BER WORKING Z4PER SERIES ‘THE THTERNATIONAL MONETARY FUND AND THE DEVELOPING COUNTRIES: ‘A CRITICAL EYALUATION Sebastian Tdvards Working Paper to. 2909 NATIONAL BUREAU OF ECONOMIC RESEARCH 11050 Marsachuseets avenue Caabeidge, *& 02138 March 1989) This is a revised version of a paper presented at the Carmegie-Rochester Confrence an Public Policy, Novenber 18-19, 1988. In preparing this paper T have benefited from discussions with a minber of colleagues. I am espectally grateful to the many Fund staff and executive directors (present and past) that helped ne understand a little bit the functioning of the Fund. Also, Want to thank nusber of former and current senior policy-makers in the Seveloping countries for sharing with me their experiences in dealing with the fund. Tam grateful to Allan Meltzer, John Taylor, John Willtanson, Guido Tabellini, Debra Glaesaan and zy discussant Norris Goldstein for helpful consents. I thank Me, Azizali F, Mohanmed for allowing ae to use tnferaacion on the characteristics of recent Fund prograas, Miguel Savastano provided able research assistance and very useful comments. I am indebted to Beta's Acadenic Senate and to the National Selence Foundation for Clnancial Support. This paper 1a part of NBER’s research program in International Studies, Any opinions expressed are those of the auchor not those of the National Bureau of Eeonoaie Research.NBER Working Paper #2909 March 1989 THE INTERNATIONAL MONETARY FUND akD THE DEVELOPING COUNTRIES: ‘A CRITICAL EVALUATION ansTaact ‘The purpose of this paper Ls co critically evaluate the IMF's role in the developing countries’ adjustment precess. In particular, the paper tetes to anaver the folloving questions: What aodel or franevork does the IMF use to generate its advice, and is that advice eclectic? Is there evidence that councries that folloved the IMF’s advice do better than countries that proceed in other vays? Are the policy decisions of the Fund based on technical knovledge or do they reflect the political views of the Larger meabers? Is the IMF position regarding the debt crisis conducive to fa realistic solution? hat can ve expect from the Fund in the future? The lan evaluation of recent IMF programa, as well as an paper algo include sconomstric analysis of che contractionéry devaluation tssue. sebastian Edwards Deparenent of Eeonontes nla. Lie Angeles, CA 90024-1477"There may be no vay out for the IMF... [T]he Fund will be tonsed occasional bones ~~ tone statistics to collect, some indicator to keep an Gye on, and.so forth, But Af the past fev years fare ony putts, che agreenents that aatter will be sectied privately beoreen the Finance minist~ rs of the big economies" ‘The-Eeonomiss (24 Sept. 1988, p. 87) 1. Introduction ‘The International Monetary Fund {s a mysterious and often-feared instieutfon. One of the auay ayths that surround the Fund is that ite staff travels azound the world Laposing unnecessarily harsh adjustment policies to the developing countries. Strictly apecking this is incorrect: the IMP cannot tnpose any policy to any country. Howexer, occastonally -- frequently, may be sistance, both technical and a more accurate word -- countries require finanetal, from the Fund. In aost cases before providing financial help, and thts Le the catch, the country has to agree to follow a given ret of macroeconoaic policies. This process, ty which the Fund provides financtal help on the conditton chat the rectpfent country agrees on a policy action has come to be known as conditionality. Since the eruption of the debt crisis in/1982 the Fund has played an taportent role in the effort to bring sbout an orderly adjustaent to the world econoay. Not only did the Fund provide financial help to the highly indebeed countries, but ¢ was also instrumental in coordinating the private bank Anvolvenent {n the first “emergency” packager. Since 1982 the Fund's evalua elon ef a country’s performance has beccne a key elenent in the process of debe restructuring and refinancing. The Fund provides a “seal of approval" that assures the banks that the country in question ir indeed asking « serious ‘effort to improve things. People from very different persuasions have recognized the iaportant, indeed crucial, role of the Fund in helping avert a global international finenc{al collapse folloving the debt criris, However, ore and more observers are nov questicring the wisdom of the Rind's current approach tovard the debt crisis and adjustaent. Interestingly encugh, these erttictsms are coming from all sides of the ideological and political spect