one central issue that got little public-discussion: who was, in fact, to control the day-to-day operationsof this powerful instrument? No one disagreed that in theory and

William Clark joined the Bank in I9b8 and was Vice President, External Re-lations, from 1972 to 198(1. In 1980 he succeeded Barbara Ward as President ofthe International Institute for l:.nrironnient and Droelopinent with offices inLondon (U.K.) and Washington, D.C. (U.S.A.).

practice the ultimate authority on all policy matters was theBoard, where some 20 Executive Directors sat as appointed orelected representatives of 139 member governments.

In Mr. McNamara's view, it was his duty as Chairman of theExecutive Directors arid as President of the Bank to put forwardpolicies that would command a broad consensus of agreementwithin the whole Board. It was his particular concern to ensurethat the Board was never polarized, especially along the North/South fault line, and on this he was nearly always successful.

On one policy matter Mr. McNamara was adamant; though itwas often requested, he always refused to submit his policyspeeches in advance. "If you insist on that you'll have to findyourselves another President," he used to say with jovial firm-ness.

These speeches were his chosen method of telling his mastersand colleagues around the world what he had learnt and whathe had perceived in his relentless search for a more equitableworld order. There were many uncomfortable words for rich andpoor alike in those speeches, which contain the pa infu l t ruthsand hopeful perceptions of a dedicated and practical visionary.

finance fy Development I June 1981 7

Wold bankpage


Goals of development" . . . the principal goals of development . . . are: to accelerate economic growth, and toeradicate what I have termed absolute poverty. . . .

The two goals are intrinsically related, though governments are often tempted to pursueone without adequate attention to the other. But from a development point of view thatapproach always fails in the end. The pursuit of growth without a reasonable concern forequity is ultimately socially destabilizing, and often violently so. And the pursuit of equitywithout a reasonable concern for growth merely tends to redistribute economicstagnation. . . .

. . . any successful effort to combat poverty would have to do two basic things:• Assist the poor to increase their productivity; and• Assure their access to essential public services. . . .Development is clearly not simply economic progress measured in terms of gross

national product. It is something much more basic. It is essentially human development;that is, the individual's realization of his or her own inherent potential."

Annual Meeting, Washington, D.C., U.S.A., September 30, 1980

Absolute poverty" . . . absolute poverty is a condition of life so degraded by disease, illiteracy, malnutrition,and squalor as to deny its victims basic human necessities . . . a condition of life so limitedas to prevent realization of the potential of the genes with which one is born; a conditionof life so degrading as to insult human dignity—and yet a condition of life so common asto be the lot of some 40 per cent of the peoples of the developing countries. And are notwe who tolerate such poverty, when it is within our power to reduce the number afflictedby it, failing to fulfill the fundamental obligations accepted by civilized men since thebeginning of time?" Annual Meeting, Nairobi, Kenya, September 24, 1973

" . . . a poverty-oriented approach must be country-specific; it cannot be global. The areasof intervention will differ country by country. Basic needs may not be met in one societybecause it is not allocating sufficient resources for their production or importation. Theymay not be met in another society because it has done little to improve the efficiency of adelivery system. . . .

What a poverty-oriented approach offers is not a substitute for economic growth, but analternative way of achieving that growth through raising the productivity of the poor. Themain point is this: a targeted, poverty-oriented approach can eradicate or reduce absolutepoverty in a shorter period of time, and with fewer resources, than the more conventionalgrowth-oriented approach." Annual Meeting, Belgrade, Yugoslavia, October 2, 1979

National strategies"The need to reorient development policies in order to provide a more equitabledistribution of the benefits of economic growth is beginning to be widely discussed. Butvery few countries have actually made serious moves in this direction. And I should stressthat unless national governments redirect their policies toward better distribution, there isvery little that international agencies such as the World Bank can do to accomplish thisobjective." Annual Meeting, Nairobi, Kenya, September 24, 1973

"In the past decade, the poor nations have financed over 80 per cent of their developmentinvestments out of their own meager incomes. But it is true they must make even greaterefforts. They have invested too little in agriculture, too little in population planning, andtoo little in essential public services. And too much of what they have invested hasbenefitted only a privileged few.

That calls for policy reforms, and that is, of course, always politically difficult. But whenthe distribution of land, income, and opportunity becomes distorted to the point ofdesperation, political leaders must weigh the risk of social reform against social rebellion.Too little too late' is history's universal epitaph for political regimes that have lost theirmandate to the demands of landless, jobless, disenfranchised, and desperate men."

University of Chicago, Chicago, U.S.A., May 22, '1979

Finance b Development I ]unc 19818


Food and agriculture". . . despite the magnitude of the problem in the countryside, focusing on rural povertyraises a very fundamental question: is it a really sound strategy to devote a significant partof the world's resources to increasing the productivity of small-scale subsistence agricul-ture? Would it not be wiser to concentrate on the modern sector in the hope that its highrate of growth would filter down to the rural poor?

The answer, 1 believe, is no. . . .Without rapid progress in smallholder agriculture throughout the developing world,

there is little hope either of achieving long-term stable economic growth or of significantlyreducing the levels of absolute poverty." Annual Meeting, Nairobi, Kenya, September 24, 1973

"As millions of people in the developing world move from the countryside to the cities,the food production system in these countries will have to undergo a quantum change. Itwill have to make the transition from a largely subsistence system to a high-productivitysystem that can yield a significant surplus for the burgeoning cities.

It is, after all, agriculture that makes cities possible in the first place. Cities do not growfood. Countrysides do. And unless countrysides--somewhere—grew a surplus of food,Cities would have none." Annual Meeting, Belgrade, Yugoslavia, October 2, 1979

Population" . . . short of nuclear war itself [.population] is the gravest issue that the world faces overthe decades immediately ahead.

The population growth of the planet is ultimately in the hands not of governments, orinstitutions, or organizations. It is in the hands of literally hundreds of millions ofindividual parents who will determine its outcome. That is what makes the populationproblem so diffuse and intractable. And that is why it must be faced for what it inevitablyis: a central determinant of humanity's future, and one requiring far more effectiveattention than it is currently receiving." Annual Meeting, Belgrade, Yugoslavia, October 2, 1979

"To put it simply: excessive population growth is the greatest single obstacle to theeconomic and social advancement of most of the societies in the developing world. . . .

For the population problem complicates, and makes more difficult, virtually every othertask of development." Annual Meeting, Belgrade, Yugoslavia, October 2, 1979

Arms expenditures"Public expenditures on weapons research and development now approach $30 billion ayear, and mobilize the talents of half a million scientists and engineers throughout theworld. That is a greater research effort than is devoted to any other activity on earth, andit consumes more public research money than is spent on the problems of energy, health,education, and food combined." University of Chicago, Chicago, U.S.A., May 22, 1979

External assistance for developing countries"There are, of course, many grounds for development assistance: among others, theexpansion of trade, the strengthening of international stability, and the reduction of socialtensions.

But in my view the fundamental case for development assistance is the moral one. Thewhole of human history has recognized the principle—at least in the abstract—that the richand the powerful have a moral obligation to assist the poor and the weak. That is what thesense of community is all about—any community: the community of the family, thecommunity of the village, the community of the nation, the community of nations itself."

Annual Meeting, Nairobi, Kenya, September 24, 7973

"It will not be enough simply to increase the level of ODA [official developmentassistance]. Its allocation must be improved as well. ODA should be increasingly directedto the poorest nations and, within them, to programs benefitting the poorest segments oftheir population." Annual Meeting, Manila, Philippines, October 4, 197b

finance & Development I June 1981 9


Apart from the major financial issues raised by the emergence oflarge surpluses in the oil-rich countries of the Middle East,important issues in economic development have arisen for them.This article identifies the significant factors that have emerged inthe economies of six of these countries since 1973 in their effortsto achieve economic development through diversification of theirdomestic economies.

The successive increases in the price of oilfrom US$2 per barrel in 1971 to $35 perbarrel in 1981 have had major reverbera-tions on the economies of the oil importingcountries, developed and developing alike.They have put at the disposal of a smallnumber of countries in the Middle Eastvast additional resources, enabling them tospend unprecedented amounts on theirown economic development while at thesame time accumulating foreign assets thatreached, by the end of 1980, some $300billion. The principal issues involved inthis process relate to the recycling of thesesurpluses through the international finan-cial system, the absorptive capacity of theoil producers themselves, and the relatedissue of the development of their owneconomies. Much has been written aboutthe recycling of petrodollars. This articlewill attempt to trace the significant suc-cesses, as well as the problems, of six oilsurplus countries with the process of eco-nomic diversification since 1973, and re-view the outlook for maintaining recenllevels of domestic absorption and growthin the future.

The capital surplus oil exporting coun-tries considered in this article are SaudiArabia, Iraq, the United Arab Emirates, theLibyan Arab Jamahiriya, Kuwait, andQatar, in order of importance as oil ex-porters. The oil revenues of these countrieshave, since 1974, consistently been largeenough to generate overall payments sur-

pluses in spite of rapidly growing importdemand. After the second round of oilprice increases in 1979, they are facing theprospect of even larger surpluses for sometime. Iraq is included in the group becauseit is assumed that its oil exports will begradually restored to previous levels oncethe hostilities with Iran have ceased. Iran,on the other hand, is not included becauseit has not been in a capital surplus positionfor a number of years; in addition, the sizeand different nature of its economy makeit difficult to apply to it some of the gen-eralizations that can broadly be applied tothe other six countries.

Wealth and underdevelopment

When the gates of prosperity wereopened wide for the oil producing coun-tries in 1974, the fact did not escape theirgovernments that the prosperity could beflawed. The dramatic additions to their na-tional income from the oil price increases,for instance, still left their economies out-side the oilfields in a state of underdevel-opment. The per capita domestic product(GDP), widely publicized as being ex-tremely high, substantially misrepresentedthe actual situation for the majority of theirpopulations. Moreover, any event thatwould adversely affect the value of theiroil could jeopardize any of the present ef-forts to modernize their economies, and inany case the oil reserves, as presentlyknown, would run out within the lifetimeof the present generation (in Iraq, the Lib-yan Arab Jamahiriya, and Qatar), its chil-dren (in the United Arab Emirates), or itsgrandchildren (in Kuwait and Saudi Ara-bia).

Hence the urge for economic diversifi-cation, implying the creation of a viablemodern economy outside the oil sector thatwould sustain a relatively high income

10 Finance & Development I June 1981

Issuesin economic

for the oil-richcountries

Rudolf Hablutzel

diversification


Table 1Oil surplus countries: national expenditures, 1973-78

(In billions of current U.S. dollars)

Total GDPNon-oil GDPInvestmentConsumption

1973

50.914.65.8

16.1

1974

84.422.511.725.2

1975

95.431.520.236.0

1976

117.1

42.226.445.8

1977

132.953.535.159.2

1978

138.963.641.163.7

Averageannual

growth rate(In per cent)

22.234.247.931.7

(In per cent)

Investment as apercentage of non-oilGDP1

Investment growth rateover preceding year

Source: World Bank estimates.— Data not available.

39.7

—

1 The investment/GDP ratio lor the industria

51.8

102

countries w«

64.2

73

61.6

31

65.6

33

64.6

17

is about 22 per cent during this period.

level after the end of the oil era. It requiresmaintaining extremely high levels of in-vestment compared with production in thenon-oil sectors for a long time, while at thesame time sustaining large expenditureson training and education.

Between 1974 and 1979, the majority ofthe countries in the group embarked uponwhat, in retrospect, might be called an ex-periment in national economic manage-ment that is unique in modern history. Itconsisted in pushing the investment/GDPratio in the non-oil sectors beyond all his-torical precedents (see Table 1), with aview to implanting the basis for a fully op-erational and economically viable moderneconomy, in the style of the advancedcountries of the world, into traditional so-cieties still marked by widespread povertyand economic backwardness. Measured bythe rate of growth of the productive sectorsof the economy outside of petroleum, theoil surplus countries made remarkableprogress in the period 1974 to 1978 (seeTable 2). Rough estimates suggest that forthe six countries the average real rate ofgrowth of non-oil GDP may have been 15per cent per annum. It was higher in SaudiArabia and lower in Kuwait.

Most of the countries in the group, withthe major exception of Iraq, have two prin-cipal constraints on the balanced growthof their economies: very limited agricul-tural land and domestic labor. There is noscope for any significant development ofagriculture in Kuwait, the Libyan Arab Ja-mahiriya, Qatar, and the United ArabEmirates. In Saudi Arabia, agriculture isrestricted too and made more difficult bythe adverse movements of the agriculturalterms of trade, the exodus of workers tomore remunerative urban occupations, andthe Government's efforts to pass on an ele-ment of oil rent to the Bedouin population

through all manner of subsidies. Such ac-tions are not entirely conducive to the cre-ation of a self-sustaining agricultural sec-tor. The limitations of domestic laborsupply, a pervasive feature for these coun-tries, has been overcome in the first boomperiod between 1974 and 1978 by the mas-sive inflow of expatriate labor. The optionof inducing a massive inflow once againafter 1980 is a delicate and many-facetedpolicy issue.

Given the limitations of resource en-dowment, governments have come to seediversification largely in terms of invest-ment in (1) capital intensive industries, (2)supporting industries, (3) infrastructure,and (4) productive services (trade, trans-port, banking, hotels, and so on).

In the first boom years from 1974 untilthe end of the decade, the countries of thegroup devoted a large proportion of totalinvestments to building up their physicaland social infrastructure, especially hous-

ing, roads, ports, electricity, and water; arelatively smaller proportion went for in-vestment in productive sectors for diver-sification. This pattern was less applicableto Kuwait and Iraq than to the other coun-tries because their infrastructure was moredeveloped and their requirements for ad-ditional housing were less.

Productive industriesIt is clearly appropriate for the oil pro-

ducing countries to develop industriesbased on the oil sector. Moreover, by ahappy coincidence for the oil-rich countrieswith small populations, hydrocarbon in-dustries are by and large extremely capitalintensive and provide an almost perfect fitwith their resource endowment: low costhydrocarbon (in some cases the cost forflared gas can be regarded as zero since itwould otherwise be wasted), capital abun-dance, and scarce domestic labor. For animportant range of petrochemical productsthe mid-1970s were a period of substantialprospective world excess capacity, but bythe end of the decade this situation hadchanged and a considerable number oflarge petrochemical projects reached theconstruction or contract stage in Iraq, Ku-wait, Saudi Arabia, and other oil surpluscountries.

Gas l iquif icat ion is another oil-based in-dustry that uses petroleum gas that wouldotherwise be largely wasted. Liquificationfor export is expensive and cannot com-pare in profitability with oil, but the pros-pect of a reasonable return has inducedseveral oil surplus producers to developsuch industries. Plants have been com-pleted in Kuwai t , the Libyan Arab Jama-hiriya, Qatar, and the United Arab Emir-ates, and have been initiated in SaudiArabia and Iraq. Many more liquificationplants are not to be expected in the future

Table 2Oil surplus countries: aggregate GOP by industrial origin, 1973 and

(In millions of current U.S dollars)

AgricultureManufacturingConstructionElectricity/waterServices, including

governmentNon-oil GDPNon-oil GDP per

capita

1973

1,3362,6402,057

246

8,35114,630

701

Percent1973

919152

55100

1978

2,9737,130

16,351605

36,59163,650

2,446

Percent1978

51126

1

57100

Annualgrowth

rate(1973-78

17.322.051.419.7

34.434.2

28.4

1978

Realannualgrowth

estimatein per cent)

5123015

12

15

Source: World Bank estimates.

I'inaih't' t* Dn\'loi»neul luiit'19^1 11


because the quanti ty of the gas availablefor such purposes depends on the quantityof oil produced, which is not, in general,likely to rise.

Hydrocarbon industries are typically forexport and have few links with the do-mestic non-oil economy. Industries out-side the hydrocarbon sector, which aregenerally smaller in scale, more orientedto the domestic market, and typically morelabor intensive (the principal drawback),have the advantage that they tend to en-gage more domestic enterpreneurship andto depend much less on highly sophisti-cated technology. By all standards of de-veloping countries, the surplus oil produc-ers have been able to develop theirmanufacturing industries outside the pet-rochemical sector fairly rapidly, in spite ofsome psychological and commercial con-straints related to the traditional promi-nence, in these societies, of the merchantclass, for whom prosperity derives fromthe import business.

However, not only did the constructionboom induce the appearance of expatriateworkers on a massive scale, but industrial-ization itself has led to the creation of manyforeign enclaves in the economy, using im-ported capital equipment, imported rawmaterials, imported management, and im-ported labor. The question of the futureeconomic viability of these investments,while important, is perhaps not as pressingfor the policymakers as is the question ofhow appropriate it will be, socially andpolitically, to promote the proliferation ofsuch enclaves. Several governments, be-fore the second oil price increase, were be-ginning to ponder the budgetary implica-tions of providing health and educationservices, subsidized housing and electric-ity, and other consumer subsidies to a rap-idly expanding expatriate work force. Thepoint has been raised that the social costsof foreign labor, if added to their wages,might in some cases exceed their contri-bution to GDP, and therefore nu l l i fy theobjectives of diversification. While most ofthese industries may be competitive withimports or in export markets, this mightwell be due to the absence of taxation andthe avai labi l i ty of concessional credit,heavily subsidized power, free gas, free in-frastructure layout, and other props. Ifdiversification means the creation of aneconomy viable without oil at some futuredate, it means it would have to stand onits own without subsidies, pay taxes, andforgo the benefit of low wages made pos-sible by increasingly heavy subsidizationof basic consumer foods.

With the second oil price rise, some ofthese concerns have again receded into thebackground and given way to the more

fundamental assertion that there simply isno other way to diversify than through in-dustrialization. All the while the politicalconcern remains about the growth of theexpatriate work force.

Construction

A common experience of the oil surpluscountries has been an unprecedented boomin construction activity from 1974 to 1977.While a sizable part of the construction wascarried out by foreign contractors with for-eign labor, the domestic construction in-dustry also had a golden opportunity toexpand and develop.

The construction boom turned out to beone of the more problematic aspects of thedevelopments in the period. Initially, thereal estate sector appeared as a convenientvehicle to make a start on the transfer ofpart of the oil wealth from governments toprivate citizens. This took place in a varietyof forms. The most important were pur-chases of land at generous prices by thegovernment, guaranteed loans to would-be builders and proprietors of office orapartment blocks, and massive housinggrants and subsidized loans to public ser-vants and other deserving citizens. Thiscould not fai l to create a class of investorswho, lacking experience but willing to ridethe wave, went in large numbers into anytype of construction project that had shownsuccess in the past. Such was the speed ofthis type of construction that by 1977 somecities in the Gulf were littered with newlycompleted apartment or office blocks look-ing for tenants that did not appear, leavingthe governments with the task of debt re-structuring. Another feature of the boomwas the high cost of construction resultingfrom the speed of bidding and contracting.But the worst aspect was the escalation of

Rudolf Hablutzel

a citizen of Switzerland,received his Ph.D. degreefrom the University ofBasle (Switzerland); healso studied and taught atthe Graduate Institute for

International Studies, Geneva (Switzerland). Sincejoining the World Bank in 1960, he has held anumber of positions—including Regional Cliiefhconotnist for Eastern Africa; Senior Adviser,Policy Planning Department; and Special Adviser,Energy Department. At present he is a SeniorEconomist in the Europe, Middle East, and NorthAfrica Regional Office.

land prices, making it in some instancescheaper to reclaim land from the sea thanto build on existing areas—which is ironicconsidering the large desert hinterland.

The speculative boom in the real estatesector in several Gulf countries terminatedaround 1977, either through its own cycleof boom and bust or because governmentsdeliberately cut back their expenditureprograms. Since then, there has been aperiod of consolidation of construction ac-tivities, a temporary reduction in the ex-patriate labor force employed in the sector,and a normalization of contract and realestate prices—reflected in some cases in areduction by more than half in the pricesfor new housing.

Reappraisal

By 1978 government expenditures in thisgroup of oil exporting countries hadreached levels that suggested that, withthe prevailing oil prices, budgetary or pay-ments deficits might emerge within onlya few years. Forecasts of such develop-ments were the first signal for turning theexperiment with diversification from anopen-ended enterprise into a finite one,notwithstanding the subsequent reversalof these forecasts in 1979. More important,a number of negative implications of rapiddiversification came to the fore at the sametime. The two outstanding problems werethe rising growth rate of the expatriate la-bor force and inflation. Accompanyingthese concerns was the ever present dan-ger of a misallocation of resources.

Following the quadrupling of oil pricesand oil revenues in 1974, the six govern-ments increased their combined public ex-penditures at an annual rate of 44 per cent,from 86 per cent of non-oil GDP in 1973 to145 percent in 1979. Their aggregate moneysupply increased at a similar annual rate.These are extraordinary ratios if one keepsin mind that, technically, there was nodeficit financing and instead, governmentbudgets were substantially in surplus.However, domestic expenditure on non-oilGDP is inflationary to the extent, in simpleterms, that its annual increments are inexcess of its real rate of growth, are fi-nanced from an "external" resource (thegovernment selling petrodollars to the cen-tral bank for domestic currency), and arenot fully absorbed by imports.

There was a sharp increase in inflationin 1975 and 1976, but the average cost ofliving increase between 1973 and 1978 re-mained less than 15 per cent a year on av-erage, mainly for two reasons. First, a largepart of the excess demand was absorbedby additional imports; second, govern-ments imposed controls on prices of essen-tial consumer goods and introduced sub-

12 finance & Dei'elopment '• June 1981

Giu

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sidles. That part, however, of the additionaldemand that was deployed on domesticnontradables had much more substantialeffects on their prices than in the case ofconsumer goods. Urban land prices sky-rocketed, the housing markets developedin a disorderly fashion, and speculationand graft became increasingly visible.Starring in 1976 and 1977, some govern-ments, aware of the inflationary pressuresboth in consumption and investment mar-kets, began to restrain the growth of publicexpenditures.

The lesson of an overheated economythrough forced absorption of rapidly grow-ing oil revenues has been learned, and thegovernments now have their own specificset of reasons to maintain an anti-inflation-ary posture. To the extent that they aresuccessful, this will affect their absorptivecapacity for the 1980s.

The concern of governments regardingexpatriate labor has become a concern re-garding the future structure of their societyand their national identity. In Kuwait,Qatar, and the United Arab Emirates theforeign population today already outnum-bers the citizen population; and in theUnited Arab Emirates, expatriates fromneighboring Arab countries are alreadyoutnumbered by expatriates from Asia.(The issue of foreign labor is not dweltupon here, because it has been discussedin "Migration and manpower needs in theMiddle East and North Africa, 1975-85" byIsmail Serageldin and James Socknat, inthe December 1980 issue of Finance & De-velopment.)

These concerns, of varying but growingimportance among the six countries, havealready had a dampening effect on ex-penditure policies in very recent years andwill not disappear because oil revenueshave taken another spectacular leap.