rus, On the one hand ve have the traditional critics that now, yesterday argue that the Fund's programs are unnecessar{ly harsh, {11-concetvedpoverty-promoting, and at best ineffictent in achleving thelr external (1.0. balance of payments and current account) objectives. hat {s nev, hovever, are the somevhat vetled eriticlans coming fron conservative quarters. Accord: ing to this view which has not yat > p fully articulated in writing, but that is perceived in many places including the IMF {eself -- the Fund haz ceased to operate as a financial institution guided by technical principles, ‘and hag taken an unre istic view regarding the debe crisis. Te is argued that by proceeding as Af the debt crisis will be solved without major relief and writeoffs the Fund 1s postponing drastic and ne led actions. In a way, this view claing, the Fund {e acting more and nore as a development ald- granting agency.! Even worse, the arpizent goes, by operating in this fashion the Fund ie endangering its om financial stabilicy ‘The purpose of thir paper is to critically evaluate the IMF's role in che developing countries’ adjustment process. In particular, the paper tries to answer the folloving questions: What model or fraevork does the IMF use to generate ts advice, and Ls that advice eclectic? Is there evidence that countrss that followed the IMF's advice do better than countries that proceed 4m other ways? Are the policy dectstons of the Fund based on technical knowledge or do they reflect the political views of the larger mexbers? Ts the IMP position regarding the debt erisis conducive to a realistic solution? What can wa expect from the Fund in the future? The paper, hovever, does not go into the institutional details of the Fund, nor dot the tt discuss in dacatl chanice of ite adainietration. There is nov a large descriptive Liters eed readers are referred to it.? Also, public choice perspective, nor does it deal in detail with whether its existence is 3 ture on this subject and the inter the paper dots not discuss in datall the Fund's behavior from Justified from an econonte perspective, Yq some axcent after the debt crisis the dlfference and the World Bank have becoe somewhat blurred between the Fund 2 mmo Fund itself has published a musber of highly informative inetitutional introductions, See, for example, the Supplenent to che Septenber 1968 issue of the IMF Survey. See also de Vries (1987) and the references cited therein ror a public choice view of the Fund and other international organizations see Vaubel (1987) and the Literature cited therein,For any outsider se 4s extremely difficult -- utterly tepossible, some would even say -- to fully evaluate the functioning of the IMF. Many of Les decisions are confidential, as are most of the key documents that set the Fund's policy position, Moreover, the details of specific prograas, including. the Letters of Intent, Mesoranda of Understanding and other docusents, are also confidential, This asker che evaluation of prograns’ performance very aiéficule, For this reason any study Like the present one bi to rely on the Limited information publicly avatleble, and partially en informal conversa tions with current and foraer staff and executive directors, as well as on inte elves. Jove vith polleynakers in the developing nations th ‘The paper 42 organized in the following vay: Section II deals with the Fund's analytical aodel. The inception and evolution of Fund financing progranning {s revieved. This section elso élscusses the contributions made by the Fund seatf to economte theory throughout che years. Section TTT deals vith the effectiveness of Fund's prograns. The Literature on che subject ts revlewed and the recent experience vith conditionality ts discussed. Section IV Le devoted to the Fund's role in the managenent of the debt crisis. This 4 done from an international political economy perspective. Section V deals with devaluation, the most controversial component of Fund prograas. Tssu relaced co the output and income distrioution effects of devaluations are eupirically analyzed for a sample of developing countries. Finally, Section VI contains the conclusions and briefly dtecusses what ve can expect from the Fund in the future 11, Analytical Bases of Fund Adjustment Proscams ‘The design of Fund programs 1s based on an analytical framework known as Hinanciel Rxogramping (FP). This framevork vas developed tn che lace 19508 and early 19608 by 4 group of econoalsts in the Fund Research Departaent Led by J.J, Polak; its theoretical underpinnings vere first fully