Outlook for non-oil investment

The future pace of domestic capital for-mation will depend both on the govern-ments' attitudes toward foreign labor andinflation, as reflected in general govern-ment expenditure policies, and on thephysical scope for new investment. Whilethe investment of oil surpluses abroadmade a quantum jump in 1980, such in-vestment is fraught with the problem ofobtaining an adequate and secure rate ofreturn, which makes domestic investmentagain look more attractive at the marginthan it did a few years ago—at least in the-ory. In practice, this attractiveness is offsetby the growing anxiety over the growth ofthe expatriate populations associated withthe continued high growth of investmentand GDP. In parenthesis, the option of re-versing the procedure of bringing the labor

to where the capital is—and embarking onmuch greater direct productive investmentin developing countries (and elsewhere)—has found increased support, but con-straints still exist in terms of both the in-stitutions and skills such a reversal wouldcall for and the exposure to adverse sen-timent.

In many areas of physical infrastructure,saturation has already been reached. Mostseaports have been expanded to a capacitythat will be adequate for some time tocome. Very large infrastructure facilities forindustry are already completed; highwaynetworks have been built—to high stan-

come redistribution. The experience ofgovernments in that respect has been thatthe social elite and the educated middleclass can be reached with relative effi-ciency, but the large mass (where they ex-ist) of illiterate farmers and Bedouins aredifficult to enrich short of systematic dis-tribution of outright gifts. Further, govern-ments cannot ignore the likelihood thateconomic diversification in the form of aninternationally competitive production ap-paratus would be frustrated by excessivegenerosity that would push a majority ofthe domestic labor force into "rentier" classstatus with no need to work for a living.

. total domestic investments in the oil surplus countriesin the next five years are very unlikely to be larger,

in relation to non-oil GDP,than they have been in the last five years . . .

dards and on a large scale; administrativebuilding complexes are completed or willbe completed in the next few years; andmore universities and hospitals are built orunder construction than could be fullyutilized for a number of years.

Manufacturing industry and construc-tion have attracted the largest number ofexpatriate workers, and earlier illusionsthat their presence would be temporary aregiving way to more realistic perceptions.To bring down their growth rate, SaudiArabia, for example, has drastically scaleddown targets for non-oil GDP growth inits Third Plan (1980-85) from 15.1 per centper annum to 6.2 per cent per annum.

In light of these factors it seems reason-able to conclude that total domestic in-vestments in the oil surplus countries inthe next five years are very unlikely to belarger, in relation to non-oil GDP, thanthey have been in the last five years, andthat this ratio might in fact decline.

Consumption

For some sections of society, especiallythe upper class, there is visual evidencethat personal consumption has reached orsurpassed the level of their correspondingclass in the industrially advanced coun-tries; but it would be hazardous to assumethe existence of a saturation point. As re-gards the middle and lower classes, futuregrowth of personal consumption will de-pend, among other things, on whether thehitherto liberal immigration policy will becontinued: in case of restrictions, compe-tition of immigrants in the labor marketwould be restrained and this would tendto push up wages.

Another factor will be the future policiesconcerning the use of oil revenue for in-

It is expected that the authorities will pro-mote upward mobility but maintain re-straint in being overgenerous to their do-mestic low-income working population.Hence, the disposable income and con-sumption levels of the latter will rise rela-tively more slowly than those of the edu-cated middle and upper classes. Total per-sonal consumption might thus continue togrow at a rate somewhat slower than thenon-oil GDP.

As regards government consumption,there is, of course, scope for compressionin many services that are overstaffed, butthere is little reason to assume any drivefor economy measures, especially whenredundant staff are unemployable else-where. Saturation in some areas may leadto a less rapid expansion of governmentservices than in the 1970s, but this will beoffset by the more rapid growth of defenseand security requirements. The growth oftotal consumption should, therefore, notbe expected to slow down appreciablyfrom the average 1973-79 rates.

On balance, all the signs point to thelikelihood that domestic absorption of oilrevenues by the six governments will growat a slower pace in the near future, espe-cially for investment, than it did in the1970s. If this scenario is valid, the size oftheir combined surplus for recycling, pres-ently just under $100 billion per annum,would decline at a much slower pace thanafter the first oil price increase (from $32billion in 1974 to $17 billion in 1978). Thiswill depend, of course, on whether theprice of oil will continue to outstrip annualrates of world inflation and on whether theproduction of oil by the six countries willremain approximately at the level of recentyears. HD

Finance & Dei'elopment I June J982 13


As the 1980s unfolded, the international economy was entering adifficult stage: inflation in most countries was high and showed nosigns of abating; growth rates were slowing down; and externalimbalances had increased and shifted among groups of countries.In this article, the author examines the recent steps taken at theFund to support members' adjustment efforts to improve theireconomic performance.

Manuel Guitian

As the decade of the 1970s came to a close,the international economy was subject tosevere pressures, associated with a newround of sharp increases in world energyprices. Many member countries were stillexperiencing difficulties from an incom-plete adjustment to and recovery from thetroubles of the early and mid-1970s. As aconsequence, the opening of the new de-cade was characterized by a number of se-riously disturbing features in the worldeconomic situation. In many countries, in-flation continued at historically high ratesand showed no signs of slackening. Ratesof growth in economic activity were slow-ing down, particularly in the industr ial

countries, a trend that threatened to jeop-ardize a needed expansion in world tradeand to steer the world economy towardanother global recession. At the same time,the current account surpluses and deficitsof major groups of countries increased andunderwent sudden shifts; these develop-ments placed greater strains on world pay-ments and gave rise to widespread con-cerns about how the unprecedented deficitscould be financed, especially by countriesin the oil importing developing world.

Meanwhile, the Fund was winding upthe second comprehensive review of itspractices on conditionality. (The first hadtaken place in 1968.) On March 2, 1979 the

Executive Board adopted a new set ofguidelines for the use of Fund resources.The guidelines incorporated a number ofthe principles that had guided the adap-tations made to the conditionality practicesin the 1970s. These principles included theneed to take into account not only thecauses of the balance of payments (BOP)difficulties of members requesting Fundresources, but also their social and politicalobjectives as well as their economic prior-ities. The guidelines made allowance forlonger periods of adjustment, a principlefirst recognized with the introduction ofthe extended Fund facility (established in1974) and later incorporated in the decision

The first two articles by Manuel Cuitidn—published in the December 1980 and March1981 issues of Finance & Development—examined the rationale of the principle of con-ditionality and described the implementation ofthe conditionality practices that have been de-veloped over the past three decades. This is thelast in a series of three articles on Fund condi-tionality.

14

Fund conditionallyx-x ->x vx-x-x-x^i- la-A- -x x-x-x v

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Finance 6- Development June 19SI

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look into the1980s


on the supplementary financing facility(adopted in 1977). Acknowledging the needfor the Fund's conditionality practices toevolve, the guidelines also provided forperiodic assessments of the experiencewith adjustment programs supported byFund resources and for the periodic ad-aptation of the terms of conditionality, ifsuch adaptation proved warranted.

Two years have elapsed since the adop-tion of the guidelines on conditionality—sufficient time to test their resilience inguiding Fund policies to help memberscope with an unfavorable internationaleconomic environment. The purpose ofthis article is to examine how the particularfeatures of recent economic developmentshave led the Fund to initiate further ad-aptations to its conditionality practices.One of the initiatives is a new emphasis onpolicies to increase productivity and to im-prove resource allocation in the programssupported by Fund resources. Another isto strengthen its collaboration with theWorld Bank. The article also reviews howthe principles of the 1979 guidelines for thepolicies on the use of the Fund's resourceshave worked so far and discusses the mostrecent changes in the framework of theFund's operations.

Structural changes neededThe payments problems experienced by

many member countries in the last twoyears led the Fund to the conclusion earlyin the period that the establishment of spe-cial facilities to provide resources subjectto no or limited conditionality (along thelines of the oil facilities of the mid-1970s)would not be appropriate. A more com-prehensive approach was necessary, fortwo main reasons. First, for many coun-tries, payments difficulties had not onlyworsened but were superimposed on long-standing imbalances; the situation requiredmore decisive policy action than had beentaken until then. Second, although thecauses of the increasing deficits were forthe most part external in origin, they werenot likely to be transitory. A realistic as-sessment of the medium-term perspectivecalled for timely and resolute adjustmentefforts to cope with the adverse externalenvironment.

From the beginning there was a consen-sus that the Fund should be able to re-spond to the needs of members in partic-ularly d i f f icu l t circumstances. Thesupplementary financing facility had beenconceived to provide resources to countrieswith large needs in relation to quotas, butthe bulk of its resources had remained un-committed during the first half of 1979; itwas decided to use these funds (under the"special circumstances" clause) to make

larger than normal commitments, bearingin mind that the use of these resources—which were made available under stand-by and extended arrangements—was ofcourse subject to observance of perfor-mance criteria.

Thus, as an interim step—in cases ofspecial need—commitments were made ofsupplementary resources up to the equiva-lent of 300 per cent of quota. This propor-tion was well above the amounts that un-der normal circumstances had beenenvisaged in the original decision on thesupplementary financing facility, whichhad been 102.5 per cent of quota for stand-by arrangements and 140 per cent of quotafor extended arrangements. An importantaspect of this interim step was that re-quests by members for Fund resourceswould be accommodated when the policymeasures that were introduced gave sub-stantial assurance that the necessary ad-justment efforts would be carried out—and, therefore, that BOP viability would berestored. In the meantime, an examinationof the wide range of issues pertaining tothe Fund's role in financing payments im-balances and in promoting adjustment pol-icies was initiated.

There was general agreement that theimbalances that currently existed in the in-ternational economy were structural andtherefore not amenable to correction overa short period of time. Adjustments tosuch disequilibria were likely to requireextensive changes in members' economies,in particular those of the oil importingcountries, if restoring BOP viability wasnot to jeopardize medium-term develop-ment and growth prospects.

The prevailing economic environmentrendered the necessary adjustments moredifficult . Inflation and inflationary expec-tations had become entrenched in manycountries; yet the danger existed that sus-tained anti-inflationary policies—which onall counts were essential—might furtherdampen growth rates at a time when, asnoted at the outset, they were generallybelow historical levels. These develop-ments, in turn, could slow down or evenreduce the volume of world trade andthereby complicate the task of adjustmenteven further. These considerations formedthe basis for moving to a relatively longtime frame for the adjustment effort; theaim was to allow for structural changes inpatterns of production and demand—changes that can only be made gradually.

The ultimate aim of Fund financial assis-tance is to restore viability to the BOP ina context of price stability and sustainedeconomic growth, without resort to meas-ures that impair the freedom of trade andpayments. These basic purposes of the

Fund have not been altered by the recentdisturbances that have beset the interna-tional economy; only their attainment hasbecome more challenging, not to say morearduous. Consequently, the design of thestance and the mix of the policies normallysupported by the Fund has become subjectto constraints that make it more complex.

Thus, the broad demand managementpolicies usually included in the Fund'sprograms, particularly in the fiscal andcredit areas, continue to be needed, per-haps even more than before, to hold ag-gregate domestic demand down to a levelthat is sustainable and consistent with theglobal availability of resources. The Fundhas traditionally concentrated on thesebroad macroeconomic policies, which wereexamined at length in the first article in theseries (published in the December 1980 is-sue of Finance & Development). Demandmanagement provides the appropriate fi-nancial framework for development andgrowth, because financial stability encour-ages the mobilization of domestic savingsand the efficiency of resource investment.But recent events have called for attentionto complementary measures directly aimedat bringing about an efficient utilization ofresources to strengthen an economy's pro-ductive base. This concern has led theFund to advocate policies affecting incen-tives for production.

Supply management

Strictly speaking, interest in supply isnot a new development in the Fund. It canbe argued that demand managementmeasures and financial stability may havebeen proximate instruments and objectivesof Fund policies, but the full attainment ofsupply potential has always been the ulti-mate aim. The novelty is in the emphasisthat is now openly found in the Fund andelsewhere on the effects of adjustment pol-icies on resource utilization and thereforeon production. It is, of course, as difficultto distinguish between demand and sup-ply measures as it is to determine whichof the two blades of a scissors does thecutting, to borrow Alfred Marshall's classicanalogy. Policy measures have an impacton both demand and supply; therefore,they need to be catalogued according towhere their greatest effect lies for the dis-tinction between them to be useful.

The longer adjustment period allowedunder the new guidelines partly explainsthe current explicit accent on supply. Onthe one hand, measures that stimulatesupply through productivity increases andhigh investment rates show results onlyover the medium to long term. On theother hand, more time for adjustment re-quires the mobilization of resources in

Finance £f Dnvlapment June '1981 15


amounts larger than otherwise would bethe case, thus allowing the process to takeplace more gradually; it then becomes im-perative to ensure that those resources areproductively used to attain supply poten-tial.

The relationship between demand andsupply management is illustrated by sev-eral factors that normally constitute a partof the design of a domestic stabilizationprogram. In many instances, programs in-corporate foreign borrowing strategies thatdirectly enlarge the amount of resourcesavailable to the member. As a result, higherlevels of expenditure can be achieved, aswell as higher growth rates over the me-dium term. It is also common to have anumber of important policy understand-ings in the formulation of an adjustmentprogram, which provide the basis on whichthe feasibility of the domestic financial pol-icies is predicated. These understandingsare rarely made performance criteria inprograms supported by the Fund, but theycan be critical for the at tainment of finan-cial balance and sustainable growth rates.They normally include: public sector poli-cies on prices, taxes, and subsidies, whichcan contribute to eliminate financial im-balances and to promote efficiency in pub-lic sector activities; interest rate policies,which foster the generation of domesticsavings and improve resource allocation;exchange rate policy, which helps to con-trol absorption and the external accountsbut is also a powerful tool for develop-ment; and incomes policies, which keepclaims on resources from outstepping theiravailability.

Actions in these policy areas are of directinterest to the Fund because they fostersavings and investment—the basis for ex-panding supply and for the sound devel-opment of an economy. Measures of thistype elicit supply responses on two differ-ent levels: by ensuring appropriate pricingin the broadest sense, the flow of outputout of a given stock of resources is maxi-mized, and by fostering the mobilizationof savings and the efficiency of investment,the medium-term to long-term growth rateof output is enhanced.

CollaborationBoth the World Bank and the Fund share

a concern over the economic and financialpolicies followed by member countries.Within this broad common interest, thereis substantial scope to distinguish areas olprimary responsibility for each institution.In general terms, it has long been agreedthat the Fund is primarily responsible foiBOP adjustment, and the Bank, for devel-opment programs and project evaluation.Over time, the two institutions have col-

laborated effectively in providing consist-ent policy advice to members while main-taining their distinct character and separatefunctions.

The complementary roles of the Fundand the Bank have acquired increased im-portance in the current world environmentwith the sharp increase in energy costs, theemphasis on appropriate supply re-sponses, and the need for productive in-vestment flows. At a time when the Fundhas extended the time frame of its arrange-ments and the scale of its assistance, theBank has undertaken a program of lendingfor structural adjustment to provide sup-port to countries with BOP difficulties thatrequire structural changes; this kind oflending will be an important complementto Fund assistance.

These recent Fund-Bank initiatives havecalled for an important additional measureof coordination. The range of subjectswhere coordination is required includes:the structure and functioning of moneyand capital markets; the generation of do-mestic savings; the financial implicationsof development programs; and externaldebt management. In providing policy ad-vice, the Fund continues to focus on themacroeconomic and BOP adjustment pol-icies, while the Bank concentrates on thequality and effectiveness of developmentplans and investment priorities. This di-vision of responsibilities remains essential;nonetheless, an increasingly close consul-tation between the two institutions is beingdeveloped as more members enter into ad-justment programs supported by financialresources from both agencies.

Scale of Fund assistance

Both the larger current-account imbal-ances and their structural nature on theone hand and the emphasis on inducingadjustment as well as promoting supplyresponses on the other, provided a basis

Manuel Guitian

who is from Svain,graduated in lau' andeconomics from theUniversities of Santiagoand Madrid (Spain), andholds a Ph.D. in

economics from tlie University of Chicago (U.S.A.).Mr. Guitian is Senior Advisor in the Exchange andTrade Relations Department of the Fund, and liaswritten articles on international monetary economics.

for a decision by the Fund in 1980 to con-tinue lending resources in substantiallylarger amounts and for longer periods thanheretofore. The guideline of 300 per centof quota for supplementary resourcesagreed by the Board in 1979 already ap-peared insufficient in the months followingits introduction. For a long time, limits onthe resources of the Fund had been basedon a concept of total, cumulative use, butattention has since shifted to a concept ofannual use, albeit within a maximum globallimit. A consensus has emerged in currentcircumstances that broad norms for themaximum use of Fund resources should beadopted in terms of annual amounts, tosupport members' adjustment effortswhich, in many instances, would in alllikelihood take more than one year to becompleted.

Two issues arise in the context of thescale and duration of Fund lending: first,the length of the period of commitment ofFund resources, and second, the propor-tion of the amounts of assistance relativeto quota that can be provided to members.On the basis of the quotas prevailing inmid-1980 (those under the Sixth GeneralQuota Review) an annual limit of 200 percent of quota, or a limit of 600 per cent ofquota over a three-year period, was broadlyaccepted. The operation of these limits in-volved resources both owned and bor-rowed by the Fund and excluded any fi-nancing available under the compensatoryfinancing and buffer stock facilities. TheInterim Committee of the Board of Gov-ernors of the Fund endorsed these guide-lines during last year's Annual Meeting.

Soon after this endorsement, work onthe Seventh General Review of Quotas ap-proached completion. This review wouldresult in a substantial — 50 per cent —increase in members' quotas. The interimlimits adopted earlier had to be reassessedin the context of the forthcoming quotas.In December 1980, the Seventh Quota Re-view came into effect. During that monthnew guidelines on commitments of Fundresources (excluding, as indicated above,those under the compensatory financingand buffer stock facilities) were discussedand subsequently adopted by the Fund'sExecutive Board. These guidelines pro-vide, in general terms, for commitments ofFund resources of up to an average of 150per cent of quota a year within a maximumof 450 per cent of quota over a three-yearperiod. The new guidelines thus providedfor larger absolute amounts of assistancethan those prevailing earlier. In terms ofthe new quotas, the 200/600 per cent limits,in effect until the Seventh Quota Review,were equivalent to 133.3/400 per cent; ac-cordingly, the new 150/450 per cent guide-


Q&

u-


lines represented an increase of one eighthover the amounts previously available.

These new guidelines, which will, ofcourse, be subject to periodic reviews,were supplemented by a maximum limiton total cumulative access to Fund re-sources, net of scheduled repurchases orrepayments, of 600 per cent of quota. Sucha maximum absolute limit was necessaryto take into account past use of Fund re-sources so that members would be treateduniformly, regardless of whether or notthey had used Fund resources before theadoption of the new guidelines. The ques-tion of uniformity of treatment also arosein the context of the financial arrangementsthat came into effect prior to the guidelinesand remained operative. Requests underthose arrangements for an augmentationof the amount of resources will be consid-ered by the Fund on a case-by-case basisin the light of developments within theprogram. This will normally be at the endof the first year of an arrangement, butsome flexibility on the timing is allowedfor.

Flexibility was built into the guidelinesto accommodate the circumstances of aparticular member without impairing theprinciple of uniformity of treatment.Amounts in excess of the guidelines couldbe allowed in clearly exceptional cases—for example, when there is general recog-nition that a member's quota is unusuallylow in relation to the size of its economy,or when an exceptionally strong and wide-ranging adjustment program is undertakeninvolving, inter alia, dismantling of con-trols and other restrictions that would re-quire, at least in the initial stages, large fi-nancial support.

Actual implementation of the newguidelines will require the Fund to enterinto new borrowing arrangements withmembers or to tap other sources of financ-ing in amounts of SDR 6 to 7 billion a yearover the next few years, a process in whichthe Fund is currently engaged. The guide-lines will accordingly be reviewed in lightof the experience not only with members'adjustment programs but also with thepace and modalities of Fund borrowing.Both of these factors will affect the liquidityof the Fund, a key element in its ability toprovide timely assistance to members.

The Fund as catalystThis article, the last in a series of three

on the subject of Fund conditionality, hasexamined the steps undertaken at the Fundto help members cope with the rising en-ergy costs, high inflation rates, and slug-gish growth rates prevailing in the inter-national economy as the 1980s opened.These steps aimed at achieving a balance

between adjustment efforts and financingneeds over a period of time that would al-low results to emerge on the one hand andalso be compatible with the revolving char-acter of Fund resources on the other.Guidelines on enlarged access to Fund re-sources were agreed upon to support arapid and decisive implementation of ad-justment measures, the impact of whichwould show over the medium term.

Thus, in the brief period since the begin-ning of the 1980s, the Fund has striven toadapt the adjustment policies it supportsand the financial assistance it extends tothe needs of its membership. In its collabo-ration with members in the design of ad-justment programs, the effectiveness of theFund as an institution goes far beyond itsprovision of resources. One of the mostimportant aspects of the Fund's financialassistance to members in BOP difficulties,if not the most important one, has been theclose relationship between the provision ofthe assistance and the adoption of com-prehensive programs of economic policyaction. As a critical side-effect, the mix ofadjustment and financing built into theprograms supported by Fund resourceshas helped members obtain flows of capitalfrom sources other than the Fund. In thepast few years, the major source of financ-ing for an important number of countrieshas been the international capital markets,and, in particular, foreign commercial banksin their important role as intermediaries.

This has contributed to the efficiencyand sustainability of resource transfersamong members. Generally speaking, anarrangement with the Fund has been use-ful for members seeking to tap the capitalmarkets because it tends to reduce uncer-tainty by providing a clear indication of thedomestic policies to be followed and theobjectives sought. The complementarity ofthe resources from the Fund and thosefrom the private international markets islikely to become more important in the pe-riod to come, as countries face increasinglyserious constraints and difficult policychoices.

A number of members have a relativelysubstantial and continuing dependence onflows of aid and concessional loans to fi-nance their development efforts. Hereagain, technical and financial assistancefrom the Fund and other multilateral agen-cies has encouraged donor countries toprovide funds for members with a limitedresource base and at a low level of devel-opment.

At present, the problems of adjustmentfaced by member countries are particularlycomplex. Large imbalances in current ac-count deficits are likely to continue to pre-vail for some time. Appropriate adjust-

ment policies will therefore continue to beneeded to justify and make sustainableflows of capital on both concessional andcommercial terms. In this context, the im-portance of the role of the Fund as a cata-lyst for other sources of f inancing cannotbe overstressed.

The practices on the conditionality at-tached to the use of Fund resources aredynamic. They evolve over time as eco-nomic circumstances change and as theunderstanding of economic processes andthe transmission mechanism between pol-icy instruments and objectives is aug-mented with experience. The new decadeof the 1980s is likely to see further impor-tant initiatives as the Fund responds to theneeds of its members in a rapidly shiftinginternational economic environment. Thedevelopments analyzed in this article canbe viewed as an indication of the capabilityof the Fund to create a workable consensusin order to respond rapidly and resolutelyto help members adapt to these changingcircumstances. ED

Related reading

J. de Larosiere, Address to the Economicand Social Council of the United Nationsin Geneva, July 4, 1980 (reproduced inIMF Survey, July 7, 1980).

, Address to the 1980 Annual Meet-ings of the World Bank and the Inter-national Monetary Fund in Washington,DC, September 30, 1980 (reproduced inIMF Survey, October 13, 1980).

, "Recycling Needs and the CapitalMarkets," Address to the Federal Asso-ciation of German Banks in Bonn, Oc-tober 29,1980 (reproduced in IMF Survey,November 10, 1980).

International Monetary Fund, Annual Re-port 1980 (Washington, DC, InternationalMonetary Fund, 1980).

, "Supplementary Financing Facil-ity," Annual Report 1978 (Washington,DC, International Monetary Fund, 1978),pp. 112-19.

, World Economic Outlook (Washing-ton, DC, International Monetary Fund,1980).

, "Policy of Enlarged Access byMembers to Resources to be Continuedby Fund," IMF Survey (March 23, 1981).

R. C. Williams et al., International CapitalMarkets: Recent Developments and Short-Term Prospects, Occasional Paper No. 1(Washington, DC, International Mone-tary Fund, 1980).

E. Peter Wright, "World Bank lending forstructural adjustment," Finance & Devel-opment (September 1980).

Finance & Development I June 7987 17


G. Russell Kincaid

Conditionality andthe use of Fund resources:How the Fund made available an unprecedented volume ofresources and adapted its conditionality practices for a member indifficult economic circumstances.

Source Jamaican authorities and Fund staff estimates'Fiscal year basis (April-March)

For a detailed account of developments in Ja-maica see the "Fund's assistance to Jamaica" bythe same author in the IMF Survey (December75, 1980).

18

Policies related to the use of Fund re-sources (its conditionality) have evolved asa result of the Fund's experience with itsdiverse membership and of changes in theinternational economic environment. Themain objective of the Fund's financial as-sistance has always been to help a countryattain a viable medium-term external po-sition, a sustainable level and rate of growthin economic activity, and reasonable infla-tion rates. The precise economic policy ac-tions required to achieve these objectivesmay vary from year to year and from onecountry to another according to the priori-ties of the authorities and the structure ofthe economy. The only overriding con-straint on policy is the necessity to matchthe demand for resources with availablefinancing. The application of this principlecan often encounter difficulties, and has,at times, generated considerable publicity.The chronicle of the Fund's recent relation-ship with Jamaica is an example of such anepisode.

In the difficult years from 1977 through1979, the Fund had a particularly close re-lationship with Jamaica, providing it witha high level of financial assistance. Theseresources were extended under a series ofprograms to support the authorities' effortsto reverse the economy's falling real in-come—a trend which began in 1974. Theseprograms and resources were aimed, inparticular, at increasing both imports andexports to levels essential to restore sus-tainable growth. This article shows howthe design of policies undertaken to achieveeconomic objectives—and even the objec-tives themselves—were altered over time,in response to both the priorities set by theJamaican authorities and the changing eco-nomic circumstances of the country. Thiscollaboration was especially important be-cause the volume of support extended

by the Fund was unprecedented at thetime in terms of the size of the Jamaicaneconomy.

Stand-by, 1977

A period of rapid economic growth inJamaica (averaging 6 per cent a year in the1960s and early 1970s), associated with theexpansion of the bauxite and tourist in-dustries as well as with substantial privateforeign investment inflows, came to an endin 1972. The Jamaican authorities re-sponded to slackening aggregate demandby embarking upon expansionary eco-nomic policies that resulted in a rise in thecentral government deficit from 5 per centin 1972 to 19 per cent of gross domesticproduct (GDP) in 1976 (see Chart 1). Sub-stantial increases in wages also took place,with nominal wages doubling and realwages rising by 30 per cent between 1973and 1976. These developments promoteda shift in expenditure patterns toward con-sumption and away from investment, withconsumption's share of GDP rising to over90 per cent in 1976 from 81 per cent in 1972,while investment declined to 19 per centfrom over 27 per cent. During the last threeyears of this period economic activitysteadily declined, which produced a cu-mulative reduction of 11 per cent in GDP(or nearly one fifth in per capita terms)over a three-year period (see Chart 2).

By the end of 1976, after years of exten-sive official external borrowing to financesubstantial current account deficits, bothJamaica's foreign reserves and its access toforeign commercial bank credit were vir-tually exhausted. Jamaica was then con-fronted with the urgent need to adjust itsliving standards to accommodate the se-vere constraint imposed by the reduced in-flows of foreign resources.

L'iiuiiife & nrcelopment ]itne 1981


JAMAICAAt this point Jamaica turned to the Fund

and in August 1977 negotiated a two-yearstand-by arrangement with the Fund forabout US$75 million (that is, SDR 64 mil-lion, or 121 per cent of its quota) to supporta program to stabilize the economy. Theprogram sought to bring the budget deficitinto line with projected available real re-sources. The aim was to attract foreignfunds to allow a more gradual adjustmentin the balance of payments (BOP) than Ja-maica was in fact experiencing and therebyto arrest the rapid decline in economic ac-tivity. Substantial net foreign assistance(equivalent to 5.5 per cent of GDP) wasexpected to help finance the budgetary andcurrent account deficits, thus permittingthe adjustment process to be spread overtime. Under the program, a high degree offiscal restraint and the establishment of atight incomes policy were adopted to en-sure that the overall measures would beconsistent with the Government's prefer-ence for limited exchange rate action.

The combination of wage moderation,fiscal adjustment, and external financingwas not achieved. By December 1977, theperformance criteria for the stand-by ar-rangement had not been met, and Ja-maica's drawings from the Fund were in-terrupted. The fiscal deficit reached 16.3per cent of GDP, compared with a targetof 9.1 per cent. This deficit was primarilyfinanced by expanding domestic credit,which led to additional wage-price pres-sures and to a further weakening of Ja-maica's external competitiveness.

Adjustment policies, 1978-80

In mid-1978, a new adjustment programoriented toward increasing domestic pro-duction and supported by a three-year ex-tended arrangement—for about US$250million (SDR 200 million or 270 per cent ofquota)—replaced the stand-by arrange-ment. The new program emphasized thegoals of reviving economic growth and re-versing the substantial fall in investmentof the past few years: additional resources

were to be allocated to stimulate produc-tion and investment, and Jamaica's reli-ance on foreign savings was to be gradu-ally replaced by greater domestic savings.To restore incentives in the traded goodssector, the overvalued Jamaican dollar wasdevalued and a schedule of small monthlydepreciations was instituted. This ex-change rate action was also designed topermit a less restrictive domestic financialstance. Because the depreciation would in-crease the prices of essential importedfoods, additional subsidies—equivalent toabout 2 per cent of GDP—were introducedin the budget to soften the impact onprices. Notwithstanding these new currentexpenditures, it was planned that the pub-lic sector's deficit would decline from 16.3per cent to 11 per cent of GDP in order tobring aggregate demand and supply moreinto balance and to ensure adequate fi-nancing for the private sector.

The results of the first year with the ex-tended arrangement were mixed. Produc-tion continued to decline, although moreslowly than previously, and investmentactivity remained weak. Equally worri-some were the deviations in fiscal policyfrom the program target. The overall cen-tral government deficit exceeded the targetby 2.3 percentage points of GDP. Jamaicacontinued to rely on foreign resources tofinance its current budgetary expenditures,a situation that was clearly not sustainable.On the external side, the further accumu-lation of arrears on international paymentsmeant that the anticipated private externalcapital flows did not materialize (includingtrade credits), which had the effect of ham-pering Jamaica's productive effort and in-tensifying its requirements for BOP assis-tance.

For the second year of the extended ar-rangement, the Jamaican authorities pro-posed, and the Fund agreed to, a changein the mix of economic policies and a re-vision of the program targets set in June1978, both in order to respond to the grow-ing social tensions and in an effort to stim-

Source: Jamaican authorities and Fund staff estimates

ulate a more rapid recovery of the econ-omy. Among the policies adopted was asuspension of the monthly currency de-preciations that was to be combined withgreater moderation in both wage demandsand price adjustments in order to diminishthe upward pressure on prices; there wouldbe no increase in taxes. Program targetswere revised to permit higher recurrentand overall fiscal deficits and a greater cur-rent account deficit, which would accom-modate a further expansion of imports re-quired to foster economic growth. Tosupport the latter effort, and to reduce ex-ternal payments arrears, the Fund doubledits commitment for the remaining twoyears of the arrangement to about US$330million (SDR 260 million).

In 1979, Jamaica, like the rest of theworld, was buffeted by higher oil pricesand rising interest rates. The country alsoexperienced severe floods in mid-year thatdamaged export crops and entitled Jamaicato obtain US$42 million from the Fund un-

Fitmnce fr DfTP/opWHf / lime 1981 19

Chat.2JAMAICA: Selected economic


der the compensatory financing facility.While these external shocks jeopardizedthe objectives of the second extended fa-cility program, major difficulties in themanagement of economic policies, particu-larly fiscal policy, resulted in the nonful-fillment of the quantitative criteria em-ployed to monitor progress.

Two major factors—greater than agreedwage increases granted to public sectoremployees and an inability to contain otherexpenditures—led to a recurrent budgetdeficit of 4.0 per cent, instead of a balance,and contributed to the overall public sectordeficit expanding to 13.7 per cent of GDP,compared with the target of 8.9 per cent.The deficit was financed primarily by do-mestic credit expansion, with bank creditto the Government growing by three anda half times the amount envisaged in thefinancial program. Excess demand pres-sures led to a widening of the current ac-count deficit to 6.8 per cent of GDP, anincrease in the overall external deficit, anda doubling of international payments ar-rears from their mid-year level. These di-vergencies from program targets led to aninterruption in Jamaica's right to makepurchases under the extended arrange-ment, pending a review of the conditionsunder which access to the Fund's resourceswould be restored.

In September 1979, when the slippageswere recognized, attempts were made todevelop new policies to return the econ-omy to its agreed stabilization path. TheFund was willing to modify the program'squantitative targets relating to Fund pur-chases in order to accommodate thechanges arising from unforeseen and ex-ogenous developments, just as it had un-der the 1978 program for that year's exportshortfall and purchase under the compen-satory financing facility. However, domes-tic consensus on economic policies did notemerge quickly. During this period of dis-cussion from September 1979 to February1980, the loss of policy momentum re-sulted in such departures from the pro-gram's targets that the original objectivesclearly became unattainable. Moreover,weakening social and political cohesionfurther complicated development of anagreed economic policy. Conscious of theneed to have the broadest possible supportof the Government's programs, the PrimeMinister, in an address to the nation onFebruary 3, 1980, stated:

"/ believe that the country needs to settle anddecide its economic strategy and that whenthat is settled, it will be easy to understandwhat part the IMF should play; or whetherit should piny any part at fill. What must bebrought to an end is the present state of con-fusion, because the country lias to settle down

on a path and understand the efforts, thediscipline, and the sacrifices that are neces-sary to that struggle."

The statement concluded with the an-nouncement that elections would be heldas soon as feasible.

Even though efforts under the extendedarrangement had collapsed and the Fund'sfurther role in Jamaica was in question, theFund and the Jamaican authorities agreedto negotiate an interim stand-by arrange-ment. This was viewed as a holding op-eration and, as such, the arrangementsought policies consistent with those pre-viously agreed by the Government for fis-cal year 1979/80. The Fund was to maintainthe same annual level of financial support(US$185 million, or about 6.1 per cent ofGDP) as under the extended arrangementand to solicit, on behalf of Jamaica, ex-panded foreign assistance. But negotia-tions were broken off by the Jamaican au-thorities on March 23, 1980 prior to thecompletion of the financial program.

Financing, 1978-80

Along with the modifications in the ad-justment strategies just outlined, the Fundparticipated in developing a supporting fi-nancing package in order to smooth theadjustment process and make it less costlyboth economically and socially. Given Ja-maica's extreme dependence on importedmaterials for production, every programhad sought an expansion of imports in anattempt to achieve the program's economicgrowth targets. To finance greater importsbetween 1977 and 1979, the Fund agreedto provide access to its resources in un-precedented amounts (about US$516 mil-lion, or 537 per cent of Jamaica's quota).Actual Fund assistance was greatest in the

G. Russell Kincaid

a L I . S . citizen, is agraduate of the Universityof California, Los Angeles(U.S.A.) and ColumbiaUniversity (U.S.A.). Mr.Kincaid joined the fund as

a Young Professional in 1976, after having taughtat universities and worked for the Board ofGoi'ernors of the federal Reserve Si/stem in theUnited States. Currently, lie is an economist in ther.xtcrnal Finance Division of the Exchange andTrade Relations Department in the fund and hasworked on Jamaica for the past two years.

Chart 3Jamaica: selected sources ofexternal financing, 1972-79

(Percentage of GDP)

Source: Jamaican authorities and Fund staff estimates

two years of the extended arrangement,when purchases were over US$260 million(about 270 per cent of the quota); the Fundalso helped to mobilize additional officialBOP support (about US$193 million), aswell as supporting efforts to obtain a me-dium-term refinancing of the bulk of am-ortization payments due to foreign com-mercial banks (US$141 million), along withan increase in short-term commitments ofUS$39 mill ion. Resources of this magni-tude—totaling about US$630 million, orabout 12.25 per cent of GDP a year during1978-79—could only be provided on a tem-porary basis in the expectation that theywould be used to build an economic basethat would make further massive assis-tance unnecessary and ensure the revolv-ing nature of Fund resources.

For the Fund's contribution to assistanceon this scale could only be of limited du-ration, with repayments beginning threeto four years after each purchase. Between1977 and 1979, the Fund was by far thelargest single source of external resources(see Chart 3). In fact, the level of Jamaica'spurchases from the Fund increased from0.8 per cent of GDP in 1977 to 7.5 per centof GDP in 1979—representing US$188 mil-lion—reaching a peak equivalent to 10.4per cent of GDP in the second half of 1979.

20 Finance ?* Development I June 1981

u-


In that year, Jamaica's drawings on theFund were far greater than its borrowingsfrom other sources, whether private or of-ficial. Net flows from foreign commercialbanks were actually negative in 1979, byabout US$11 million, while assistance fromother international organizations was aboutUS$61 million.

A number of observations can be drawnfrom the Jamaican experience concerningthe application of conditionality—espe-cially regarding the strategy adopted foradjustment and financing, the flexibility inselecting the mix of policy measures, andthe importance of timely action to correctimbalances. Jamaica experienced substan-tial imbalances that had persisted over aprotracted period prior to the Jamaican au-thorities' approach to the Fund in 1977. Bythen, foreign sources of financing and in-ternational reserves were depleted. The re-percussions of this combination of devel-opments on economic performance wereadverse. Imports had to be cut sharply anddomestic production was disrupted due toshortages of imported inputs. External re-sources were no longer available to cush-ion the severity of the adjustment process,extend the time period over which it musttake place, or increase the range of policyoptions open to the authorities. This dem-onstrates the desirability of approachingthe Fund at a timely stage. However, un-fortunately, this was not the path pursuedby Jamaica.

The magnitude of the financing gap, as-sociated with an economic and financialprogram designed to secure a balance be-tween aggregate demand and supply at thehighest possible income level, clearly in-dicated that actions to increase the supplyof and curtail the demand for foreign ex-change were necessary. To help bridge thisgap, the Fund assisted the Jamaican au-thorities to develop a financing packagethat included new loans from governmentsand international lending institutions, andrefinancing by foreign commercial banks.The Fund also provided Jamaica with ac-cess to its resources that was unprece-dented in terms of the size of the economy.If the resources committed under the re-vised two-year extended arrangement hadbeen fully disbursed, they would haveamounted to about five times Jamaica'squota. Actual disbursements in 1979 weremore than three times the net amount ob-tained by Jamaica from foreign commercialbanks, governments, and other interna-tional organizations.

Special BOP assistance would only bridgepart, but not all, of the financing gaps con-fronting Jamaica during this period. Do-mestic policy measures then would haveto close the remaining external resource

gap in order to make the program viable.Therefore, the domestic adjustment effortneeded was a result of both the resourcesrequired to make the program viable andthose that were available. Nevertheless, itis also clear that, throughout the period,the selection and combination of domesticpolicies undertaken to achieve the objec-tives of the programs supported by theFund—and indeed, even the targets of theprograms—varied in response to prioritiesset by the Jamaican authorities themselves.Thus, the Fund remained conscious of thecountry's circumstances and social priori-ties. The particular structure of policies de-veloped was based on the authorities' un-derstanding of the relative social costs andbenefits, while the Fund staff providedtechnical assistance as to the likely eco-nomic impact on the balance between re-source demands and available resources.

Jamaica's experience with the Fund dur-ing the period 1977-79 has been used tosupport the claim that the Fund's condi-tionality is politically impractical and ap-plied in a rigid fashion. With regard to thelatter, the adaptations in the policies andtargets of the programs supported by theFund indicate the degree of flexibility thatthe Fund is able to bring to coping with acountry's economic difficulties. For exam-ple, when external shocks buffeted the is-land's economy in 1979, the Fund was pre-pared to modify the program's ceilingsrelating to purchases just as it had done

under the 1978 program to accommodatethe changes arising from unforeseen andexogenous developments. However, majordifficulties also existed in the managementof economic policy, particularly fiscal pol-icy, which meant the quantitative criteriaemployed to monitor progress were notfulfilled. The emphasis placed on variouspolicy instruments also varied from pro-gram to program. This flexibility enablesthe authorities to construct a package ofpolicy measures that best suit their coun-try's political and economic circumstancesbut within existing financial constraints.

On the first point, that the adjustmenteffort required under Fund programs ispolitically unrealistic, it is important to rec-ognize that, in most circumstances, ad-justment will take place with or withoutthe Fund. Eventually claims on resourcesmust be reconciled with limited supply.When a country has delayed correctivepolicy actions until foreign financing hasdried up—as Jamaica did—then adjust-ment tends to be unduly large and swiftwith relatively large social welfare costs.Even unprecedented Fund financial sup-port and assistance from governments andother financial institutions may not be suf-ficient to lessen the constraints imposed bythis adjustment process. In any case theadjustment with Fund support was less,especially in the case of Jamaica, than itwould have been without its substantialfinancial assistance. HD

Recent developmentsAfter elections in October 1980, the new Government announced that it wouldinitiate negotiations with the Fund on an economic program to revive the economy. InDecember 1980, staff from the Fund and other international organizations, such as theWorld Bank and the Inter-American Development Bank, visited Jamaica to join theJamaican economic team in dei>eloping a framework for economic policies and inestimating external resource requirements. Thus, the process of designing a policy mixcapable of meeting the social and economic objectives of the authorities, whilebalancing the resultant resource demands with available resources, was resumed.

As with previous programs, the Fund assisted the Jamaican authorities indeveloping a financing package, consisting of new loans from governments,multilateral lending agencies, and foreign commercial banks, that would permit thenew program to achieve its objective of resuscitating economic activity. In March1981, at a meeting of the Caribbean Group for Cooperation in Economic Development,chaired by the World Bank, official lenders pledged to disburse at least US$350 million(excluding Fund resources), or 8.8 per cent of GDP, in new resources during the nextyear to support Jamaica's adjustment efforts. Later in March, meetings were also heldwith commercial banks to further progress on arrangements for deferral andrefinancing of amortizations due them and for new credits. The Fund staff described toboth groups the details of the stabilization effort and gave an assessment of theprospective economic situation, focusing on the financing requirement, to provide aframeiuork for their contributions. The Fund's direct contribution will be access to itsresources over the three-year period of the extended arrangement of about US$625million, or equivalent to 450 per cent of Jamaica's quota—the maximum permissibleunder the new policy for enlarged access. In the first year, Jamaica will be eligible todraw about US$250 million, or equivalent to about 6.3 per cent of GDP, plus apurchase of about US$45 million under the compensatory financing facility, or about1.2 per cent of GDP.



The Brandt Commissionand international monetary issuesThe wide-ranging recommendations of the Brandt Commission inits report on the world economy contained proposals for refprmingparts of the international monetary system. This article identifiesthe main issues raised by the Commission in this area andoutlines the debate on each against the backdrop of the evolvingrole of the Fund.

Augustus W. Hooke

The Independent Commission on Inter-national Development Issues (the BrandtCommission) was established in December1977. Its brief was to study the major globalissues resulting from economic and socialinequality, to suggest solutions to inter-national development problems, and to in-dicate suitable directions for internationaldevelopment policy in the 1980s. TheCommission's Report, which was com-pleted in December 1979 and published asNorth-South: A Program for Sunnval, dealtwith a wide spectrum of issues arisingfrom recent changes in international rela-tions and the world economy. Amongthese was the reform of the internationalmonetary system, on which its proposalscan be grouped under four main heads:reserve assets, lending by the Fund, ex-change rates, and management of the in-ternational monetary system.

This article will discuss the principalproposals of the Brandt Commission inspecific areas and also outline the steps theFund has taken, both prior and subsequentto the publication of the Commission's Re-port, in response to the continuing needfor changes in the international monetarysystem. The discussion will be limited toa number of specific topics in the area offinancing and international liquidity: thechanges that have been made in the valu-ation and use of the special drawing right(SDR); the ongoing debate on the pro-posed "link" between SDRs and develop-ment assistance; the liberalized access tothe compensatory financing facility and theproposal to establish a facility to meet thehigher costs for food imports; and the es-tablishment of the Subsidy Account for thesupplementary financing facility. (TheFund's conditionality practices, a subjectof concern to the Commission, are not dis-cussed at length here because they havebeen the subject of articles by Manuel Gui-tian in the December 1980, March, andJune 1981 issues of Finance & Develop-ment.)

The Commission's recommendationsconcerning reserve assets were aimed bothat promoting the acceptability of the SDR

as a reserve asset and at increasing the re-sources available to developing countries.The Commission shared the generally heldview that the SDR should become the prin-cipal reserve asset of the internationalmonetary system. It believed this could bepromoted in several ways: by the adoptionof a valuation system for the SDR that en-sures its predictability and stability; by therelaxation of restrictions on the use of theSDR; and by the establishment of a sub-stitution account. The Commission agreedthat the size of new allocations of SDRsshould be determined by the world's needfor additional liquidity. It maintained,however, that a larger share of these allo-cations should go to developing countries,establishing a l ink between allocations andthe provision of resources for develop-ment. It also supported the demonetiza-tion of gold, which it thought could be fa-cilitated by two actions: the use of part ofthe Fund's gold as collateral for borrowingin the capital markets to finance additionallending to developing countries (particu-larly the middle-income countries) and thesale of part of the balance of these holdingsto finance an interest-subsidy account forthe least developed countries.