exposed in an arcicle by Polak published tn the Staff Papers in 1957, Financial Programming consists of a set of simple equations that relate, for che case of a snall ‘open econoay with a fixed exchange rat the behavior of the monetary sector to the balance of payments. This franevork had its direct intellectual origine in che vork of Robert Triffin and in the models used by the Netherland's Central Bank. Financial Programming corresponds closely to what in the 19708 came co be know as the Monetary Approach to the Balance ofPaynents (WABP). In fact, practically all of the insights of the MASP hed been made by the architects of FP in the 1950s and early 1960. Although since 1957 the Staff Pauexe has published « nunber of theoretical papers dealing with different aspects of FP, the Fund has traditionally been very circumspect with respect to its operational details tor In fact, te ts only recently that official publications and pepers by of how the Fund actually uses FP to staff menbers have provided « glisps formulate its edjustaent prograns.” Uhet 1a most striking from reading these documents {2 how ttle Financiel Programming has changed in 30 years. Te is not an exaggeration to say chat Fund econoalsts use today a very similar analytical apparatus to that used by thelr colleagues 25 oF 30 years ago. This, of course, {2 both reassuring and troubling. On the one hand ic 4s reassuring thac the franevork has endured the passage of tine; this inéi- cates 1c, that thie 44 a poverful and useful tool. On che ac the very Le other hand, hovever, it is troublesoue that in {e8 operational work the Fund has not picked up many of the Large miaber of davelopments in open econoay ‘macroecononics of the last 25 years.® Tn this section I briefly present the essentials of the Fund's model. A useful and natural starting point 4s folak’s odel. I will show thet, contrary to what @ nunber of critics have argued, this model is quite general and flexible. In fact, for its tine se vas quite elegant. Moreover, Polak: and his colleagues vere fully avare of its Limitations. I will then deal vith the evolution of the Fund's model in the Last 30 years, presenting the “on the monetary approach see Frenkel ané Johnson (1976). For an early smathenatical formulation of the Polak nodel see Prats (1961) Stn 1981 che IME ingtitute published a case study on Kenya vhere the Aitferent components of FP were explained in detail. However, in che Preface the Dizector of the Institute says! "I vish to stress that thes workshops aust not be construed as rerresenting necessarily the techniques Used by the Fund staff in dealing with meaber countries" (p. viii), In 1984 the IM Institute published a second case study dealing with Coleabie, "Only in che lest couple of years has the Pind publicly exposed the nuts and belte of Financial Programaing as practiced at the Find. See Khan, Montiel and. Hague (1986, 1988) and the IMF (1987). Rabichele (1985) has recently provided an’ insiders account on how FE 48 practiced. "the eaphasts here 1s on the word Toperational". Anyone that has kept up wich Scaft Papers is avare that sophisticated and current research ta Gone at the Fund:essential aspects of FP as 12 understoed today, Next T will briefly deal with FP as actually practiced vhen formulating a program. Finally, I will @iscuse ways in which the incorporation of sone of the most important recent Gevelopments in open economy macroaconeaics could affect the Fund's advice 11.1 The Bolak Model ‘The Polak model, on vhich the Fund's analytical approach 1s based, wa: developed in the 1950s to analyze the relation between the financial and nonetary sectors and the balance of parzents {n the developing nations. In accordance with the institutional setting of the tine the model assunes fixed pominal exchange rates. The key assumption of the model is that there exists fs stable demand for donestic money chat depends ona small munber of vari- ables, In fact, in tes siaplest representation the model assuaes that the denand for (nominal) money depends on (nominal) income only and that velocity As constane.’ Te is agsuned that capital flows and exports are predetermined ‘and chat {aports depend in a proportional vay on income, Following Triffin, changes in che dos ele credit (money of internal origin) and changes in net Jetle money supply are broken down into two coaponents changes. tn dom ete of the monetary system money of excernal origin). The foreign behavior of nominal income ts left unspecified and it ts not broken dow between changes in the price level and changes in real income The functioning of the model ts staple and very well-known by now. Aseuming (permanent) monetary equilibrius, and given the estima of the exogenous and predetermined variables -- capital flows, exports, income -- ic 1s possible to compute the evolution of domestic credit that 1s compatible vith a corcain balence of payments target: ‘The analysis ... can be used to derive an estimate of the amount of incernal credit expansion by the sonetary system vblch an econosy can afford. (Polak: p. 47) ‘The main Insights of che Polak wodel are: (1) in @ small open econoay. with a fixed exchange rate both the retl and nominal quantities of money 41 endogenous; (2) donestic credit Ls the relevant policy tool for conducting Tcontrary to Vhat tome critics have insinuated, Polak was fully avare that there can be (and chat chere are) Important changes in velocity. In fact, Section V of his 1957 article 1s fully devoted to the case of « changing velocitymonetary policy: (3) in the short run, with « given level of nosinal income, domestic credit increases vill be exactly offset by losses in International, reserves, ané (4) mt ing teporte (4.0., devaluattons) will only generate tesporary {aprovenent in che sures geared touarde increasing exports or decres balance of paynente,® Polak did not consider FP at necessarily competing with other approaches for understanding balance of paynente behavior, In fact FP var originally viewed as a vay of analyzing belance of payments behavior from a different perspective than that of the incose-expenditure model. By focusing on the monatery side of the sane cfrcular process, ve can approach the prablea from another angle, which makes it sore tractable in sary’ situations @olak, p- 25) Overall, Polak had an eclectic attitude with respect to this model. He clearly stated that his presentation vas deliberately staple, and acknowledged that many of the assumptions made in the paper vere not fully realistic, For instance, he pointed out that velocity aay actually change depending on the evolution of other variables (pp. 51-85); he recognized that donestic credit ay not be fully exogenous and that {r aay vell be governed by a feedback rule (pp. 26-27); and he certainly acknovledged that the evel of soney income is not fully appropriate in any clrcumstances (p. 44). ssumption of « given I belleve that ie 12 fair to say that from the very beginning FP vas seen as 9 siniual franevork to analyze balance of payments behavior fron monetary perspective, It vas neither rigid nor dogatic; quite the contrary, it var seen as a fairly eclectic and flextble construct, The franevork could, in fact, be supplenented by different macroeconomic nodels, If these models were staple (constant velocity, full employsent, lav of one price) the outcome of FP vould be simple. If, on the other hand, a nore sophisticated supplenencal aacroeconoatc model vas used, a richer set of resulte would emerge fron the ute of FP. 11.2 The IMF Model in che 19808 Wan, Montiel ané Haque (19865, 1968) have provided the most authoritative “wotice, however, that in Polak's (1957) there is no explicit reference to exchange Tate changes as policy seasure, However, the first paragraph on page 42 can clearly be interpreted as including the case of develuations (The page tusbers Fefer to the version of Polak reprinted in the 1970s.)insider's exposition of the Fund's sode. as currently ured.? Following ches, the 19808 version of the Fund's model cen be described by equations (1) enrough (11):19 weReD aw f= recy) @ pao + of o vee % Pe ve?s Cowere o Re ee 6) ant is a a ae ” Be = ab*P + af*6 (8) ae PH Oy Y= B.EPH/EL) ao) ane a? ap where the following notation is used: M—: nominal stock of money R : stock of international reserves of the monetary system expressed in doaestie currency D: domestic credit donestic credit to the private sector DE domestic credit to the nonbanking government sector another useful insider exposition of the Fund model available to the general public is IMF (1987). Robichek (1985), vho vas for many Years one of the major intellectual forces in che Fund, provides a fascinating description of how FP vorks in practice *re ts taportant to emphasize that this description of the Fund model hnas been taken verbatin from Khan et al, (1986, 1988). It fully corresponds to an insiders’ description of the model used by the Fund,+: domestic price Level +: nominal income real incone prices of domestic goods nominal exchange rate Pr: world price of taperte expr in foreign currency RY atock of international reserves in