The Commission's recommendations onthe provision of financial assistance by theFund were directed both at making moreresources available and at permitting lessrestricted access to existing resources. Itproposed the establishment of new facili-ties, such as an interest-subsidy accountfor the least developed countries, the ex-pansion of the scope and the liberalizationof the terms of lending of the compensa-tory financing facility, and the reduction ofthe degree of conditionality attached to theuse of Fund resources. The Commissionaccepted the need for the Fund to attachconditionality to the use of its resourcesbut believed that conditionality was ap-plied severely. It argued that the Fund'sapproach was monetarist; paid too littleattention to the social, political, and eco-nomic objectives of borrowing countries;and did not make allowance for the causesof their payments difficulties. The Com-

mission also claimed that the Fund's pre-scriptions were biased toward deflation,involved inappropriate or excessive regu-lation of the economies of borrowing coun-tries, and imposed a heavy burden on thepoorest sections of their populations. Asa result, developing countries had beendiscouraged from making timely and ade-quate use of the Fund's resources.

On the exchange regime, the Commis-sion urged the creation of an environmentthat would promote greater stability of ex-change rates. It believed that this would befacilitated by the adoption of its proposalson reserve assets and conditionality as wellas by encouraging surplus countries to ac-cept greater responsibility for balance ofpayments (BOP) adjustment. The Com-mission also recommended that the majorindustrial countries exercise greater disci-pline and improve coordination of theirnational policies to increase the stability oftheir own exchange rates.

The Commission argued that the man-agement of the international monetary sys-tem should not be dominated by a singlecountry or a small group of countries. Itshould include the Council for MutualEconomic Assistance (COMECON) coun-tries, and it should provide a growing rolefor the developing countries. Such collec-tive leadership would, it believed, be fa-cilitated by rules ensuring that decisionmaking in the Fund was not based whollyon quotas. The Commission also recom-mended that the developing countries begiven enlarged participation in the staffing,management, and decision making of theFund.

Changes in the SDR

The Commission's proposals on the SDRwere directed at promoting the SDR as areserve asset; the Commission recom-mended, first, that the SDR be valued soas to ensure its predictability and stability,and, second, that it be made available fora wide range of uses. These were generallyacceptable to both the developing and theindustrial countries and important pro-gress has been made on both since theCommission's Report was published. In1974, the stability of the SDR had been en-hanced by switching its valuation from theU.S. dollar to a weighted average of a bas-ket of 16 currencies. Subsequently, at thebeginning of 1981, the valuation of theSDR was simplified. The size of the basketof currencies in which the SDR is valuedwas reduced from 16 currencies to the 5

22 Finance f-r Development lime 1981


currencies most widely used in interna-tional trade and investment—that is, theU.S. dollar, the deutsche mark, the Frenchfranc, the Japanese yen, and the poundsterling. This change makes the currencycomposition of the valuation basket iden-tical with that of the basket used to deter-mine the interest rate of the SDR; theweighting system employed in the twobaskets was also made identical. Thisshould help to foster the private use of theSDR by promoting public understandingof its nature, making the currency com-position of the basket more stable, andmaking it easier for participants in the pri-vate markets to cover exchange risks in-volved in SDR-denominated transactions.During 1980, the Fund also permitted theuse of SDRs in donations, adding this toa range of transactions that includes swaparrangements, spot and forward opera-tions, loans, and pledges.

Several other improvements have re-cently been made to the characteristics ofthe SDR. In 1980-81, the Fund designatedseven additional institutions as "otherholders," raising to eight the number ofinstitutions other than national treasuries,central banks, and the Fund itself that canhold SDRs. In 1980, it was agreed to raisethe interest rate paid by the Fund to mem-bers on their holdings of SDRs from 80 percent of the market rate on specified short-term obligations in the money markets ofthe five countries whose currencies are in-cluded in the SDR valuation basket, to thefull combined market rate on those obli-gations. This change should make the SDRmore competitive with other reserve as-sets. In 1981, the Fund decided in principleto abrogate the requirement that membersmaintain, over time, a minimum averagelevel of SDR holdings.

These adjustments to the SDR—thechange in the valuation basket, the rise inthe interest rate, the increase in the num-ber of "other holders," and the abrogationof the reconstitution requirement—shouldfacilitate transactions in SDRs and enhancethe role of the SDR as an important reserveasset in the international monetary system.These changes should increase the useful-ness of allocations to developing countriessince they raise the proportion of holdingsthat can be used (to 100 per cent) and theyincrease the willingness of a larger numberof institutions to hold SDRs.

The link

The proposal to establish a link betweenthe Fund's allocations of SDRs and financefor development has been made in manyforums. The Fund's Articles of Agreement,which originally established the SDR facil-ity in 1969, specify that allocations of SDRs

be proportional to Fund quotas. But therewere proposals to allocate a larger share ofSDRs to developing countries prior to theFirst Amendment of the Fund's Articles,and the matter was considered more ex-tensively in a technical report prepared forthe Committee of Twenty in July 1973. Inthe last few years the issue has been re-vived, in part because of the rising pay-ments deficits of the developing countries.The ensuing debate has focused mainly onthe effects of a link on the quantity andquality of aid, BOP adjustment, and infla-tion.

While most supporters of the link em-phasize its potential to transfer resourcesto developing countries, the Brandt Com-mission stressed the contribution suchtransfers could make to the internationaladjustment process. The Commission ar-gued that it was in the general interest forcountries to be provided with sufficientshort-term resources to permit them toavoid measures that could be harmful toworld trade and payments or to their owneconomies. It believed that additional re-serves should be created and then be al-located mainly to developing countries:their low level of development and heavyconcentration on primary production in-crease the instability of their export earn-ings and raise their costs of adjustment,and they have limited access to interna-tional capital markets and pay high oppor-tunity costs in acquiring reserves.

However, in response to the BrandtCommission's view, it has been suggestedthat the effective transfer of SDR alloca-tions from industrial to developing coun-tries would lead to increased expenditureon the exports of those industrial countriesthat normally run large surpluses, thuswidening payments imbalances among theindustrial countries. A link arrangementmight also be effective only so long as theadditional allocations were unanticipated;once these countries included the largerallocations in their forecasts they could betempted to plan for and incur correspond-ingly larger payments deficits.

Finally, a common objection to the linkis its possible contribution to worldwideinflation, as a result of the greater interestdeveloping countries would have in largerallocations and of the higher propensity ofdeveloping countries to import. It may benoted that the Brandt Commission did,however, stress that the si/e of SDR allo-cations should be determined wholly bythe world's need for additional l iquidity.The Commission also observed that a de-cision to allocate SDRs requires an 85 percent majority of the Fund's voting powerand that the developing countries couldnot push through an allocation over the

determined opposition of the industrialcountries or even of the United States ora small group of other major industrialcountries.

The proposal on the link is a continuingsubject for worldwide debate both in theFund and in other international and pri-vate forums. However, opposition to it re-mains strong among the industrial coun-tries and there is little prospect of itsadoption in the immediate future.

Compensatory financing

The Fund's compensatory financing fa-cility was established in 1963 to provideresources at low conditionality to mem-bers, especially those exporting primarycommodities and experiencing shortfallsthat are temporary and largely attributableto circumstances beyond the member'scontrol.

The Commission's proposals for liberal-izing and expanding the facility were de-signed to make it more consistent with theCommission's view of the underlying ob-jectives of the facility and to take into ac-count the individual circumstances ofcountries using it. The Commission be-lieved that quota limits on access shouldbe removed; the relevant factor determin-ing the amount of assistance should be themember's payments shortfall, not its quota.It argued that the facility's resources shouldbe made available to members sufferingfrom any shortfall resulting from factorsbeyond its control—particularly such fac-tors as increased import prices and cropfailures—to forestall the need for harmfulcutbacks in imports. In addition, the Com-mission recommended that repaymentterms be made more flexible and limited tothe member's capacity to repay and thatcalculations be made in real terms to allowfor the effects of inflation.

The Fund has been improving access tocompensatory financing for some time,based on periodic reviews of its lending forthis purpose. From 1963 to 1974 there wereceilings of 25 per cent of a member's quotaon the amount that it could purchase inany one year and of 50 per cent of quotaon the total of outstanding purchases. In1975, these limits were raised to 50 per centand 75 per cent, respectively. In 1979, theceiling on annual purchases was abolishedand the limit on outstanding purchaseswas raised to 100 per cent. These changeshave considerably increased the propor-tion of member countries' export shortfallsthat can be financed under the facility.

In addition to compensatory finance onthe export side, there has been consider-able support for the proposal that the Fundprovide f inancial assistance to net food im-porting developing countries. Such assis-

b'iiiunce ft- Development I lime 198'! 23


tance would be provided to members ex-periencing BOP difficulties resulting fromthe effects of crop failure at home or abroadon the volume or price, respectively, oftheir food imports. It would permit thesecountries to maintain food consumptionlevels without having to curtail those im-ports needed for economic development.The Fund's existing facilities already pro-vide assistance to members experiencingtemporary BOP difficulties of this kind. Buta new arrangement for this specific pur-pose, it is argued, would enable the Fundto respond more quickly to members' needsand would allow it to provide assistancewithout reducing the ability of affectedcountries to borrow from the Fund to meetother payments difficulties. The proposedarrangement could take the form of a spe-cial facility or a broadened compensatoryfinancing facility.

Since the objective of the compensatoryfacility is to cushion the effects of exportfluctuations on the BOP, and thus on thecapacity to import, it could be argued thatcountries should have access to the fundsonly when they have an export shortfalland an overall payments deficit, and beobliged to make repurchases as soon asthey have an export excess and an overallpayments surplus. However, such a policywould be administratively burdensome tocarry out; it would require repeated time-consuming calculations on the changingpositions of all members that have pur-chases outstanding under the facility. Itcould also work out that the Fund mightfind it necessary to agree to an open-endedextension of the repayment period. Ac-cordingly, the Fund has always requiredthat repurchases under the facility be madewithin three to five years, as is the case forrepurchases under its regular facilities.

Augustus W. Hooke

an Australian, is Editor ofthe Fund's PamphletSeries and OccasionalPapers. He graduated fromthe Australian NationalUniversity and theUniversity of Queensland (Australia). He joined theFund in 1968 and u'tis resident representative inKorea between 7974-76. Between 1976-78 Mr.Hookc worked in the Fund's Paris office on issuesaffecting developing countries. Until 1980 heworked in the Asian Department in the Fund onSri Lanka, Japan, and Korea. Mr. Hooke is theauthor of The Burden of the Public Debt 0976;and lias contributed to other hooks on economics.

The Commission believed that the Fundshould establish an interest-subsidy ac-count to help low-income developingcountries meet the interest costs of usingthe Fund's resources.

The Fund recognized the need for a sub-sidy account as world interest rates rosesharply in tandem with inflation and thedeveloping countries made considerableuse of its supplementary financing facility.This facility, which came into effect in1979, is financed with resources borrowedby the Fund at market-related rates fromcountries with surpluses and, in turn,makes assistance available to borrowers atmarket-related rates of interest that areconsiderably higher than the rates chargedunder regular Fund facilities.

In November 1980 the Fund establishedthe Supplementary Financing Facility Sub-sidy Account to reduce the interest cost todeveloping country members of using re-sources under the supplementary facility.The subsidy may be as high as 3 per centof the member's outstanding purchasesunder the supplementary facility and isavailable to a group of some 69 developingcountry members whose per capita in-comes in 1979 did not exceed the level usedto determine eligibility for assistance fromthe International Development Association(IDA). The subsidy at half this rate is avail-able to a second group of some 14 otherdeveloping countries. The resources of thefacility are expected to be about SDR 1 bil-lion, from repayments of Trust Fund loans(SDR 750 million), donations, and borrow-ings.

Increased stability

The Brandt Commission's proposals oninternational monetary issues are broadlysimilar to those made by representativesfrom the developing countries in other fo-rums, such as the Conference on Interna-tional Economic Cooperation (CIEC) andthe United Nations Conference on Tradeand Development (UNCTAD). They aredesigned to give the developing countriesaccess to greater amounts of financial as-sistance on easier terms, to produce a morestable exchange rate system, and to pro-mote a more equal distribution of the ad-justment burden between surplus and def-icit countries. This article has describedsome of the changes that have been madeby the Fund in areas of concern to theCommission. It has also reviewed the de-bate over the link and the coverage of thecompensatory financing facility. On these,continued technical work and possibleswings in political attitudes could leadeventually to their partial or completeadoption.

There are both technical and politicalbarriers to the adoption of the Commis-sion's other recommendations. On some—such as substantially redistributing votingpower in the Fund in favor of developingcountries and lowering further the degreeof conditionality associated with the use ofFund resources—opposition is strongamong the Fund's industrial membercountries. The proposals could even beself-defeating. If countries that are majorsuppliers of resources to the Fund were tohave less control over the uses of these re-sources, or to believe that these resourceswere no longer being used to promote in-ternational adjustment within a coopera-tive framework, they may become lesswilling to vote for large quota increases orto lend to the Fund.

Recent changes in the Fund's policiesshould contribute to the stability of the in-ternational monetary system by promotingthe role of the SDR as a reserve asset andby increasing the amount of assistanceavailable to individual countries experienc-ing BOP difficulties. The benefits can beexpected to be greater for the developingthan for the industrial countries since thedeveloping countries tend to be net usersof SDRs and will receive most of the ad-ditional assistance under the compensa-tory facility and all of the assistance fromthe new interest-subsidy account. TheBrandt Commission Report has attemptedto focus attention on issues that are of con-cern to many Fund members. The propos-als for changes that come regularly fromgroups within the Fund's membership, to-gether with the issues raised in the Com-mission Report, will become an agenda forconsideration by the Executive Board andthe staff in the immediate future, as theydeal with the continuously changing prob-lems that confront the international mon-etary system. HD

Related reading

North-South: A Program for Survival. TheReport of the Independent Commissionon International Development Issues un-der the Chairmanship of Willy Brandt(Cambridge, MA, U.S.A., MIT Press,1980).

International Monetary Reform: Documents ofthe Committee of Twenty (Washington,DC, U.S.A., International MonetaryFund, 1974).

"Outline for a Program of Action on Inter-national Monetary Reform." Attachmentto a Press Communique issued by theDevelopment Committee, September 30,1979 (Reproduced in the InternationalMonetary Fund's Annual Report, 7980,pp. 160-65).

24 Finance & Development i June 1981


^W*

Enzo R. Grilli

At some point in the late 1960s, naturalrubber began to look like a doomed prod-uct. World demand for rubber, largely pro-pelled by the growing use of automobiles,was increasing at 6 per cent a year in thedeveloped countries, 7 per cent a year inthe centrally planned countries, and 10 percent a year in the developing countries.Natural rubber, with its long gestation pe-riod between planting and production,was growing at less than 3 per cent. Thegap was being filled by synthetic rubbers.Evolved during World War II, these rub-bers were able to boost output by about 9per cent a year after 1949, thanks to a com-bination of technological innovation, econo-mies of scale—and cheap energy. By theearly 1970s, synthetics had captured thelion's share of the market.

But now, less than a decade later, itlooks as if natural rubber could regain agood share of the market lost to synthetics.There are several reasons why. First, be-tween 1973 and 1980 the real price of crudeoil—that is; the price of oil expressed inconstant dollars—more than quadrupled.The production costs and prices of syn-thetic rubbers, which depend heavily onthe cost of petroleum-based inputs, morethan doubled in the industrial countries.Natural rubber costs were affected but notnearly as much, since the share of energy-related inputs is much smaller in the pro-duction of natural rubber. Second, duringits period of apparent stagnation, the natu-ral rubber industry had developed a strongbase for potential growth. By the mid-

The world rubber economy,which consists of natural rubberand its synthetic counterpart,underwent a profoundtransformation after WorldWar II as synthetics began topush the natural product out ofthe market. But while 10 yearsago it seemed that naturalrubber could not retain a strongmarket position, today,principally because of theeffects of the oil price increaseand the proven resilience of thenatural rubber industry itself, thesituation could be reversed.

aysian Rubber Bureau photo

1970s its productivity had increased dra-matically, as a result of replanting, the de-velopment of higher-yielding varieties oftrees in key producing areas, and improve-ments in cultivation, production, and mar-keting. At the same time, it seems as if thecapacity of the synthetic rubber industryto innovate and to adjust to market changesmay have reached some limit or at least atemporary quiescence.

The short-term effect of the oil price risesduring the late 1970s was to increase—ifmarginally—the share of natural rubber ina declining overall market. The long-termeffects are uncertain; they depend uponsuch factors as whether the rubber marketwill recover; how synthetics will respondwith structural changes in their productionprocesses, both to the end of cheap energyand to changes in product demand itself;and whether the natural rubber industrywill continue to increase its productivityand to emphasize research and productimprovement. This article will contend,however, that although the natural prod-uct still supplies only about 30 per cent ofthe world rubber market, while its syn-thetic counterpart supplies the other 70 percent, the combination of rising oil prices

See The World Rubber Economy: Struc-ture, Changes, and Prospects, by Enzo R.Grilli, Barbara Bennett Agostini, and Maria ].'t Hooff-We/wars, JVorM Ban* Staff OccasionalPapers, No. 30.


Natural rubber a better future?


Chart 1Synthetic rubber production

(In per cent of world total)

Sources: International Rubber Study Group. Statistical Bulletin, various issue— Zero or negligible.

and the relative competitiveness of the twoindustries could mean that natural rubberhas the potential to come to the fore again.

The rise of syntheticsFrom the end of World War II until the

early 1970s, the world rubber economy en-joyed a period of rapid and steady growth.Profound structural changes took place,resulting mostly from technological evo-lution as synthetic rubber, developed un-der the needs of World War II, gained apredominant position in the world marketand dissipated the near-monopoly positionenjoyed by natural rubber since the firsthalf of the 1900s. Between the late 1940sand the early 1970s the share of syntheticsin the rubber market rose from 20 per centto 70 per cent in industrialized countries,from 30 to 65 per cent in centrally plannedeconomies, and from nearly zero to 50 percent in developing countries.

There was one main reason for the rapidexpansion of the synthetic rubber industry:the fact that the surge in world demand forrubber could not be met by existing naturalrubber production. World consumption ofrubber increased by over 6 per cent perannum between 1948 and 1973, fostered bythe greater use of motor vehicles in indus-trialized countries—particularly in Western

Europe and Japan—which created a strongdemand for rubber products. Over 65 percent of all rubber produced is used directlyby the automotive industry in tires andother parts. Demand for nonautomotiverubber products (footwear, belts, hoses,and so on) also increased quite rapidly inthe wake of the fast expansion in worldindustrial production.

Stimulated by this demand, the syn-thetic rubber industry was able to maintainhigh growth rates over an extended period(see Chart 1). Production became concen-trated in a few, large private companies ina restricted number of countries. Some 65per cent of the world supply of syntheticrubber is now produced by the EuropeanEconomic Community, Japan, and theUnited States; 28 per cent is supplied bythe centrally planned economies. Con-sumption is distributed in roughly thesame proportions: 64 per cent of supply isabsorbed by the developed countries, 28per cent by the centrally planned group,and the remainder by the developingworld.

The growth of the synthetic rubber in-dustry was helped by technological break-throughs. In the early 1950s, for instance,the profitability and quality of styrene-butadiene rubber (SBR), the single most

important kind of synthetic rubber, wasdramatically improved by innovations inproduction and processing. The industryalso developed, among others, an almostperfect replica of natural rubber—polyiso-prene rubber. Thus, the production of syn-thetics became more and more diversified;different types were developed, in differ-ent places, using different processes. Pet-rochemical producers and tire manufactur-ers gained predominance in the industry.Petrochemical interests alone appear tocontrol over 50 per cent of existing pro-duction capacity. Most of the remainder iscontrolled by tire manufacturers whichmoved into synthetic rubber production.Economies of scale, technological innova-tions, and improvements and di-versification in products led to lower pro-duction costs and market prices.

Natural rubber shared this overall mar-ket growth only partially, growing mod-estly at less than 3 per cent a year as priceand nonprice competition from syntheticrubber became progressively more intenseand spread to new products and geo-graphical markets. The profitability ofnatural rubber production also deterio-rated steadily. Falling costs and prices ofsynthetic rubbers, particularly of SBR, cameto determine more and more the trend ofnatural rubber prices, which in real termsdeclined by one half between 1952-53 and1970-71.

During these years, natural rubber pro-ducers were confronted with a seeminglyinsurmountable challenge, as natural rub-ber looked increasingly like a productwhose future was threatened by the de-velopment of a superior synthetic substi-tute. Technological innovations in the pro-duction of synthetic rubbers seemed neverending in the energy-happy world of pre-1973; petroleum for petrochemical inputswas available and was being offered at pro-gressively cheaper prices.

Positive reactionThe natural rubber industry, however,

reacted positively to the challenges in sev-eral complementary ways. Natural rubber,like its synthetic counterpart, is producedby a few major countries: Indonesia, Ma-laysia, and Thailand in Asia account for 80per cent of world production; India, Li-beria, Nigeria, and Sri Lanka together pro-duce a further 12 per cent (see Chart 2).However, within each country natural rub-ber is produced by an extremely largenumber of productive units, estates, andsmallholdings. Smallholder rubber is nowthe predominant mode of production in allmajor countries. Estate rubber is to a verylarge extent owned by private domesticand public interests. Foreign concerns, in-

26 Finance & Development I ]une 1981


eluding some large companies, account fora relatively small share—16 per cent to 17per cent—of rubber estate production ona world basis. Of this 16 per cent onlyabout 5 per cent is accounted for by U.S.tire companies, most of which are involvedin synthetic rubber production.

This geographical concentration of pro-duction made it easier to rationalize the in-dustry to make it more efficient. The majorrubber producing countries realized that toremain competitive they had to modernize.They invested in long-term research, madetechnical innovations in production andprocessing, and vigorously promoted de-velopment programs. Old, unselectedseedling trees, for instance, were replaced

with high-yielding materials (clones andclonal seedlings), which, in combinationwith good cultivation practices, could im-prove yields several fold. The use of chemi-cals to stimulate yields was another im-portant technical innovation. Ever sincerubber was grown on a commercial scale,planters and research workers had endeav-ored to find some method of artificially in-creasing yields through prolongation oflatex flow. In the early 1970s an importantbreakthrough was made with the discov-ery that ethylene-releasing substancesstimulated the flow of latex. It has beenshown that one substance, ethephon, canincrease tree yields by 30 per cent to 60 percent, if judiciously used, although some

Chart 2Natural rubber production


Sources International Rubber Study Group,Statistical Bulletin, various issues; Food andAgriculture Organization, Production Yearbook, variousissues; and World Bank, Economic Analysis and

Projections Department.— Zero or negligible.

1ncluding Oceania.

uncertainty remains about its long-termeffects on the productive life of the trees.

Although the productivity gains werenot evenly distributed among producers,they were nevertheless widespread enoughacross countries and producing sectors(both estates and smallholdings) for natu-ral rubber production to remain viable, de-spite falling synthetic prices. To give small-holders a greater share of the gains,attempts were also made in a number ofproducing countries to rationalize produc-tion processes and to streamline internalmarketing systems.