foreign currency ant: balance of paynents in foreign currency S# : exports in foreign currency zt: Awporte in foresgn currency Pt: change in net foreign assets in foreign currency ar*P : change in net foreign assets of the privat ar*€ ; change in the net foreign assets of the public ¥ volume of Laporee. Equation (1) Ls the balance sheet of the monetary system, and states that the stock of money is composed of the stock of international reserves (noney of foreign origin) ant domestic credit (soney of domestic origin). Equation (2) As che demand for money, vhich ts assumed to depend only on incoue. Equs thon (3) decomposes domestic credit into domestic credit to the private sector and domeatic credit to the public sector, Equation (4) ie the definition of nominal income, where real incowe j is considered to be exogenous. Equation, (5) 19 che price level, assumed co be « weighted average of the prices of domestic goods and the dovestic currency prices of saportable goods. Equation (6) relates international reserves in domestic and foreign currency, Equation (7) defines the balance of plus the capital account. The change in net foreign assets (HFA) Le exogenous syaents in foreign currency at the trade account and in equation (8) 4¢ 4s broken don into changes in NFA of the private sector and of the public sector. In «quation (9) the foreign currency value of Amports is defined. Equation (10) atates that the volume of mports is « function of 1 1 income and relative prices (the real exchange rate), Finally ‘equation (11) Ls the key relation in the model and states that the money market (2 {n (Flow) equilibrium The targets of most Fund adjustment prograns are the balance of paysents (08) and the change in domestic prices (aP*). Domestic credit expansion and exchange rate changes are the instruments, If equation (2) 4s replaced by a constant velocity demand for money equation (H°4K?y), and the import demandfunction 4a asnuted to be Linear (V= 0 + ayy - a5(EP4/Py)) the sodel can be reduced to a te Linear equations in aR end 4P°,1 Por given values of 1 income, exports foreign price the exogenous vartabl. capital flows, re + and of the balance of payments and inflation targets, che sys of the policy instruments AD (domestic cre- cen be solved for the required chang: Ait) and AE (the nominal exchange rate). Denoting the balance of paynents and donestic inflation targets as ak and af? ve obtain: AD = ((7y/B) = 1) ABA yy = yA /By) OP + ay ar = Bib ak - (By/8,) af + ¥ a) were gy and ¥y are constance and Ae een ah ey ne To oe PER) Since equation (12) Links directly credit creation to the belance of payzents earget, {£ provides the intellectual rationale for using credit ceflings az an performance criterion" (an intermediate target) in Fund conditionality prograns.!? In fact, according to Khan et al. (1986) Since policymakers’ loss functions in countries experiencing balance of paynenta deficits presumably attach Iictle weight to positive Geviations of AR from the desired value... the targeted expe of domestic credit is set aa « celuing. (page 10) Of course, this model is vary siupie, If prices and inports axe taken as given, and the exchange rate {2 azsuaed not to change, the aodel will actually collapse into the siaplest versfon of the Polak model where there is a strict one-to-one inverse relation between doaestic credit creation and the balance of payments. In fact, there axe almost no substantive differences between the basic model of the Fund described in equations (1) through (11) above, and th odel developed more than 30 years ago. This aiatlerity has been acknovledged Uthese equations correspond to equations (9b) and (20a) in Khan, e€ al cases) 22se0 also Guitién (1981) for an explanation of the incellectual underpinnings of conditionalicy along the lines of the aodel presented abovewishin the Fund teseif:1? ‘The Rind approach to economic stabilization, genes 15 "financial programming", 1s based largely on the oral tradition Si. (T]he analycical baste’ of the program ves articulated... ina Ihuaber of papers ... principally by Polak (1957) ... and Robichek (2967, 1971)... {Ejven the aore recent writings by Fund staff in the general area of Financfal progranming closely follov the Atrections set by these contributions (MF 1987, p. 1) ‘The actual process of program design can be best described as one that 2 its backbone, This baste framework Ls then supplemented by « uses FP ries of models that pertain to particular sectors of the econosy, In prac toe, the us the exogenous variables and to looking in great detail