During this period of slow growth, theexternal marketing of natural rubber wasalso rationalized, emulating the distribu-tion of synthetic rubber. In the mid-1960s,new "block" rubbers were developed, anda process of grading the quality of naturalrubber according to rigorous technicalspecifications was started. Standardizingthe quality of natural rubber rendered itmore attractive to the consumer; in addi-tion, the smaller bale size of these blockrubbers facilitated handling and stacking,and saved on transport, handling, andstorage costs.

Apart from the direct economic advan-tages of the introduction of standardizedrubber products, these improvements

Chart 3Rubber consumption


Sources: International Rubber Study Group. Statistical Bulletin, various issues; Food and AgricultureOrganisation. T;ude Ycatbcak. various issues; and World Bank. Economic Analysis and Projections Department.



demonstrated to consumers the capabilityof the natural rubber industry to meet thechanging requirements of the market place,and gave them renewed confidence in theinherent strength of the industry.

Oil price increase

In 1973, the world rubber economy suf-fered its first severe jolt: the oil crisis andsubsequent sharp rise in crude oil pricesand then the recession in the industrialcountries. For synthetic rubber, which de-pends so heavily on petrochemicals, thesudden drastic increase in crude oil pricesin 1973-74 implied a major change in costsand production (see Chart 4). As much as70 per cent of the production cost of syn-thetic rubbers depends on the costs of pet-rochemical ingredients and energy. Be-tween 1973 and 1975, these costs morethan doubled, labor and overhead chargeswent up, and, as a result, the average costof producing synthetic rubber from exist-ing facilities increased by 70 per cent to 100per cent in the industrial countries.

Natural rubber was less affected di-rectly—the average direct cost of produc-ing rubber in Malaysia went up by about30 per cent between 1971 and 1974. Theindustry was, however, still subject to allthe indirect effects of the oil crisis: accel-eration of world inflation, changes in con-sumer expectations, and rising doubtsabout the long-term future of world de-mand for rubber in the energy-intensiveautomotive sector.

Doubts about the long-term future of therubber industry deepened during the eco-nomic recession that affected the indus-trialized countries after 1973. As industrialproduction fell, so did the output of theautomotive industry, and so did world de-mand for rubber. Between 1978 and 1980the price of crude oil again increasedsharply in real terms, bringing the cumu-lative increase since 1973 to more than 400per cent. Costs and prices of synthetic rub-bers went up again and the expected prof-itability of new investments, facing in ad-dition to severe cost pressures a moreuncertain outlook for demand, deterio-rated further. Actual investments as wellas plans for new investments in syntheticrubber capacity have virtually come to ahalt outside the centrally planned econo-mies.

It is generally expected that the futurerate of expansion of world demand for allrubbers will be below historical trends inthe next 10-15 years—perhaps by as muchas 1 to 1.5 per cent per annum. These ex-pectations are borne out by detailed analy-sis of future world demand for rubbers.The basis for this analysis is, first, the pros-pects of slower growth in economic activity

in the 1980s; and, second, the structuralchanges expected in the relationships be-tween economic activity and rubber de-mand, brought about by changes in con-sumer choices in transportation and bygovernment policies affecting the produc-tion and use of motor vehicles.

This slowdown is likely to be more vis-ible in industrialized countries, where themajor structural changes in demand areexpected to occur and where demand forrubber is already high. The reduction indemand is likely to be less marked in thecentrally planned economies, where theconsumption of rubber is lower and is lessaffected by consumer choice and bychanges in income and industrial produc-tion. Strong growth is still expected to con-tinue in developing countries, particularlyin high-income developing countries,where the use of motor vehicles is increas-ing.

Better market prospects

A key question posed by these devel-opments is whether the relative marketposition and future prospects for naturalrubber have also deteriorated with theworsening prospects for the overall de-mand for rubbers. The prospects for rubberdepend critically on the competitive posi-tion of natural vis-a-vis synthetic rubbersand on those developments of technologythat affect the choice of rubber inputs inthe production of rubber products. Analy-sis of these factors shows that on bothcounts natural rubber is potentially in abetter market position than at any othertime in the recent past.

The long-term competitiveness of pro-ducing natural rubber from existing treeshas improved considerably, given the evo-lution of costs and prices in the secondhalf of the 1970s. It is estimated, for ex-ample, that to have invested profitably in

SBR production in Western Europe in1977, the industry would have needed fu-ture real prices of at least 40 cents perpound. Equally profitable investments innatural rubber in Malaysia would have re-quired a future real price of about 35 centsper pound. The profitability of natural rub-ber investment would have been evengreater in relation to other kinds of syn-thetic rubbers, such as polyisoprene. The60 per cent increase in the real price of oilbetween 1977 and 1980 has added at leastanother 7 cents a pound to the future ex-pected price necessary to invest profitablyin SBR. The crude oil price increases ex-pected in the 1980s will further improvethe long-run competitiveness of naturalrubber.

Closely reflecting the climb in the pricesof synthetic rubbers (which in turn fol-lowed the upward trend set by crude oilprices), the prices of natural rubber in-creased markedly in the second half of the1970s (see Chart 4). Natural rubber pricetrends are set to a large extent by those ofsynthetic rubbers. While in the late 1960s,falling synthetic rubber prices pulled downnatural rubber prices, they have pulled upnatural rubber prices since 1973. More im-portant yet, rising synthetic rubber pricesand favorable product developments—suchas the spreading use of radial tires, whichrequire relatively more natural rubber thanother types of tires—have contributed toreverse the long-term decline in the realprices of natural rubber. After falling bymore than one half in the 1960s, real pricesof natural rubber have increased by about45 per cent between 1972 and 1979. Thisreversal is not likely to be a temporary phe-nomenon. It is expected that the real priceswill continue to increase in the 1980s, asdemand for natural rubber goes up and theprices of synthetic substitutes follow thetrend set by rising real energy costs.


Chart 4Price trends of natural rubber, styrene-butadiene

rubber, and crude oil in the United States: 1947-80(In current dollars) I

Source World Bank date


Another reason to be sanguine about thefuture for natural rubber is that the scopefor future productivity gains in the syn-thetic rubber sector appears to be morelimited than it was. Outside the field ofspecialty rubbers, technological innova-tions in production and economies ofscale, which were the major factors behindthe exceptionally fast growth of general-purpose rubbers in the postwar period,appear to have almost run their course.Their future effect is likely to be much lessstrong than in the 1950s and 1960s—al-though it will by no means be negligible.The synthetic rubber industry outside thecentrally planned economies is reaching amature stage where emphasis is likely tobe on rationalization, consolidation, andbetter planned growth. Inside the centrallyplanned economies, expansion programsare likely to continue for the sake of self-sufficiency, regardless of developments inworld rubber markets.

Apart from these economic constraintsto further rapid growth, the synthetic rub-ber industry will also face greater uncer-tainties than in the past about the avail-ability and prices of chemical feedstocksand mounting pressures over environmen-tal and health issues.

Exploiting the potential

The natural rubber industry is in a fa-vorable position to take advantage of thepresent good market opportunities. De-spite these favorable prospects, however,natural rubber producers will need to fulfillseveral important conditions in order totake full advantage of this potentially fa-vorable market situation:

• Natural rubber supply will have tokeep pace with the expected growth in de-mand for the synthetic replica isoprenicrubber, and a secure supply will have tobe assured.

• Existing successful production tech-nologies will have to be adopted bothwithin and across countries.

• Research, development, marketing,and technical assistance programs will haveto be maintained and strengthened.

Maintaining an adequate supply of natu-ral rubber to meet world market demandfor isoprenic rubbers is clearly of the ut-most importance—yet it is uncertain thatnatural rubber producing countries canfulfill it. On the basis of current informa-tion on the area under rubber, on projectedyields of trees already in the ground, andon expected rates of replanting and newplantings, it appears likely that beyond theearly 1980s natural rubber supply will growat rates below potential market needs.Even on the basis of relatively conservative

assumptions concerning the growth of de-mand for isoprenic rubber outside the cen-trally planned economies and a relativelyoptimistic assessment of the likely growthof natural rubber supply from existingplantings and from plantings scheduled tocome into production, there is likely to bea gap between supply and demand by theend of the 1980s.

If this gap is not filled by increased sup-plies of natural rubber, it will probably bemet by synthetic polyisoprene. Since thelags between planting and production ofnatural rubber are relatively long, deci-sions to invest to increase supply in thelate 1980s will have to be made immedi-ately in the key producing countries. Syn-thetic polyisoprene producers outside thecentrally planned economies have sparecapacities and, more important, muchshorter investment lags. Since their pro-duction can be increased more rapidly,their investment risks are lower. Yet analy-sis shows quite clearly that natural rubberproducers have a substantial competitivecost advantage over polyisoprene (at leastunder known production technologies) andthat, with its technical and economic po-tential, natural rubber can fill the potentialdemand gap for isoprenic rubber in the late1980s.

Enough capital from public and privatesources should be available to expand theworld production of natural rubber. Thetechnology is not only available but alsoreasonably well proven. Land for newplanting and replanting is plentiful incountries such as Indonesia and Thailandand, to a lesser extent, Malaysia. Brazil, thePeople's Republic of China, India, the Phil-ippines, and West Africa also offer scope

Enzo R. Grilli

from Italy, has degreesfrom the University ofGenoa (Italy) and JohnsHopkins University(U.S.A.). He is Chief ofthe Commodities andExport Projections Division of the World Bank.Previously, Mr. Grilli was Director of the ResearchDepartment of the Confederation of ItalianIndustries in Rome. He has taught at theUniversity of Genoa and at Johns Hopkins. Mr.Grilli is the author of several publications oncommodities, including The World RubberEconomy and "Commodity Price Stabilization andthe Developing Countries," Banca Nazionale delLavoro Quarterly Review (March 1978), withE. Brook and J. Waelbroeck.

for new and higher production of naturalrubber. Even with current acreage, supplycan be increased considerably by speedingup current replanting and using higheryielding varieties of trees. Chemical stim-ulants can also increase output rates fromexisting old trees.

Expanding output to meet market needswill involve, over the next 25 years, sub-stantial changes in the country distributionof natural rubber production. The relativeimportance of Indonesia and Thailand,where new land and labor are more abun-dant than in Malaysia, will probably in-crease. In the long term, the People's Re-public of China, and eventually Brazil,could become major natural rubber pro-ducers. The modes of production may alsochange substantially, with single small-holders becoming less important at the ex-pense of cooperative types of smallholdingorganizations, offering members commoninfrastructural support in both the produc-tion and the processing of the rubber latexand sharing the ownership of the produc-tive unit. There are strong economic andtechnical reasons — as well as examples ofsuccesses — for this type of organization.Geographically, however, the location ofthe industry will not change much, withAsia accounting for most of the world out-put.

The possibility of expanding natural rub-ber production will also offer unique em-ployment opportunities in agriculture tocountries having a large and underem-ployed labor force. Natural rubber produc-tion is labor intensive. It also offers scopefor tangible and sustained productivitygrowth. Expected future price and produc-tivity trends should leave ample room forincreasing real returns to producers.

Natural rubber producing countries haveshown willingness to cooperate with eachother, to share technological advances, andto further research. In October 1979 theyalso entered into a new agreement withconsuming countries to stabilize marketprices. The new International Natural Rub-ber Agreement that came into effect in 1980foresees the use of a fairly large bufferstock to keep market prices from exceedinga predetermined, but flexible, band of fluc-tuation. If it is successful, market stabili-zation will make natural rubber supplymore secure and reduce the volatility of theprice of natural rubber for its users. To-gether with sound policies concerning pro-duction and exports, the Agreement cangive added impetus to the resurgence ofthe natural rubber industry. The marketconditions for a better future for naturalrubber seem to be in place: it is up to theproducers to take advantage of this oppor-tunity. ED



John Russell Adapting extension workProviding farmers with relevant advice and technical support inunderdeveloped areas requires much more attention to localconditions than is generally given. This article emphasizes theneed to integrate extension work with other development effortsand shows how extension systems can be adapted to becomemore effective in less developed agricultural areas.

Agricultural extension can be defined asthe provision of increased knowledge andskills necessary for farmers to be able toadopt and apply more efficient crop andanimal production methods to improvetheir productivity and living standards. Itdepends crucially on effective communi-cation, which has to be a two-way processbetween farmers and extension workers.

The Bank's experience with the role ofextension in improving the productivity of

I farmers in underdeveloped areas shows^Very clearly the key function of three hi-

ll | gredients of success: inputs—seeds and1 fertilizer—adapted to local conditions andi § practices; an acceptable production tech-

nology; and, once the farmer has pro-gressed beyond the subsistence stage, amarket for his products and related infra-structure. (There are other components ofsuccess, but these are supportive. Credit,for instance, may well assist by making in-puts more readily obtainable for the farmer;government price and subsidy policy canlikewise create vital incentives or disincen-tives.)

As a result of its success, particularly inSouth Asia, the training and visit systemof extension is being widely adopted to im-prove agricultural practices and yieldselsewhere. However, when the system istransplanted without adaptation to partsof the world that do not possess the kindof supporting services—the marketing sys-tems, the staff, the high-quality local re-search—that exist in places where it hasbeen successful, it becomes all too appar-ent that it is not only the extension systemthat leads to higher crop yields. It is thecombination of a system suited to localneeds, with well-developed supportingservices and new high-yielding varieties ofcrops. Systems developed for one regiondo not necessarily work in another.

This article will review the constraints onextension work that exist in poor areas andwill discuss how present research workand extension systems can be adaptedmore closely to the needs of local farmers.The fundamental problem is how thefarmer can be helped to progress beyond

subsistence farming and to become moreproductive; the solution rests largely ingearing local agricultural research to de-velop inputs and practices that are accept-able and usable in a particular context. Thiscomes down to working with the local peo-ple to produce local answers to local ques-tions. A further issue, not discussed here,is that these answers must work in thewider context of how surplus crops can bemarketed. Extension work enables the wideand rapid dissemination of improved tech-nology to large numbers of farmers, buthowever good it is, it cannot be effectiveif inputs, market infrastructure, and eco-nomic incentives are lacking.

Need to adaptOver the past decade, the introduction

of the training and visit system of exten-sion has been particularly successful inSouth Asia, following its early develop-ment within Bank practice on the Seyhan



to poorer agricultural areasProject in Turkey. This system is essen-tially one of management and organizationaccording to simple principles that can beadapted readily to different conditions. Itprovides a framework in which all agricul-tural extension activities are combined intoa unified service whose staff preferablydevote all of their time to strictly extensionactivities. Work is then organized in a sys-tematic program of training and visits,which usually has the field worker visitingfarmer groups with specified farmers oncea fortnight. A seasonal program of a fewkey practices is drawn up by research andextension personnel with farmers after re-viewing their constraints. Out of a numberof improvements that could be made to in-crease yields, a few readily acceptablepractices are generally selected that are ex-pected to have a significant impact. De-pending on circumstances, these practicesmight vary from the use of a seed dressingto method of fertilizer placement, or froma method or time of planting to a way toidentify pests. Extension specialists (knownas Subject Matter Specialists) then traingroups of field workers with their super-visors once a fortnight with the messagefor the following fortnight, and obtainfeedback from farmers at these sessions.These extension specialists themselves are

trained and supported by research staff,and are responsible for overseeing adap-tive field trials in their own areas. The ex-tension effort is thus concentrated, withnew programs drawn up every seasonwith farmers, consistent with the farmers'resources and abilities, while constantfeedback to and from research keeps thesystem dynamic.

Its success in India is well evidenced bythe enthusiasm of farmers, extension staff,and research workers for the new systemand the demand it has generated for bothincreased inputs and help in developingmore sophisticated recommendations. Amajor reason for this success is that exten-sion had been the weak link in the fairlywell-developed agricultural sector in India;once it was improved, yields increased.There were several technical findingsavailable on research stations that had notreached the farmer. Some required littleadaptation, like the new high-yielding va-rieties of wheat and rice. A reasonable in-frastructure with innumerable retail outletsfor supplies was in place. Most farmerswere used to market production, and well-educated staff were available and willingto fill the village extension worker cadre.

The success of extension work in Indiawas built on the three key ingredients: well

adapted inputs, suitable technology, andworkable marketing systems. If we turn toagriculture in other developing areas suchas sub-Saharan Africa, we find a very dif-ferent state of affairs. A market-orientedagricultural economy has only developedin certain places and sometimes only withcertain types of farmer. Research, essentialto the development of locally suited inputsand technologies, is almost nonexistent insome countries. In Sierra Leone, for in-stance, the only relevant agricultural re-search being done until recently was onrice. In some countries the quality of re-search has deteriorated or the research it-self has become restricted to the confinesof the research station. Thus, the results ofagricultural research, where they exist, areoften poor and are not well adapted tovarying ecological zones or types of farmer.

Sometimes causing, sometimes com-pounding the isolation of research, agri-cultural extension in developing countrieshas tended to emphasize the passing of in-formation from research to the farmer andhas insufficiently involved farmer partici-pation in passing information back to re-search. Far too many research activities gono further than how to obtain optimumyields from a given crop or enterprise,rather than actually to address the reasonswhy farmers are not able to improve yields.

This one-way flow of information hasmeant in many poor areas that mainly thericher farmers benefit from the technologyand expertise that does exist. Since thetype of research carried out in most devel-oping countries optimizes returns to par-ticular crops, its recommendations may bedifficult for a small farmer to apply, sincein many cases he plants most of his cropsin mixtures to minimize the risk of one ofthe crops failing. His first concern is sub-sistence; he usually only has his own fam-ily labor available and so wishes to maxi-mize returns to his scarce resource, whichis often labor rather than land. A largefarmer, by contrast, is able to come closerto the conditions existing on the researchstation because he has better access to allthe factors of production. He can morereadily add labor to change planting datesand can risk changing part of his croppingpattern, as he has either other enterprisesor resources as an insurance in the eventof failure.

And finally, as might be expected inareas emerging from a largely subsistenceagriculture, the extension services them-



selves are generally provided on an ad hocbasis and are subject to political and ad-ministrative abuse. In the absence of anorganized program, there is no regularservice to farmers, and no systematic ad-vice is given. The extension agent rarelyhas extensive farming experience and oftentends to be a young man; and his advice,therefore, is generally not highly regardedby farmers. Since he has no backing froman efficiently organized research service,he has no means of convincing the farmerthat his extension messages have some-thing to offer.

Adapting research

The first step in improving extensionwork in developing areas is to improve thequality and relevance of research. Sincesome research capability exists in mostareas, improvement usually comes downto developing closer links between the re-search work and the farmer. Research isoften organized nationally in separate de-partments, ministries, or parastatal agen-cies and has no link with extension at re-gional levels or below. One of the biggestadvantages of the methodology developedunder the training and visit system inSouth Asia was this: when carried throughto its logical conclusion, it benefited thefarmer by bringing research to him and in-volved the research worker intimately infarmers' problems.

Linking research with extension worknot only involves doing adaptive trials onfarmers' fields but also implies graduallychanging an approach. It is generally agreedthat proven recommendations are mostappropriately introduced to farmers bydemonstrations on their own fields carriedout by themselves. At the same time,adaptive research trials should test newrecommendations before introducing themto farmers. Such trials need to be designedto answer key problems that emerge fromlocal farm experience within the limitationsimposed by other factors (such as funds orstaffing). At the same time, trials shouldbe dispersed throughout the project area,and field days should be held on them todiscuss findings with farmers.

Closer links with the farmer will tend toemphasize the analysis of farming sys-tems, which are far more important for thesmall farmer than the large, since the for-mer has many more constraints to be con-sidered. An extension service has to lookat improvements for the small farm in thecontext of the farmers' own priorities. Forexample, in one area of northern Nigeriasmall farmers would always plant a rec-ommended long-maturing variety of seedcotton four weeks late and get yields of 250kilograms per hectare. If they had planted

on the correct date, the variety would haveyielded 650-800 kilograms. In fact, thefarmers always planted late in order to gettheir subsistence crops in first. They wouldbe far better off if research developed forthem a shorter season variety, giving re-turns of say 450-600 kilograms, whichwould be more appropriate for their plant-ing priorities and labor constraints and yetgive them higher returns than their presentpractice.

A classic example of the need for adapt-ing existing programs to the small fanneris the common practice of recommendingonly one level of fertilizer to be applied toobtain an "optimum" yield. What is ac-tually needed by the small farmer is an ini-tial recommendation for a minimumamount and type of fertilizer sufficient toobtain a significant increase in productionand then a series of recommendations toenable him to increase his yields graduallyup to the optimum, while minimizing therisks involved. This has been a key findingin evaluating the t ra ining and visit systemin India; it is certainly even more relevantto other areas of the world just emergingfrom subsistence farming.

Adapting services to the small farmerrequires a conscious effort. In Brazil, forinstance, a major task of extension workershas been to prepare farm plans and creditapplications for farmers, particularly thelarger ones. In many states, as the exten-sion service obtained a percentage of theinterest rate from the credit agency for pro-viding the service, it became a major sourceof funds and hence more attention wasgiven to this aspect of extension work. Toovercome this inequity, the state extensionservices are now changing their approach,and programs are being introduced toreach all types of farmers, including share-croppers. The Bank-sponsored IbiapabaProject in Ceara has been a pioneer of suchnew extension approaches.

The program is working well but stillinevitably has a built-in bias for helping the

John Russell

(7 British citizen, iscurrently Rtiinfed Cm/isAdviser in the Agricultureand Rural DevelopmentDepartment of the WorldBunk. He is a graduate ofCambridge and Oxford Universities ( U . K . ) andfollo'a'ing work u'itli a consulting firm in Pakistan,was Chief ['arm Management Officer with theZambian Government. He joined the Bank's Nairobioffice in 1972 and came to Washington in 1976.

larger farmers. The area incorporates atransition from a humid through a sub-humid to a dry zone over a few miles andincludes large and small landowners aswell as sharecroppers. Cropping programsare easier to improve in the wetter zonesand these naturally tend to receive moreemphasis and are more easily adopted bythe larger farmer, for reasons already men-tioned. Moreover, given the wide varietyof crops on which research is needed, it isdifficult to give priority to the lower valuecassava, bean, and maize crops, which arethe main, if not only, crops planted bysharecroppers in the drier zones, on whichin any event few improved practices haveyet been identified. An effort is now beingmade to rectify this in the design of quar-terly research and extension programs.

Adapting the systemMost extension in developing countries

could be improved by being made moresystematic. Under the training and visitsystem the approach is to demarcate clearlythe area each field worker is responsiblefor covering and establish by a simple sur-vey the number of farm families in thearea. If appropriate, at this stage, some"stratification" of farmers bv size and typeof farm should be made, so that seasonalextension programs can be designed to ap-peal initially to the largest number of farm-ers, and later be revised in the light of ex-perience, with the addition of specialprograms for d i f ferent types of farmers.

Reorganizing field workers and devel-oping fanner groups, who themselves as-sist in selecting contact farmers, are essen-tial steps in revitalizing an extensionservice. However, it cannot stop there. Thesystem can only work if there is a well de-fined program of the key improvementsthat can be made initially on the majorcrops planted in the area. Then it must putin place, at district or subdivisional level,extension specialists who will carry outregular training of junior extension staff atthe field level throughout the growing sea-son, oversee an adaptive trials program,and themselves be trained and supportedby research specialists.

Apart from making these rather generalexhortations to be more systematic aboutextension work, it is difficult to lay downhard and fast rules — or even to give widelyapplicable recommendations — for adapt-ing extension work to underdevelopedareas. So much depends on nonagricul-tural factors.

A major problem, for instance, especiallyin sub-Saharan Africa, is the recurrent costof maintaining a large extension service. Itis certainly not worth setting one up ifthere are only funds to pay salaries and not

32 Finance & Development / June 1981

! Q


to cover other operating costs needed tomake it effective. The caliber and qualifi-cations of extension staff also need carefulassessment. Too often staff with overlyhigh education levels are not prepared tolive in villages. Often a person with six toeight years of schooling, selected by hisown village for training, makes a betterextension worker. In India, the trainingand visit system benefits from being ableto recruit and use college graduates as ex-tension workers; it will be a long time be-fore this is possible at the field level in mostof Africa.

Multipurpose extension

It is, too, somewhat sterile to discuss inprinciple the important issues of whetheror not extension workers should only con-centrate on giving extension advice. Ideallythey should, providing other services areeffective; even if they are not, it is prefer-able that agricultural services be providedseparately. For reasons of cost, inst i tu-tional weakness, and poor coordination,however, this is not always feasible or de-sirable. Certainly in India, l imiting exten-sion workers to extension activities hasbeen beneficial (though with considerableopposition in some states). On the otherhand, if other services are nonexistent orweak, the introduction of an extensionservice might well be counterproductive.For however well trained the staff may be,and however good their l inks with re-search, without a supply of inputs and amarketing infrastructure, the credibility ofthe extension worker will soon be lost.

It is thus not surprising that the initialsuccess of the Minimum Package Programin Ethiopia was largely due to a better sup-ply of fertilizer and marketing facilities, inwhich extension and supply of inputs werejoint functions of extension staff workingalongside marketing/credit assistants withinthe same organization. Only now are thetwo being split, with marketing and inputsupply being handled by a new marketingagency. A similar approach was used inMalawi, where the supply of inputs andmarketing facilities were integrated closelywith extension, though with separate staffunder one management system. Once thenew system was soundly established, itwas handed over to an agricultural supplyand marketing organization. With the im-proved input supply, marketing, and in-frastructure in place, Malawi can nowbenefit more readily from improved exten-sion.

A common question is how many exten-sion workers should cover a given numberof farmers. Again, there can be no hardand fast rules. There is no point in tryingto set up comprehensive extension cover-

age if a viable local basis of usable inputsand practices has not been developed.Thus, in the proposed Koudougou projecton the Mossi Plateau of Upper Volta,where these still have to be developed, itwas realistic to accept a 1:800 ratio of work-ers to farm families, since initially only asmall proportion will be reached. But in theBougouriba project in the same country,where a viable "package" is available, aratio of 1 worker to 250 farmers seems ac-ceptable.

There remains the issue of selecting con-tact farmers, who are important in en-abling extension workers to reach largernumbers of farmers by a group approach.Traditional village leaders should be con-sulted in setting up farmer groups, but itis important to choose as contacts typicalfull-time farmers who are representative oftheir peers. In India, contact farmers areoften used to train other farmers; in Africaand Latin America, by contrast, it seemspreferable to rotate contact farmers amongdifferent members of the group. Likewise,while it is socially effective to deal just withmale heads of households in India, itseems more appropriate to reach both hus-band and wife in Africa and Latin Americabecause of the varying organization of thefamily household in managing the farmsystem.

Making extension work

The format of extension essentially needsto be pragmatic. A programmed disci-plined approach is needed through a uni -fied service. Development has to be inte-grated, key constraints defined, and thestrengths and weaknesses of existing in-stitutions taken into account. A major needis to ensure effective monitoring and evalu-ation. In the short term, it is vital to assesshow far farmers are adopting the key les-sons selected for a season, so that prob-lems can be addressed through appropri-ate research and changes in extensionapproach in a subsequent season, whichwill keep the whole system dynamic.

At the same time, the overall impact ofextension needs to be evaluated beforechanges in the system are widely replicated. It is impor tan t that new advances inmethodology for evaluat ing the impact ofextension are regularly reviewed, particu-lar ly as it is so d i f f i c u l t to isolate the partplayed by extension from other key factors.

This article has demonstrated that exten-sion systems evolved for tine region ot theworld cannot simply be t ransp lan ted andbe expected to work in another In movingfrom Southeast Asia to, say, sub-SaharanAfrica , one goes from a relat ively rich andwell-developed agr icul tura l envi ronmentto one where few of the ke\ factors that

facilitate high returns to improved exten-sion exist. This has implications for re-search, for the way the system is orga-nized, and for what it aims to achieve.Because the research base is much weaker,initially extension work has to be limitedto improvements that bridge the gap be-tween what is achieved by a few betterfarmers and what the rest practice. Mostextension systems are hierarchical, and amajor change is needed to shift them to asystem in which farmers and extensionworkers act in partnership. This shift im-plies not only a change in the attitude ofextension staff; it also implies an equallydi f f icu l t change in farmers' attitudes.

The constraints on extension that existin poorer agricultural areas imply that ex-tension systems should incorporate a longertime horizon than is appropriate for otherparts of the world. Targets should be moremodest, and programs should be based onachieving them over a relatively long pe-riod. What has been achieved in extensionwork in India in one decade will need alonger time f rame in much of sub-SaharanAfrica. Against this background, the chal-lenge of the 1980s for extension work withthe small farmer will be to restructure re-search. This will need to combine the dif-f icu l t study of farm systems with the longeriterative approach of greater part icipationby farmers in p lanning and evaluat ing aswell as implementing fu r the r improvedpractices tha t are already being developed.

£D

Related reading

Daniel Benor and James Q. Harrison, Ag-ricultural Extension: The Training and VisitSystem (Washington, DC, World Bank,1977).

Michael M. Cernea and Benjamin J. Tep-ping, A System of Monitoring and Evalu-ating Agricultural Extension Projects(Washington, DC, World Bank StaffWorking Paper No. 272, 1977).

"Economics of Investment in Organizationof Extension Services in Agriculture," inthe Conference Number of Indian Journalof Agricultural Economics (October/Decem-ber 'l979).

Sister Nora McNamara, "The Psychologyof Agricultural Development," Elaeis Ig-alaland Journal, Ayangba Agricultural De-velopment Project, Nigeria (Vol. 2, No.2, 1980).

Arthur T. Mosher, Getting Agriculture Mov-ing (New York, Praeger, 1966).

David Rohrbach, Discussion of Issues Rele-vant to the Development and Implementationof a Farming Si/stems Research Program(Washington, DC, U.S. Department ofAgriculture/Office of International Co-operation and Development, forthcom-ing)-

33


Technical assistance from the Fund:Central Banking DepartmentWhile the contribution that the Fund's financial assistance hasmade to the strengthening of members' economies is generallyrecognized, its accomplishments in the field of technicalassistance—which is no less useful to the developing countries—are not as well known. This article explains the evolving role of theCentral Banking Department of the Fund in its efforts to meet theneeds of member countries for technical assistance in a growingnumber of areas.

P. N. KaulSince its inception, the principal objective Service—now the Central Banking Depart- making the request. From the beginning,of the International Monetary Fund has ment—in 1963, and both the Fiscal Affairs certain guidelines for administering thisbeen to strengthen the international mone- Department and the IMF Institute in 1964. program have been followed,tary system, ensuring thereby balanced This article deals with the present func- First, experts are assigned only to a cen-growth of international trade, high levels tions of the Central Banking Department tral bank or its equivalent, such as a cur-of employment and real income, and full and portrays how these have evolved, rency board or monetary authority. Fromutilization of productive resources in mem- partly under the compulsion of events but the vantage point of a central bank, whichber countries. The Fund promotes this ob- largely in response to requests of member constitutes an important organ of a coun-jective by permitting its members to make countries for new forms of assistance. Be- try's policymaking apparatus and is theuse of its financial resources in times of tween 1964 and 1980, the number of tech- leader of its financial system, an expert canneed while encouraging members to pur- nical experts provided by the Department make an effective contribution to policy-sue monetary, fiscal, and other policies to member countries has increased sharply; making—an area in which many develop-that will contribute to the steady, stable in addition, their areas of specialization ing countries need assistance—and guidegrowth of their economies. However, in have significantly changed. Initially, it had the development of the financial systemdeveloping countries, implementation of concentrated on providing technical assis- along suitable lines. Where special circum-the desired policies often necessitates the tance on such matters as the setting up of stances have warranted, experts have beencomplementary development of an appro- central banks and monetary authorities, assigned to such multinational institutionspriate financial infrastructure and admini- banking and monetary research, account- as the Central American Monetary Coun-stration. ing, bank inspection and supervision, and cil. Assistance has been provided to such

Recognizing these needs, the Fund, soon foreign exchange control. With the passage organizations because the ultimate bene-after it commenced operations, began to of time, the Department's work has be- ficiaries have been the central banks ofoffer technical assistance and advice to come more diversified and has developed member countries.member countries requesting it. Over time such new facets as advising central banks Second, the position of experts is wellthis function has become an integral part about their relations with commercial defined. The experts are generally as-of the Fund's activities. Initially, technical banks, the development of money mar- signed in either an executive or an advisoryassistance was provided on an ad hoc kets, and the adaptation and refinement of capacity, depending on the needs of abasis, in conjunction with the Fund's regu- the use of monetary instruments. Thus, country. Third, the relationship betweenlar consultations or by sending special the principal activities of the Department the Fund, the expert, and the host insti-teams into the field. Later on, the Fund now fall into three distinct but interrelated tution is also carefully defined. Though theprovided its members with training facili- categories: (1) the assignment of experts; Fund generally contributes a major shareties in financial analysis and balance of (2) the provision of advisory services; and of the expert's remuneration, with the hostpayments (BOP) concepts at its headquar- (3) research work in the use of monetary country's contribution varying according

. ters in Washington, D.C. Because of the instruments, financial sector development, to its capacity to pay, the experts are re-sharp increase in Fund membership in the and other associated issues. In conclusion, sponsible to, and work solely under thelate 1950s and particularly the early 1960s, the article indicates how the Department's direction of, the host institution. They arewhen numerous countries gained political functions will change in the future. not regarded as employees of the Fund,independence, the prevailing arrange- . Since the experts deal with the day-to-dayments for providing technical assistance Assignment OT experts affairs of a central bank, some of which

required enlargement. Newly emerging A principal means of providing technical may be sensitive, the Fund decided thatmember countries urgently needed a va- assistance to member countries is borrow- the experts should owe their loyalty to theriety of technical assistance services to en- ing experts from older, well-established institution to which they are assigned. Theable them to manage their economies more central banks and assigning them to mem- Department evaluates the progress of theeffectively. In order to meet this need, the ber countries whose central banks are in work done by experts, through correspon-Fund institutionalized the technical assis- need of assistance. As far as possible, ex- dence and regular staff visits, and offerstance program by setting up three special- perts are provided according to the speci- advice on technical issues when this isized departments: the Central Banking fications and preferences of the member sought by the expert or the central bank.

34 Finance & Development I ]une 1981


Table 1Central Banking Department: technical

assistance provided by experts inspecialized fields1

(In per cent)

Specialization 1964 1970 1980

AccountingStatisticsResearchTrainingManagementOperationsBank supervisionForeign exchangeOrganizationOthers

34.7

65.3

9.21.6

23.55.6

30.75.3

13.54.33.33.0

6.74.3

22.6

22.06.9

23.110.72.31.4

100.0 100.0 100.0

Source: Central Banking Department, IMF.— Indicate no services were provided.'The services of experts attached to the Department

measured in man-months are as follows: 1964: 24.5 man-months; 1970: 582 man-months; 1980: 838 man-months.

Changing needs

Currently, there are about 70 expertsserving in the field, under the auspices ofthe Department, in 45 countries. Between1964 and 1980, the number of man-monthsof technical assistance provided annuallyhas increased from 24 to 838 (the totalnumber provided during the period wasmore than 10,000). Such a sharp increasewas largely accounted for by the numberof countries that attained self-governmentduring the 1960s and 1970s and also by the

rise in requests by individual countries fora variety of financial specialists to meet theincreasing complexities and technicalitiesinvolved in running a modern financialsector.

Equally striking have been the changesin the fields of specialization that expertsprovide (see Table 1). At the inception ofthe program, specializations were dividedbetween research and management, withthe latter dominating. With the passage oftime, the share of management experts inthe technical assistance provided by theDepartment has declined (though it re-mains quite significant). Reasons for thisdecline are the growing involvement of thelocal staff in central banks, expanding edu-cation in developing countries, and theaccumulation of experience by local man-agement cadres. Its continuation as a majorfield of specialization is largely due to theemergence of new financial activities andinstitutions in a number of member coun-tries that has led to requests for assistance.

Experts in research and statistics haveaccounted for over one fifth of the programthroughout the period 1964-80. This iseasy to understand, since in a large num-ber of developing countries that gained in-dependence, the levels of education, par-ticularly higher education, and theexperience that senior staff of central bankshave in research matters have been lim-ited. It has, therefore, been difficult to gen-erate local researchers. Furthermore, in re-gard to developing research capability,"learning by doing"—which is what the

Fund's technical assistance program triesto promote—is a relatively slow process.Thus, the progress made by experts in thisfield may be slower than the progress thatcan be made in other fields of specializa-tion.

Aside from management and research,bank supervision has recently emerged asan important specialization. In 1980, it ac-counted for about 23 per cent of total man-months worked by experts, almost twiceits share of the 1968 total. As a country'sfinancial system develops and diversifies,control and supervision tend to shift to thecenter of financial management policies.This occurs because the operations of theestablished institutions, if they are to servethe social goals of the country concerned,need to be monitored and directed. Fur-ther, an increase in the number of newbanks, as an economy grows and becomesmore competitive, requires close vigilanceby bank supervisors. What has emergedfrom the Department's experience in ad-ministering its expert assistance programsover the last 16 years is the conclusion thatresearch, management, and bank super-vision will be the dominant areas in whichexperts will be required in the years tocome.

The geographical distribution of techni-cal assistance provided by experts is evi-dent from the Chart. In 1980, Africa hadthe largest share, while Asia, Latin Amer-ica and the Middle East claimed roughlyequal shares. This regional distribution canbe explained, in part, by the differences in

Central Banking Department: regional distribution of technical assistance provided by experts(In man-months)

Source: Central Banking Department. IMF. 1 Includes Cyprus, Malta, and Turkey.



the number of new central banks estab-lished in the various regions and by thedifferences in the degree of developmentof their financial infrastructures.

Experts selected by the Department aregenerally drawn from the central banks ofmember countries, academia, and (onlyoccasionally) from the ranks of the Fund'sstaff. By and large, however, reliance hasbeen placed on central banks as a majorsource, for the obvious reason that practi-cal experience in central banking provesvery useful in assisting the host institution.In the research field, however, some aca-demics have been found to be well suitedin view of their familiarity with moderntrends in banking and monetary theory.

A further aspect of the recruitment ofexperts is reflected in Table 2, which tracesthe origin of experts, who have been drawnfrom both developing and developedcountries. The proportion of experts drawnfrom the former countries has increasedfrom 28 per cent in 1969 to 43 per cent in1980. Experience has shown that inter-change of experts among developing coun-tries has been rewarding because of thesimilarity of their environments, problems,and possible solutions. Considering thatexperts have been provided to membercountries as far as possible according to thelatter's specifications and preferences, itmay be surmised that commonality of ex-periences is at least as important in thereckoning of developing countries as theirdesire to imbibe the fruits of scientificprogress in the developed countries.

Judging the experts program by theyardstick of its direct usefulness to thecountries for which the experts haveworked, the program on the whole ap-pears to have been successful. Expertshave, with a few exceptions, adjusted tothe local environment, conducted expedi-tiously the tasks allotted to them, and seemto have offered advice well suited to theprevailing economic and financial condi-tions. However, this success may be some-what offset if the program is judged ac-cording to whether or not it has made therecipient countries self-reliant. There havebeen several cases where experts' assign-ments, having accomplished their objec-tives, have been phased out. In some othercases, countries have come to rely increas-ingly on experts, mainly because it has notalways been possible for the assigned ex-perts to train local counterparts to takeover completely from them in as short atime as desired. The causes of this phe-nomenon are, however, endemic to thesocial, economic, and political milieu in thecountries receiving experts. Nevertheless,the Department can help to alleviate them,albeit modestly.

Table 2Central Banking Department: sources ofexperts providing technical assistance1

1969 1975 1980

Number of expertsDeveloping countries

Developed countries

Number of recipientcountries

64 99 1002

18 42 43(28) (42) (43)46 57 57

(72) (58) (57)

26 33 36

(100) (100) (100)

Source: Central Banking Department, IMF.' Percentage distribution in parentheses.2 There were 102 assignments filled by 100 experts.

Advisory services

At the request of members, the Depart-ment provides advice on a wide range offinancial subjects. It generally undertakesthis function in collaboration with the areadepartments of the Fund, which have first-hand knowledge of the member countries,and with other departments of the Fund,as appropriate. In addition, the requestsfor advice may touch on areas of interestto other institutions such as the WorldBank and its affiliate, the International Fi-nance Corporation. Therefore, the Depart-ment participates in joint missions withthese institutions. Such close and continu-ing cooperation between the various de-partments of the Fund on the one hand,and between the Fund and other interna-tional organizations on the other, helps tocreate a pool of accumulated experience,knowledge, and expertise, while avoidingoverlapping of activities and consequentwaste of resources.

In its early stages, the Department's ad-vice was sought on the establishment ofnew central banks and the drafting (in con-junction with the Fund's Legal Depart-ment) of central bank statutes. This workgrew to embrace other banking legislationas the financial systems of member coun-

P. N. Kaul

an Indian national, heldvarious senior positions inthe Reserve Bank of India

Department. He is currently the Director of theFund's Central Banking Department.

tries expanded and became more complex.Gradually, other matters of financial de-velopment and policy were included in thescope of advisory work. Now, the Depart-ment's advisory activities cover virtuallythe whole gamut of issues relating to thedevelopment of a financial sector. Theseissues range from the internal organizationof a central bank, the reform of a coun-try's banking structure, the relationshipbetween central and commercial banks,multipurpose banking, pros and cons ofoffshore banking to monetary unions, re-gional cooperation among central banks,and the establishment and operation offorward foreign exchange markets. Theyinclude the relative effectiveness of variousmonetary policy techniques, such as inter-est rates, selective credit controls, and thedevelopment of money market instru-ments (see Table 3).

The provision of advisory services by theDepartment, measured in man-months,increased from 10 man-months in 1965 toa peak of 54.5 man-months in 1973 and hasdeclined somewhat to 31.5 man-months in1980. The changes in the level, as well asthe relative share, of each category reflectthe changes in requesting countries' needsfor this kind of assistance. On the whole,advice on legislation and studies related tofinancial systems and central bank struc-ture have accounted for nearly nine tenthsof the man-months of advisory service, re-flecting the requesting countries' needs inthese areas. As its economy expands andits financial institutions develop, eachcountry feels the impact of economic in-terdependence and the complexity of theproblems involved, which leads them toseek advice promptly. Present indicationsare that this area of work is likely to growin the future.

Research

With the expansion of its area of opera-tions, the Department's research activitieshave become more specialized and therange of topics covered has widened. Ini-tially, the research was confined to studieson monetary policy techniques in devel-oped countries. From these studies, it washoped, countries availing themselves oftechnical assistance could draw lessons.Gradually, the scope of research has sig-nificantly changed to cover an array of sub-jects relating to the economic and financialdevelopment of developing countries.

The principle governing this research isthat it should complement the Depart-ment's advisory work. Research work ishelped, particularly in its policy aspects,by insights and first-hand experience gath-ered during advisory missions. Withoutsuch complementary research, the advice


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Table 3Central Banking Department: advisory services provided1

(In per cent)

Service provided

Legislation2

Financial system3

1965

20.015.0

1968

38.323.4

1970

37.628.6

1973

35.835.8

1975

23.120.4

1980

29.417.5

Central bank structure,organization, andoperations

Central banking policies andtechniques4

Monetary arrangements5

Assessment and exploratorymissions

27.5 17.0 33.8

— 21.3 —37.5 — —

19.2

9.2

39.8

7.45.6

3.7

44.4

3.24.8

0.7

100.0 100.0 100.0 100.0 100.0 100.0

Source: Central Banking Department, IMF.— Indicate no services were provided.1 The advisory services provided by the Department measured in man-months are as follows: 1965: 10 man-months;

1968: 11.75 man-months; 1970: 19.25 man-months; 1973: 54.5 man-months; 1975: 27 man-months: 1980: 31.5 man-months.2 Legislative projects are generally undertaken jointly with the Fund s Legal Department.

3 Including reform of financial system, capital and money markets, offshore banking, statistical reporting, and banksupervision and regulation.4 Including structure of interest rates, savings mobilization, and monetary instruments and techniques.

5 Including studies relating to establishment of new monetary authorities.

offered to member countries would merelyconsist of policy prescriptions derived frompreconceived theories that might or mightnot be appropriate for the member's eco-nomic circumstances.

The Department's research activities havegenerated studies on the problems of de-veloping countries in a wide variety ofareas. These include the financial inter-mediation process, efficiency and cost cri-teria for the banking system, the moneysupply process, the money demand func-tion, selective credit controls and other al-locative financial policies, the rationale andmanagement of interest rate policies in de-veloping countries, multipurpose banking,bank adequacy, offshore banking, concen-

tration measures in banking, and a numberof other issues relevant to financial insti-tutions and policies. The results of the re-search are often used in the recommen-dations embodied in advisory reports. Mostof the studies have been published, for thebenefit of a wider readership, in estab-lished academic journals and the Fund'squarterly journal, Stnff Papers.

Future evolution

As this article indicates, the CentralBanking Department has responded flexi-bly to the requests made by member coun-tries. Countries have come to rely on it fortechnical assistance, whether it involvesassigning experts, providing advice on fi-

nancial policies and development, or con-ducting supportive research. In the pro-cess, however, the Department has comeacross certain lacunae in its work. One isthe need to pool the whole spectrum ofdata on member countries' comparative fi-nancial systems into an up-to-date databank from which information on all coun-tries can be extracted and used. Anothergap is the inadequacy of training arrange-ments for central bankers in operational,as distinct from economic or theoretical,aspects of central banking. The Depart-ment will, therefore, endeavor to move, inconjunction with other departments of theFund, in two new directions: (1) creatinga data bank to meet the need of membercountries, and more particularly the de-veloping countries, for information onvarious facets of financial systems and in-struments; and (2) devising somecontinuing training facilities to assist cen-tral banks in developing countries to be-come self-sustaining and more effectiveentities. By undertaking these new initia-tives, the Department hopes to enhance itsusefulness to all member countries, andparticularly the developing ones. HD

Related reading

Anand G. Chandavarkar, 'Technical Co-operation Within the Third World," IMF,Finance & Development (December 1972).