at some aspects of the of these supplesentary models anounts to endogentzing some of feconoay such as government finances. Which sectors are actually singled out for additional analysis depends on the specific cireuastances of the country An question, on the date availabli The fact that the sodel described above is considered only as « general and on the specific staff Involved. Franevork, and not as a rigid recipe, is clearly captured by the actual role of exchar of the ve instrunents considered in the analytical model, there are many rate adjusenente in Fund programs, Although davaluations are one cases where the Fund does not consider « change in the exchange rate as a required elesent in an actual program, For example, Reichaan and St{llson (1978) peine out that between 1963 and 1972 only 308 of upper-credit- tranche programs included a devaluation, In 1977-80, however, the proportion of programs that Included « devaluation increased to 50 percent (Loser, 1984) ‘An area vhere FP is particularly strengthened in practical application refers to government finances, Moreover, in this area the Fund has shown some flexibittty in Incorporating into che anelysie the changing circumstances of & given country. A particularly interesting example refere to taking into Account the effect of indexation and inflation in the fiscal deffeit. For instance, after Long and protracted dlacussions with the Brez{lian Ure shoulé be noted chat ehis document goes on to say that "the design of Rund-supported adjustzent prograas has gradually absorbed many of the new developaents that have taken place in the study of macroeconomics and international econontes™ (p. 1). Hovever, aost of the “new developments” that the docunent discusses are rather siaple extensions. For instance. the paper Giscusses the role of lags in denand for money adjustment, the role of nontradables and the Like:u authorities, che Fund recognized chat indexation hed « significant distortive affect on fiscal accounts, Aa a result, modifications were introduced into the definition of performance criteria for Brazil; instead of focusing exclusively on the public sector borrosing requirements (PSBR), che program shifced ite emphasis to the “operational budget”, vhich excluded interest payments on governaent aebe./* 11.3 Financial Programing in Practice ‘The franevork described above 48 used in practice to design adjustment prograns. In doing #0 the staff follous « step-by-step approach that requires fe deal of judgnent. The f Large anount of information as vell as a grt progras 1s put together in an iterative fashion, vhere consistency checks are frequently isplesenced. If the outcome is not consistent, the progran is The design of « program usually starts vith an evaluation of the country's situation. Next, targets for che key variebles are determined and a .ged. E. Walter Robichek, one of the intellectual fathers of FP, has recently described the key steps Lovelved in course of policy actions { envi designing « financial program. hat follovs is « summary of Robichek’s (1985) description of the steps involved in putting # Fund program cogether! 1. Levels for cargets picked 2. Given (1), the exogenous components of che balance of paysents (1. net foreign assets, inflation and others -- are exporte, interest payzence, noncoapensatory capital flows) are estinated From (2) 4 preliminary value of iaports consistent with (1) 4s obeained 4. Tf, as dm moat cases, the value of iaporcs obteined form (3) differs fron the historical trend it Le necessary to decide Lf exchange rate action is needed. If a devaluation is considered, steps (2) end (3) have to be redone in the Light of the nev exchange rate level, 5. The quanciey of money demanded 14 forecasted. This requires estiaat pominal income and velocity, The,latter Ls asny tines, but not always, caken as given Mane Braz{ltans, hovever, have argued that it took « very long tie for the Fund staff co recognize this fact. Moreover, according to Bastos Marques (2986) the inability of the Fund to recognize chis problem early enough vas at the root of the repeated violations of the targetsR 6. A preliminary decision on vhether "interest rate action" ts needed is made at ehis stage. If the answer 1s positive, step (5) Le revised. 7. The relation between the country’ monetary aggregates and che central Dank monetary aggregates ie determined, 8, The sustainable Level of central bank domestic credit Lies, the Level compatible vith the NFA target -- {# derived. 