H. R. Mills, Report on Training Facilities atthe Technicians' Level in South and SouthEast Asia (Colombo, Sri Lanka, ColomboPlan Bureau, 1961).

Technical Assistance Services of the Interna-tional Monetary Fund, IMF Pamphlet Se-ries, No. 30 (Washington, DC, Interna-tional Monetary Fund, 1979).

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finance & Development ' June 1981 37


Is the introduction ofa value-added tax inflationary?

Using data and circumstantial evidence, an analysis of the 31countries using VAT showed that the introduction of the tax neednot be inflationary. Concurrent acceleratipn in prices was, moreoften than not, apparently due to expansionary wage and creditpolicies, and often government intervention to control the effects ofthese policies on prices was successful.

Alan TaitValue-added taxes (VAT) are, as the nameimplies, levied on the increment in thevalue of a good (or service)—that is, on thedifference between its selling price and thecost of the inputs to the seller—as it pro-ceeds from initial production to distribu-tion and final consumption. The main dif-ference between a VAT and other taxes isthat it is, in principle, a way of "fraction-ating" the liability of taxation. A VAT usu-ally extends to the retail stage of virtuallyall sectors, including services, and the re-tail selling price represents all "fractions"of value added through the productionchain. Thus, a 10 per cent VAT yields thesame as a 10 per cent retail sales tax but iscollected at each stage of the productionand distribution process instead of at thefinal stage. Being more comprehensivethan other sales taxes, a VAT covers moretaxpayers; it is adopted by many countriesas a device to increase revenues, particu-larly when the rate of sales tax rises toabout 10 per cent. Denmark, for instance,successfully used a VAT to increase totaltax revenues by over 6.2 per cent in fiscalyear 1967/68. But because it is so compre-hensive it also often increases the burdenon the administrative structure of the taxsystem, and policymakers have to take thisinto account when planning to introduceit. (This is one reason why many devel-oping countries avoid it.) Aside from itseffectiveness as a device to increase andsecure revenues, the VAT is frequentlyused to shift the tax burden from incomes

Readers interested in a much more extendedtreatment of the data and the discussion are in-vited to write directly to the author.

to expenditures as a way of managing ag-gregate demand—it was used for this pur-pose in the Netherlands and in Norway in1968/69 and 1969/70, respectively.

Whatever the reason the authorities con-sider using a VAT, probably the most con-troversial argument advanced against itsintroduction is its effect on retail prices.From proponents of the tax who maintainit has no effect on prices to Belgians, who,in 1971, applied its initials TVA (taxe survaleur ajoutee) to the slogan tout va augmen-ter (which means "everything goes up"),all commentators confront the possibilitythat the tax will increase prices and aggra-vate current inflation. Yet there have beenno studies showing conclusively what theeffects of such a tax on inflation actuallyare.

The major reason is not because of dis-interest but because it appears too diffi-cult (even impossible) to disentangle thechanges in prices attributable to VAT fromother influences on prices. "How can weknow the dancer from the dance?" Thisarticle summarizes the conclusions of a de-tailed analysis that attempted to isolate theeffects on prices of the introduction ofVAT. The experience of the 31 countriesusing the tax was analyzed over the periodthe tax was introduced, allowing enoughtime in advance of the introduction to cap-ture anticipatory as well as subsequent ef-fects.

The analysis itself was made at two lev-els. At one, the relevant data were exam-ined—on the consumer price index and onwages and credit before and after the in-troduction of the tax. At the second levelthese data were set in the context of a moredetailed review of the situation in eachcountry over the relevant period. Other in-

fluences on prices were analyzed, and theireffects were isolated as far as possible fromthose of the tax. Thus, in many caseswhere the data seemed to show that theVAT had triggered inflationary price in-creases, more detailed study indicated thatthe rises were a result of a general uncer-tainty over prices or pressure for higherwages. The overall conclusion of the studywas in fact that the introduction of VAThad a major impact on inflation in only 4of the 31 countries under review.

Results of data

Data on prices can in theory show theeffects of the introduction of a VAT in fourways:

• There may be a single upward shift inthe consumer price index clearly associatedwith the period when the tax was intro-duced, but with an unchanged, or littlechanged, rate of increase in prices, if thetax increases government revenue and iftraders pass forward the increase. This iscalled the shift case. If inflation is definedas a continuing general increase in prices,the tax that results in a once-and-for-allprice change cannot be inflationary by it-self.

• There may be an increase in the rateof change of the index, as a result of theintroduction of the tax. This is called theacceleration case.

• The acceleration may be combinedwith a shift in the overall price level. Thisis referred to as the shift plus accelerationcase.

• There may be no discernible effects atall, if the tax substitutes perfectly for theone it replaces or if the authorities can off-set any accompanying pressures to in-crease prices.

Theory would suggest that if trend lineswere fitted to the price indices before andafter the introduction of the tax for thepure shift cases, the slope of the pricegraph should be approximately the samebefore and after, even though price levelswould differ substantially. The data wereexamined assigning the shift to the quarterbefore the tax was introduced (to cover an-



ticipatory buying and widening of mar-gins) and to the quarter when the tax wasactually introduced. The chart shows anexample (for Denmark) of this behaviorand Table 1, column A, categorizes the ef-fects of VAT on consumer prices.

The data on the 31 countries were ex-amined over four years (two before andtwo after the introduction of the tax). Outof the 31 countries, 6 pure shift cases canbe identified. Honduras and Norway wereshift cases that also had clearly acceleratinginflation. Ten of the remaining countriesfell into the acceleration category, and forthe rest no effect could be identified fromthe data.

Price shifts

To flesh out the background of each caseto evaluate whether the results shown bythe data were genuine effects of the tax onprices or were due to other concurrent cir-cumstances, a more detailed examinationwas made of each country. This examina-tion took into account such other causes ofsimultaneous price rises as changes inrelative tax burdens, uncertainty, or risingwages. It also accounted for factors thatmight have suppressed price increases sothat no effect of the tax could be discernedfrom the data alone; these factors includedany offsetting policies to control incomesor prices or to reduce other taxes. Thisevaluation suggested some reallocation ofthe countries, shown in Table 1, column B.

Table 1Countries allocated to categories according to the effect of VAT on

consumer price Indices

Allocation on dataalone1

Allocation on broaderanalysis2

Price shift upward BoliviaDenmarkEcuadorNetherlandsPanamaUruguay

DenmarkEcuadorNetherlandsPanamaUruguay

Shift plus acceleration HondurasNorway Norway

Acceleration ArgentinaChileFranceIrelandIsraelItalyMoroccoPeruSwedenUnited Kingdom

IsraelItalyPeru

Little or no effect AustriaBelgiumBrazilColombiaCosta RicaGermany, Fed. Rep. ofIvory CoastKoreaLuxembourgMadagascarNicaraguaSenegal

ArgentinaAustriaBelgiumBoliviaBrazilChileColombiaCosta RicaFranceGermany, Fed. Rep. ofHondurasIrelandIvory CoastKoreaLuxembourgMadagascarMoroccoNicaraguaSenegalSwedenUnited Kingdom

Unknown3 Mexico Mexico

Source: IMF data.1 Covering price, wage, and credit indices from International Monetary Fund, International Financial

Statistics.' Covering changes in budgetary revenue, expenditures, other taxes, uncertainty, incomes policies, and

concurrent changes in wages and monetary policy.* Introduction of the VAT too recent to categorize.

The conclusions of the more detailedanalysis did on the whole, however, cor-roborate those of the data regarding thecountries where prices simply shifted up-ward as a result of the introduction of thetax—and where the effects of the tax couldtherefore not be regarded as inflationary.Six countries fell into the shift category onthe basis of the data, and further exami-nation confirmed that this was the appro-priate place for five of them.

The experience of Denmark with the taxis fairly typical of the shift cases (see thechart). The introduction of VAT in Den-mark at a rate of 10 per cent was designedto have wider coverage than the 12.5 percent wholesale turnover tax it replaced andto yield about DKr 2.1 billion more in a fullfiscal year. However, the complete taxchangeover was more complex than the in-troduction of the VAT; higher tax-free al-lowances for wage and salary earners, high


Denmark VAT introduced July 1967(Third quarter 196? - 100)

A B


tax thresholds for low incomes, increasedchildren's allowances, and transfer pay-ments to those not liable for income taxwere all attempts to compensate for theanticipated increase in prices. These off-setting measures were estimated to havecost about DKr 1 billion in revenue for-gone, so the net revenue increase was stillover DKr 1 billion. The effect of the intro-duction of the VAT on relative prices wascomplicated further by the taxation of foodand services, items that previously hadborne little tax.

Large wage increases, just before the in-troduction of the VAT, also helped to com-pensate workers for price increases. Gen-erally, the study conducted by theMonopoly Board of Denmark concludedthat, "with few exceptions, businesseschanged prices by amounts close to the taxdifferential and did not use the VAT intro-duction as an opportunity for unwarrantedprice increases." Prices rose by 8 per centbetween April and October 1967 and thewage regulation index (which excludedtaxes) rose by 3.1 per cent; thus, the VATwas regarded as probably responsible fora rise of almost 5 per cent in prices. How-ever, the rate of change for wages beforeand after the introduction in July 1967 ofthe VAT increased from 2.3 to 3.8 per centa quarter. Despite the same trend of pricesbefore and after the introduction of theVAT, the shift acted as a trigger for wageincreases, and credit was expanded some-what to accommodate this (see the chart).

Denmark indisputably introduced itsVAT to increase revenue, and in this it wasdramatically successful—taxation on pri-vate consumption was 19 per cent higherthe year after the VAT than before. Al-though the resulting once-and-for-all shiftin prices acted as a trigger to increasewages by more than the price increase, theDanish authorities were able to contain thepotential for explosive price increases im-mediately following the VAT introduction.This success should probably be attributedto those offsetting adjustments in incometaxation which, combined with substantialwage increases (continuing a previoustrend), more than compensated labor forthe VAT-induced price shift.

Thus, in Denmark and the other coun-tries in the shift category, the effect of theVAT on inflation may have been modifiedby direct government intervention. But inHonduras and Norway, the data showednot only a shift but also a marked increasein the acceleration of prices, as the shift feda greater price-wage increase than in theother countries, which in turn led to greaterincreases in prices after the VAT than be-fore it. The reason appears to have beenanticipation by the public that the tax

Table 2Impact of introduction of VAT on prices

Country

ArgentinaAustriaBelgium

Bolivia

BrazilChile

Colombia

VATintroduced

January 1975January 1973January 1971

October 1973

January 1967March 1975

Designedeffect

on revenue

Equal yieldEqual yieldEqual yield

Equal yieldor increaseEqual yieldIncrease

Percentage CPIchange in quarters

before and after VAT

AttributedGeneral' to VAT2

January 1975 Increase

Costa RicaDenmarkEcuador

France

Germany, Fed.Rep. of

Honduras

Ireland

IsraelItalyIvory CoastKoreaLuxembourgMadagascarMexico

MoroccoNetherlandsNicaraguaNorwayPanama

PeruSenegalSwedenUnited KingdomUruguay

January 1975July 1967July 1970

January 1968

January 1968

January 1976

November1972

July 1976January 1973January 1960July 1977January 1970January 1969January 1980

January 1962January 1969January 1975January 1970March 1977

July 1976March 1961January 1969April 1973January 1968

IncreaseIncreaseIncrease

Equal yield

Equal yield

Increase

Equal yield

IncreaseEqual yieldEqual yieldEqual yieldEqual yieldIncreaseEqual yieldor increase

Equal yieldEqual yieldEqual yieldLossIncrease

IncreaseEqual yieldEqual yieldLossEqual yield

37.22.42.6

9.5

15.8146,7

12.9

8.08.7

2.1

1.5

1.0

5.5

17.96.3

4.13.53.2

2.46.2

5

7.85.0

27.1

1.64.9

66.3

minornilnil

nil

nilminor

nil5.0

(7.1)

Other concurrent tax changes

Provincial tax changesLower income taxes

New luxury tax rates, increased excises

Taxes on gasoline, incomes & propertyraisedIncome, property, capital gains taxeschanged

Increased excisesLower income taxMining taxes reduced

Tax exemptions abolished & income taxadjustments

Some tariff reductions

1.0

0.6

nil

nil

(9.0)nil

minor Changed excisesnilnil

Lower border VAT of 6%

nil1.5nil5.8

(3.1)

(13.5)

nil0.7

(53.0)

Change in corporate & production taxesLower income taxReduced customs dutiesReduced income & property taxesStamp taxes reduced & increasedexcises

1% payroll tax to offset lost revenueSelective employment tax removed

Source: IMF data.. . . Indicates data not available.1 The consumer price index for the quarter before VAT is deducted from that for the quarter after VAT and the difference expressed

as a percentage increase.2 Figures in parentheses represent broad estimates based on examination of the data; other figures are based on external and

contemporary commentaries.

change was going to increase prices andthat the adjustments in income taxationwould give them insufficient compensa-tion.

Closer examination shows that the datafor Honduras are misleading. A generalring tax was replaced by a VAT in January1976. (A ring tax applies to transactionsbetween registered and unregistered trad-ers—between those inside and outside thering. Small traders are unregistered, as isthe general public.) The revenue from do-mestic sales taxation as a percentage of pri-vate consumption increased by 12 per centbut the effect on prices was relatively mi-nor. The rate of the VAT was only 3 per

cent (as the ring tax had been) and the in-creased revenue must be ascribed to bettertax administration for checking evasion.The rate of increase of prices was trivialand is more appropriately attributed to theaccelerating credit expansion than to theintroduction of the VAT. Honduras can betransferred to the "little or no effect" cat-egory.

Accelerated inflation?

The next set of cases involves thosecountries where the data appear to corre-late the introduction of the VAT not witha single increase but with an accelerationin prices. However, as shown in Table 1,


nil

s


Any other Price New VATconcurrent changes controls Taxes mainly replaced3 rates4

Utility rates increased, devaluation Yes, but relaxed Wholesale sales tax 16Strict credit control Yes Cascade wholesale tax 8,16Increased wages Monitored* Cascade wholesale tax 6,14,18,

some control 25No Multistage ring system 5,10,15,

20No State sales & municipal industrial taxes 12

Utility rates increased & rent controls relaxed No Cascade turnover tax 20

Many incentives abolished No Simpler VAT 4,6,10,15,35

No Multistage ring system 8Increased transfers & increased wages No Wholesale tax 10Devaluation No VAT was a new tax, some turnover 4

taxes on mining & manufacturingreplaced

Increased wages Yes, after VAT Simpler VAT 6.4,13.6,introduced 20,25

. . . Monitored Cascade retail tax 5,10

Rapidly expanded credit No Multistage ring system 3

Monitored Wholesale and retail sales tax 5.26,16.37,30.26

Increased wages & tax allowances No Various sales taxes 0,8Increased wages No Central & local government sales tax 3,12,18

No Manufacturers VAT 8Proposed VAT rate of 13% reduced to 10% Yes 8 sales taxes representing 40% of revenue 0,10

No Cascade wholesale tax 2,4,8No Cascade production tax 6,12No Cascade production taxes 10

No Cascade production tax 5,12Increased wages Yes Cascade wholesale tax 0,4,12... No Multistage ring system 6Increased transfers & wages Yes Sales taxes on 65% of consumption 20Increase in utility rates No Wholesale tax 5

No Cascade production tax 3,20,40... No Manufacturers VAT —

No Retail sales tax 11.1No Multirate wholesale tax 0,10No Manufacturers, wholesale & retail taxes 5,14

3 This column is as accurate as a brief summary can be: "cascade production tax refers to a cascade tax on business turnover.restricted to the production stage; "cascade wholesale tax extends the turnover tax to include the wholesale stage; "cascade retailtax" extends the turnover tax to include the retail stage; "manufacturers, "wholesale, ' or "retail" taxes are single stage taxes—some operated on a ring system, others on a credit system

4 On tax exclusive prices.5 Monthly data unavailable for part of the period covered

column B, an examination of the particular cent after. Some of the increase in pricescircumstances in each country suggests in the first half of 1976 before the intro-that only in Israel, Italy, and Peru could duction of the VAT (and therefore includedthe acceleration be genuinely attributed to in,the pre-VAT trend figure of 5.2 men-the VAT. tioned above) was attributed to speculative

The Israeli VAT can be used to illustrate purchases in anticipation of VAT-inducedwhat happened. Introduced in July 1976, price increases that permitted the transferit was designed to yield additional reve- of higher costs into final prices. As in manynue, even though a number of sales taxes— of the other countries studied, wage in-mainly on food and clothing—were simul- creases accelerated more sharply, as didtaneously abolished. The base of the VAT credit creation.was wider than the taxes it replaced and The Israeli experience with the VAT sug-sales taxation was extended to services, in- gests that the new tax may have allowedeluding financial services. The rate of traders to pass on cost increases and jus-change of prices accelerated from 5.2 per tified cost-of-living increases in wages,cent per annum before the VAT to 10.5 per both of which triggered an increase in the

rate of change of prices. However, the ex-pansionist policies of a new government inthe second half of 1977, including a sharpincrease in government expenditure andwages, and an exchange rate reform thatincreased the capital inflow and expandedthe domestic credit base, seem to have hadmore impact on prices than the VAT.Nevertheless, Israel is regarded as an ac-celeration case in Table 1.

In France, too, the data show an accel-eration in prices of 2.1 per cent concurrentwith the VAT introduction. However,probably less than 1 per cent of this wasdue to the tax. The main problem was theuncertainty caused by the change in taxes.The French VAT is, of course, the originalfrom which all others evolved. Its modernform, introduced in January 1968, was adirect revenue replacement for the old tax(domestic taxes on private consumptionrepresented 20.4 per cent compared with21.1 per cent before VAT) but it did involvean extension of the tax to most wholesaleand retail transactions. At the same time,under the new VAT many exemptionswere abolished, and various anomalies andforms of double taxation (for example, onbuildings and furniture) were removed,while the number of tax rates was reducedfrom seven to four. Moreover, there wasa major change in the financing of localauthorities; the changeover abolished themain taxes earmarked for the local authori-ties and substituted the revenue from theemployers' payroll tax; this caused a netloss in revenue to the central government.Although the overall sales tax revenue in-volved an equal-yield substitution, adjust-ments (partly to compensate for antici-pated price changes) in the lower-incomeand middle-income brackets also cost 700million French francs in revenue.

Prices rose somewhat faster after the taxchangeover, and wages and credit in-creased sharply. But the picture is dis-torted by direct intervention later in theyear to reinforce price controls throughprogram contracts covering industrialprices, supervision of wholesale and retailtrade margins, and a price freeze for ser-vices. At the same time (November 2,1968), rates of the VAT were increased.

So the 1968 French VAT reform might becharacterized as one which, while nomi-nally an equal-yield change, involvedchanges in coverage and in rates, withoffsetting adjustments in other parts of thesystem. Although the direct effect of theVAT on prices was probably less than 1 percent, the uncertainty induced by the taxchangeover may have accelerated the rateof increase in prices. Wages increasedsharply but the vicious circle of wage-priceincreases triggering each other was con-



tained (only partially) by price controls.The French example should probably betransferred to the "little or no effect" cat-egory.

Little or no effectFrom the data, the introduction of VAT

appeared to have no (or very little) effecton the rate of change of prices for 12 coun-tries. Further analysis added 9 countries tothe "little or no effect" category, making21 in all.

The Federal Republic of Germany is thecountry most frequently used to show thaithe introduction of a VAT need not affeclprices. The changeover in January 1968from a 4 per cent cascade turnover tax (atax on turnover at each stage of produc-tion, extending to the retail level) to anequal-yield 10 per cent VAT (and a 5 peicent rate on foodstuffs and agriculturalproducts) was estimated at the time tohave increased prices by 0.5 to 1.5 per cent.Even this increase was anticipated onlybecause those sectors where prices couldbe expected to fall might prove more re-luctant to pass forward tax changes thanthose where tax liabilities rose and becausesome services were taxed at higher rates.

This moderate impact of the tax is widelyascribed to the timing of the tax change-over, which came when the rate of Ger-man expansion had slowed and firms werereluctant to raise prices. In addition, theLander (districts) operated a price moni-toring system and no further control onprices was deemed necessary.

The experience with VAT in Costa Ricawas similar to that of the Federal Republicof Germany in that the introduction of thetax coincided with a recession, and tradersdid not pass the tax on to consumers in theform of higher prices. In January 1975, theCosta Rican general ring tax of 5 per cenlwas transformed into a VAT of 8 per cent.It was estimated to have increased revenueby 50 million colones (and 1974 revenuefrom the general sales tax was £ 217 mil-lion), not through an expansion of the taxbase but because of higher effective rates.In the event, the sales tax revenue in 1975was £ 298 million and the revenue fromthis tax rose from 11.6 per cent to 13.6 percent of total tax revenue. In addition, theintroduction of the VAT was associatedwith increases in the rates and coverage ofconsumption taxes that were expected toraise another £ 100 million. This mighthave shifted prices upward and caused anacceleration in inflation, had it triggered awage-price reaction.

However, it appears that the introduc-tion of the VAT coincided with a markedslowing down of growth in Costa Rica thatseems to have been more effective in re-

straining prices than the VAT was instimulating them. The annual average rateof growth of domestic product in 1971-73was 7.5 per cent, falling to 5.4 per cent in1974 and to 3.4 per cent in 1975. Thegrowth of manufacturing output declinedfrom 10 per cent in 1974 to 2 per cent in1975. The increase in consumption taxesseems to have choked off demand and anincrease in interest rates to have stimu-lated private savings. With the depressedeconomic conditions and a substantialdrawdown of inventories, merchandiseimports actually declined.

Intervention

In Korea, the rate of inflation acceleratedas a result of the VAT, but the increase wascontrolled by direct government interven-tion. The VAT, introduced in July 1977,was a complex equal-yield substitution;that is, eight taxes (all at different rates)representing about 40 per cent of centralgovernment revenue were replaced by asingle-rate VAT. This change was accom-panied by the introduction of excises on 29categories of consumer goods and serviceswith rates ranging from 4 per cent to 160per cent.

In an attempt to meet widespread un-certainty about the effects of the VAT, theauthorities reduced the initial proposedsingle rate from 13 per cent to 10 per centjust before the introduction of the VAT andincreased the scope of price controls. TheGovernment had control over the pricescharged by monopolies (enterprises with30 per cent or more of any product market)and oligopolies (where three firms have 60per cent or more of the market) and controlover ceiling ex-factory and wholesale pricesfor 251 items. There was a huge campaignto publicize recommended retail prices for

Alan Tait

from the United Kingdom,is Assistant Director inthe Fiscal AffairsDepartment of the Fund.After graduating from

(U.K.), he became a fellow of Trinity College,Dublin (Ireland), taught at the University ofIllinois (U.S.A.), and became Professor andChairman of the Department of Economics atStrathdyde (U.K.). He is the author of TheTaxation of Personal Wealth (1967), The Value-Added Tax (McGraw-Hill, 1972), and numerousother books and articles on public finance.

a wide variety of consumer goods. Thiswas an interesting example of a sharp,short-term, widespread price control tocover the introduction of the VAT and tocurb any price increases that might haveoccurred through uncertainty, increasedbusiness margins, and profiteering. Withina few months these controls were relaxed.

Although the rate of price increase wassomewhat higher after the introduction ofthe VAT, the price control appears to havebeen successful in dampening the price-wages nexus for inflation. As a result, theintroduction of the VAT does not, broadlyspeaking, seem to have had a major impacton the rate of price increases.

Little impact on prices

After considering the circumstances ofeach country in detail, in 21 of the 31 coun-tries where the effects of introducing aVAT on prices were evaluated, no majorimpact could be identified. That is, in 68per cent of the countries the introductionof the VAT can be said to have had littleor no effect on prices. In four countries,the VAT could have contributed to an in-crease in the rate of inflation—althoughthis was associated in each case with ex-pansionary wage and credit policies. In sixcountries (19 per cent of the total) the in-troduction of the VAT is associated with ahighly defined once-and-for-all shift inprices, but in only one of these countries(Norway) could this be said to have con-tributed to an acceleration in the rate ofinflation.

Clearly it is possible to introduce a VAT(sometimes even to increase revenues)without shifting, or increasing the rate ofchange of, prices. If anything, the assump-tion should be that an equal-yield VATsubstitution will have no effect on the rateof change of prices and that even if an in-creased yield is derived and prices in-crease, it will not necessarily accelerate in-flation.

Moreover, the analysis showed that ina wide range of situations direct govern-ment intervention can be used effectivelyto offset any potential price increases froma VAT. Government policies to inform thepublic and traders about the expected ef-fect of the VAT on prices, the use of pricecontrols (particularly in Austria, France,Korea, the Netherlands, and Norway), off-setting adjustments in other taxes, the cor-rect timing of the tax changeover, and gen-erous provisions to ensure full credit forpreviously paid taxes on business assetsand inventories were a few of the moreimportant government decisions thathelped to contain any potential inflationaryeffect the introduction of the VAT mighthave had. ED

42 Finance 61 Development I June 1981

I % ^BHl* Edinburgh University

Source World Bank date


Sylvia Ann Hewlett

The Cruel Dilemmas ofDevelopmentBasic Books Inc., New York, NY, U.S.A., 1980, 243 pp.,$15.

The theme of this book is that poverty andrepression have become deeply engrainedin the pattern of Brazilian development overthe past few centuries and that these trendshave speeded up with the recent emphasison rapid growth. A highly stratified societyemerged during the colonial period, up to1900, and was ossified by an economic sys-tem that concentrated on primary productionfor export. The author contends that as thecountry began to modernize, policymakerssimply built upon existing social structures.So Brazil has never really gone through asocial and economic revolution as it evolvedfrom a primary to an industrial economy.

Brazil was a late participant in the indus-trialization process compared with Euro-pean countries, beginning to modernize onlyafter World War I. Initially, the Governmentsought to accelerate development throughcapital-intensive production techniques—first focusing primarily on import substitutionand later on promotion of exports. As a con-sequence of this pattern, employment op-portunities lagged behind the increase in thecountry's labor force, which was growing atover 3 per cent annually between 1940 and1976. Rapid economic expansion was pro-moted by the state, which intervened widelyin the operation of the economy, both bycontrolling the means of production and byoffering incentives with programs that pri-marily benefited the existing economic elite.Inequities were further aggravated by alarge inflow of foreign investment, since

multinational companies concentrated onproducing sophisticated goods for thewealthy who were the major source of ef-fective demand. Finally, an entrenched ruraloligarchy monopolized ownership of landand capital, which meant that income distri-bution in rural areas remained highly skewed.

The author posits that these inequitieshave increased since World War II and thateven with well-intentioned leaders the bestthat the poor can hope for are marginal im-provements in their lot over the next decadeor so. The possibilities for political liberali-zation are limited by the economic circum-stances of the country, particularly by thebalance of payments (BOP) position andhigh domestic inflation. The author contendsthat significant change could only be ac-complished through a radical alteration inthe political system.

Even though the book is critical of the per-sistence of inequity in Brazil, its conclusionsare ambiguous about whether any drasticchange would be desirable. As the authorpoints out, the combined social, political,and economic costs associated with growthin Brazil are no worse than the costs paidby countries that have tried more radicalapproaches to development, such as thePeoples Republic of China, or even bythose using "softer" reformist approaches,such as India or Peru between 1968 and1975. These costs of growth are unique nei-ther to capitalism nor to the Brazilian ex-perience.

This book has interesting parts, particu-larly the discussions of inflation and the roleof the state. On the other hand, it has someimportant shortcomings. The author's at-tempt to demonstrate that rapid growth has

been a root cause of increased sufferingand poverty is unconvincing. Even thoughincome distribution remains a serious prob-lem, it is unlikely that a larger proportion ofthe Brazilian population is now living underworse conditions than 30 or 40 years ago.Although, admittedly, existing data are frag-mentary, it appears that real incomes of allstrata of the population, including the poor,have risen substantially over this period.(This is even demonstrated in the book'sstatistical appendix.)

The judgments about Brazil's develop-ment experience, particularly over the pasthalf century, also seem unjustifiably one-sided. Although it clearly implies that some-thing might have been done to achieve amore equitable society, perhaps through amore inward-oriented development strategywith a lower growth rate, the possible bene-fits and costs of such an approach are notsystematically analyzed. The author doesnot explore the hard choices policymakersactually faced during the past few decades,nor does she consider what actions mighthave improved the situation. Thus the booknever really addresses the real dilemma—how to build an economy capable of com-peting in the modern world and, at the sametime, to create enough productive job op-portunities in a sufficiently open political en-vironment to ameliorate poverty and themaldistribution of income. The solutions tothese problems are not mutually exclusive(as the author implies) but neither can suchdifficult goals be realized overnight. Unfor-tunately, the author offers no insights onwhat constructive steps might be taken tospeed up progress in this direction in thefuture. Jack Sweeney

Richard Blackhurst and Jan Tumlir

Trade Relations Under FlexibleExchange RatesGATT Studies in International Trade, Geneva, Switzer-land, 1980, 80 pp., $8, Sw F 12.

One of the more enduring issues in the longand continuing debate on the relative meritsof fixed versus flexible exchange rates iswhether greater exchange rate variabilityadversely affects the level and pattern of in-ternational trade. In this pamphlet, RichardBlackhurst and Jan Tumlir of the GeneralAgreement on Tariffs and Trade (GATT)take stock of the last seven years' experi-ence with floating rates, as well as of therelevant theoretical and empirical studies, to

make an evaluation of the effect of flexibleexchange rates on trade flows. This is asolid piece of work: questions are clearlyposed, theory and empirical evidence arenicely entwined, and the authors' conclu-sions are reasonable. There are some im-balances—such as a preoccupation with in-flation to the neglect of unemployment—andsome important exclusions—for example,the discussion of monetary policy omits anymention of the rational expectations critiqueof active stabilization policy, but readers in-terested in a succinct review of the relation-ship between flexible rates and trade shouldfind this pamphlet well worth an hour or twoof their time.

The pamphlet is organized into four chap-ters. In Chapter I, Blackhurst and Tumlir ex-amine the prima facie link during the 1970sbetween the increase in exchange rate vari-ability and the slowdown in the growth ofworld trade. Like most other analysts, theyreject the view that one causes the otherand instead favor the explanation that tradeslowed during this period mainly because ofthe slow growth of real output (particularlyduring the 1974/75 global recession). Theygo on to posit that the slower output growthwas a consequence of the prevailing highinflation rates, which led, in turn, to restric-tive monetary and fiscal policies. Becauseof the large differences in inflation rates

FuuitH-'c & Dt'vt'lojnuenf I nut' 1981 43

Booknotices


across countries, large exchange ratechanges were inevitable. Hence, in the end,Blackhurst and Tumlir single out inflation asthe root of both high exchange rate vari-ability and slow world trade growth.

The latter half of Chapter I looks at theeffect of exchange rate changes on thetrade positions of major industrial countries.Quite correctly, the difference betweennominal and real exchange rate changes isemphasized, as is the dominance of cyclicalreal income movements over relative pricechanges as an explanation of observedtrade balance changes. One problem hereis that the authors expend so much effort incountering the (by now straw-man) view thatthere is a close connection between nominalexchange rate changes and changes intrade balance positions that they give insuf-ficient recognition to the significant effect ofrelative price changes on trade volumes inthe long run, other factors held constant.Nor do they give sufficient attention to theeffects of flexible rates themselves on thesize of relative price elasticities or to the roleof such nonprice characteristics of tradedgoods as delivery schedules, after-salesservice, and general product quality indampening the effects of exchange ratechanges. These complaints aside, the au-thors build a strong case that exchange ratechanges have not distorted the geographi-cal patterns of international trade, at leastin the 1970s.

Chapter II tackles the question of whetherthe existing system allows a country delib-erately to undervalue its exchange rate toobtain a temporary trade advantage. Theauthors reject the effectiveness of quanti-tative controls on trade and/or capital flows,both because these cannot increase acountry's share in world exports and be-cause the sophistication, size, and effi-ciency of capital markets preclude any sin-gle country from exercising control. Nor dothe authors regard official intervention as a

promising form of manipulation: first, be-cause its track record is poor—the volumeof intervention tends to be largest when themagnitude and frequency of exchange ratechanges are also largest; and second, be-cause its impact on the expectations of pri-vate participants in exchange markets is souncertain. A country can of course alter its(floating) exchange rate by altering itsmonetary policy. The authors regard this,however, not as manipulation but rather asthe exchange rate responding to underlyingeconomic conditions. Further, they point outthat the slow response of trade flows to rela-tive price changes limits the short-run pos-sibilities of letting the exchange rate "over-shoot" to a country's advantage. Black-hurst and Tumlir conclude that the exchangerate should not be considered as an instru-ment of national economic policy in thesame way as, say, the government budget,because the exchange rate is ultimately de-termined by private transactions in the ex-change market and because, as the ratio ofthe two national currencies, it cannot be de-termined by the policy of one governmentalone.

The chapter on whether countries havebeen "injured" by exchange rate changesis interesting in part because the authorsattempt to define injury as comprising those(exchange rate induced) repeated shifts ofresources between sectors that could, atleast in principle, have been avoided. Butsuch a definition does not lend itself easilyas a basis for even rough estimation. Thus,their conclusion that injury has been limitedunder flexible rates must rest on the propo-sition that firms will react only slowly to ex-change rate changes whose duration is un-certain. To their credit, Blackhurst and Tumlirdo recognize that in appraising injury, a dis-tinction needs to be made between individ-ual firms and the economy as a whole. Here,they do acknowledge that export and importcompeting firms in countries whose curren-

cies appreciated in real terms sufferedlosses, in the forms of temporary unemploy-ment and writing down of capital values.They also provide a useful discussion ofwhat types of injury are inherent and un-avoidable in the process of external adjust-ment and what types are not.

The final chapter on the real costs of in-ternational monetary stability serves to in-form the reader that while Blackhurst andTumlir regard the costs of exchange rateinstability on international trade as havingbeen overestimated by others, they regardthe nontrade costs as having been under-estimated. Specifically, they point to themicroeconomic costs associated with theloss of information about relative prices onthe world market and to the macroeconomiccosts deriving from the difficulty of conduct-ing national monetary policies in the ab-sence of a stable international referencecurrency. After discussing the various func-tions that an international currency shouldfulfill, they attempt to detail the costs thatarise when these functions are not fulfilled.In the end, they decry the post-1970 insta-bility of the dollar and the inflationary poli-cies of the United States.

In my view, this is the weakest chapter inthe pamphlet, not so much for its conclu-sions but rather because of the lack of depthin the analysis. There is little discussion, forexample, of the benefits and costs of beingthe issuer, as opposed to the user, of thedominant international money. Nor is thereany appraisal of how much of the decline inthe role of the dollar was consistent with thegrowth of political and economic power ofJapan and Western Europe versus irre-sponsible U.S. economic policies, or of howa multicurrency reserve system comparesto a single currency reserve system, or ofhow the role of the dollar as an interventioncurrency has changed vis-a-vis its role asa reserve currency.

Morris Goldstein

Alex Radian

Resource Mobilization in PoorCountries—Implementing TaxPoliciesTransactions, Inc., New Brunswick, NJ, U.S.A., 1980,xxiv + 266 pp., $19.95.

Books, like products, must comply with re-quirements of truth in packaging. If this bookhad carried the title Problems of Income TaxAdministration in Four Developing Coun-tries, my attitude toward it would be some-what more favorable than it is. Unfortu-nately, and presumably to increase its salesappeal, Professor Radian chose to call thisbook Resource Mobilization in Poor Coun-tries. Now this title does raise some ques-tions.

Consider these two limitations: first, thebook is essentially based on field research,consisting of interviews with tax officials, infour countries—two Caribbean (Jamaica andTrinidad) and two Southeast Asian (Thai-land and the Philippines). Surely this smalland hardly random sample cannot be con-sidered representative of "poor countries";it excludes all of Africa, all of Latin America,and all of the Middle East. Second, and inmy opinion more important, the book dealsonly with income taxes, which, as is wellknown, play a relatively minor role in the"resource mobilization" of developing coun-tries. The truly important revenue sources—foreign trade, domestic indirect taxes, anddeficit financing—receive hardly a mention.

The basic assumption that affects muchof the discussion is the belief, fashionablein the 1960s but clearly out of favor in the1980s, that the basic problem of poor coun-tries is lack of public revenue. If only thegovernments of these countries could raisethe average tax rate to, say, the level pre-vailing in rich countries, they would be ableto solve many of the economic problemsassociated with low incomes, including thatof slow economic growth. This assumptionaffects much of the discussion of tax reformfor which success seems to be measuredexclusively in terms of increase in revenue.

Professor Radian shows no awarenessthat, given the level of a country's income,private revenue—and consequently private

44 Finance & Dcvdopincnt I ]une 1981


consumption and saving—must fall whenpublic revenue goes up and that this fall maycreate more serious problems than the onesthe government is attempting to solve. Thereis no discussion of the effect of highertaxation on the allocation of resources norof the possibility that governments may usethe additional resources for purposes un-related to the solution of the serious nationalproblems. This pro-government bias may bedue to the fact that the book was written (orat least the research on which it is basedwas done) in the early 1970s. This is con-firmed by the dates of publication of most ofthe works cited and by the data used in vari-ous chapters (as for example those on taxratios).

In spite of these shortcomings, this bookis not without merit. In fact, once one getsover the fact that the book deals just withproblems of income tax administration andcollection in selected developing countries,the book is useful. It is for the most part very

well written and contains a fair amount ofcommon sense and wise advice. Of particu-lar interest is the second section entitled"The Instruments and Resources of Imple-mentation." This section consists of fourchapters dealing with (1) the limitation of re-sources to tax administrations, (2) audit andassessment, (3) collection, and (4) compli-ance and enforcement.

Chapter 4 discusses issues such as thelimitation and unreliability of data available,the impact of decentralization on revenue,the allocation of resources between headoffice and regional offices, the shortage ofwell-trained personnel, the low level of sala-ries, the frequent turnover of qualified per-sonnel, and, finally, the consequences ofthese factors. Chapter 5 deals with methodsto reduce evasion. The sample for auditmust include all areas of activity; it must besufficiently large so that the chance that ataxpayer will be audited is not negligible;and the audit must be thorough. The author

discusses the strategy that the auditor mustfollow as well as possible outcomes. Chap-ter 6 deals with the collection process itself.This process is far more complex in poorcountries than in highly industrialized coun-tries where it may just involve sending acheck through the mail. Consequently a farlarger proportion of available administrativeresources will need to be spent on this ac-tivity in the poor countries. This means thatfewer resources will be left for pursuing de-linquent accounts. Chapter 7 deals with en-forcement and with penalties to induce thetaxpayer to comply.

This is, in my view, the core of the bookand the part that can be productively readby anybody interested in developing coun-tries. The remaining five chapters—1 through3, dealing with theories and policy, and 8and 9, dealing with reforms—can be ignoredby the busy reader without much loss.

Vito Tanzi

Other books received

Gary S. Fields

Poverty, Inequality andDevelopmentCambridge University Press, New York, NY, USA. , 1980, xi •281 pp., $29-50 (cloth), $7.95 (paperback)

An addition to the compendium of recent work onestimating the incidence of poverty, analyzing theusefulness of relative and absolute measures,and on determining the effects of growth on in-come distribution. Fields reviews material onthese topics, arguing persuasively for giving pri-macy to distributional objectives and concentrat-ing attention on how the rate and type of growthinfluences the attainment of equity. He drawscopiously on studies conducted in Brazil, CostaRica, India, the Philippines, Sri Lanka, and Tai-wan.

Jagdish N. Bhagwati

International Trade:Selected Readings

MIT Press, Cambridge, MA, U S A . 1981, xxii - 414 pp., $25(cloth), $9.95 (paperback)

In 1969, the Penguin Modern Economics seriespublished a collection of 16 essays on interna-tional trade edited by Jagdish Bhagwati. The cur-rent volume may be seen as a successor to theearlier book. It includes 28 articles, only 6 ofwhich are carried over from the Penguin edition.This gives some indication of the turnover in so-called classic articles in trade theory. The newcollection also shows how the continuing interestin economic distortions, the theory of tariffs, theeffects of foreign exchange constraints, and thenature of comparative advantage has now beenjoined by a greater concern for general equilib-rium conditions and for tracing the consequencesof capital accumulation in models of open econ-omies.

M. C. Kemp and N. V Long (editors)

Exhaustible Resources, Optimalityand TradeNorth Holland Publishing Company, Amsterdam. Netherlands,1980, xii + 250 pp., $44.50

Walter C. Labys

Market Structure, Bargaining Powerand Resource Price FormationDC Heath and Company, Lexington, MA, U.S.A., 1980, xiv *238 pp., $22.95.

Both these books are about the economics ofmineral resources but they differ considerably intheir focus and in the level of theoretical sophis-tication. The Kemp and Long volume is con-cerned with deriving optimal rules for the exploi-tation and trade of natural resources, andconsiderable mathematical skill is required tocomprehend each paper. Labys' book is moredown to earth. It goes quickly over the basicframework for analyzing price formation and thenapplies it to the pricing of copper, tin, bauxite, andiron ore in world markets. Although the empiricalmaterial does not extend much beyond the mid-1970s, this is an informative book—especiallyabout the institutional arrangements underlyingpricing actions.

Christopher P Brown

The Political and Social Economyof Commodity ControlPraeger Publishers, New York, NY, U.S.A., 1980, xvii + 375 pp.,$3995.

An attempt to identify the principal economic, po-litical, and organizational factors that fashionedthe Integrated Program for Commodities workedout by the United Nations Conference on Tradeand Development. A useful guide to recent inter-national efforts in the field of commodity stabili-zation with a bibliography.

Warren L. Coats, Jr and Deena R. Khatkhate (editors)

Money and Monetary Policy in LessDeveloped Countries:A Survey of Issues and Evidence

Pergamon Press, Oxford, U.K., 1980, xiv t 827 pp., £40/$95(cloth), £8.507520 (paperback), and £1Z.50/$30 (cloth, developingcountries).

A collection of 46 articles, of which some 40 havebeen published previously in academic journals,exploring aspects of the general problem ofadapting monetary theory to monetary manage-ment in less developed countries. Both editorsare members of the Fund's staff.

P. J. Drake

Money, Finance and DevelopmentJohn Wiley & Sons, New York, NY, U.S.A., 1980, xi ^ 244 pp.,$27.95

A useful and lucid introduction to the role ofmoney in development. The nine chapters coversuch topics as the money supply, informal fi-nance, financial development and economicgrowth, and the securities market, combiningfairly elementary concepts with the main findingsof relevant research. A ten-page bibliography tes-tifies to the author's efforts in this regard. How-ever, a reader expecting to find fresh ideas andangles may be a trifle dissatisfied.

David Bigman and Teizo Taya (editors)

The Functioning of FloatingExchange Rates:Theory, Evidence, and Policy Implications

Ballinger Publishing Company, Cambridge, MA, U.S.A., 1980, xiii+ 419 pp.,$25.

A collection of 13 papers by academic or institu-tional economists and 5 papers by prominenteconomic policymakers on the workings of thesystem of floating rates since 1973.



a practical approach to financial policy making...

FINANCIAL POLICY WORKSHOPS:The Case of Kenya

a publication of the IMF Institute

This book offers a series of workshops on Kenya that are and practice to provide a better understanding of the useused as a case study in the IMF Institute's course on Financial of major financial policy instruments in the managementAnalysis and Policy for officials of the International Monetary of national economies.Fund's member countries. The workshops combine theory

Topics of the Workshops:

1. Monetary and Financial Survey 4. Flow of Funds 7. Revenue Forecasting2. Government Finance Statistics 5. The Polak Model: An Application 8. Balance of Payments Forecasting3. Balance of Payments Statistics 6. Projection of Monetary Aggregates 9. Financial Programming

In addition to the workshops, the book includes background tables present the data for analysis, forecasting, and financialinformation on Kenya as well as exercises and issues for programming on a national level. Charts and a map illustratediscussion (with answers to many exercises). Numerous the book.

xx + 315 pp.; clothbound, US$12.50.

RECENT PUBLICATIONSOccasional Paper 2 Occasional Paper 3Economic Stabilization and Growth in Portugal External Indebtedness of Developing Countries

by Hans Schmitt by a staff team headed by Bahram Nowzad and Richard C. Williams

There is no charge for these publications.

STAFF PAPERSPublished quarterly in March, June, September, and December.

Summaries of each paper in French and Spanish, as well as in English.

.. , „ ~ , ,„, ~ " Fiscal Proxies for Devaluation: A General ReviewVoL 28 March 1981 N0-1 by John F. Laker

A Survey of Measures of Capacity UtilizationStabilization Programs in Developing Countries: A Formal by Lawrence ]. ChristianaFramework Effectiveness of Exchange Rate Policy for Trade Account

by Mohsin 5. Khan and Malcolm D. Knight AdjustmentStabilization Policies in Developing Countries: Some Policy by Alfred SteinherrConsiderations A Note on Heller's Use of Regression Analysis

by Andrew D. Crockett by Alan Rabin and Leila ]. PrattDemand Management and Exchange Rate Policy: The Italian International Reserves and World-Wide Inflation: FurtherExperience Analysis

by Giuseppe Tullio by H. Robert Heller

Special rate to university libraries, faculty, and students: US$4.00 a volume; US$1.00 a single issue.Subscription: US$9.00 a volume; US$3.00 a single issue.

Advice on payment in other currencies will be given upon receipt of order.

Copies of the above publications are available from:External Relations DepartmentAttention: PublicationsInternational Monetary FundWashington, DC 20431 U.S.A.


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