9. The domestic credit target detersined in (8) is checked for consistency land realisn. This is done by anclyzing {n detall the demand sources for donestic credit. The key element here {s the potential demand for credit by the public sector. This step, this, includes « eiffioult and detatled analysis of government finances 10. If the public sector borrowing requirements are inconsistent vith che nmaxtmun expansion of douestic credit, nev sources of adjustment are ought, These include demand aarageaent, supply oriented polictes and polletes geared to the financial side UL. After che nev measures are devised, steps (1) through (10) are repeated and the exercise 1s iterated until consistency is achieved. 12, Once an “equiltbriua" program is achleved, the performance criteria that WALL guide the monitoring of the program are determined, These criteria lwsutlly fall into evo groups: nen-quantitative performance criteria and quantieative criteria, 13, The program ts then negotiated with the country's authorities. ‘As Ls evident from the above description, FP t+ « painful and difficult exercise, Its inplementation not only requires knovledge of the country and ample statistical inforastion, but alo good Judgment, In the actual prepare: elon of a financial program there ts usually « need to obtain estimates of the relevant parameters of che underlying aodel. It 1 often at this stage where nore sophisticated analyses thet incorporate never approaches and statistical techniques are incorporated. 11.4 Economic Theory and the Fund's Model The analysis of Polak’s original article, and of Khan et al, (1986, 1987) and Robichek's (1985) recent contributions, clearly indicates that the Fund's ‘ininal model has renained fundamentally unchanged in the last 25 years or so. ‘This has happened during perfod when economic theory in general, and open ‘sconony macroeconoaics in particular, have experienced tmportant developsenteb chat have in one vay or another changed the way economists think abou feconoate policy. Even though, as alzeaty stressed, the FP nodal is not used rigidly, and sany tines when used {n practice it is algnificantly enriched, it ts still fair co say chat che Fund's basic opexational framework has atased any of the most {sportant nev developsents in the theory of economic policy ‘The Fund's baste sodel ts fundamentally static, has a fairly rudimentary Financial sector, ignores the existence of uncertainty and has no fundanencal role for expectations! Moreover, the basic franevork arsunes that real Income is exogenous and does not respond to the policies implesented in the program. This model has fatled to formlly incorporate iesues related to the Intertenporal nature of the current account, the role of risk and self-insur- ‘ance in portfolio choices, the role of tine cons{etency and precommitaents in sconosic policy, the econoates of contracts and reputation, the econoatcs of equilibriue re the "Lica eritique,* and the theory of speculative attacks and devaluation erites, just to mention a few of the more 1 exchange rats Important recent developzente {n international aacroecononice.!® Tam avare, of course, that this critieiea may sound picayune; even as souevhat frivolous. One can alwaye argue that soneone else's model 1s not sophisticated or general enough, or tha: 1¢ does not include this or that exquisite refinesent, or, as i has become vay too conaon in the recent yea be argued chat what te Le not Moreover, 1¢ a 4 on *Elrat principles the nev developaents in macroecononic theory are too abstract and not relevant, fron an operational point of view, or that it 4s too difficult to incorporate then into an actual policyaaking framework, of even that, if incorporated, the ain thrust of the model will not change. I don’t think that this 1s the case, I believe that many of the new developaents in the theory of economic cion in which the incorporation of nev ideas the theory of economic policy would affect the Fund's policy advice. At the end of the road they could very well strengthen che type of advice the Fund now dispenses, It tz also possible, however, that, in the Lighe of these nev ideas some of the Fund's recommendations would appear incorrect. Obviously, concrete answer to this question vould require ich. Below I provide seme siaple examples of how some of the could, in fact, alter the fund's policy advice see stocknan (1988) for « recent interesting discussion of the Ancerrelation betveen nev developaents in the cheory of international finance and econonie policy in the developed countries. See Fischer (1988) for « survey on recent developaents on uacrosconoaics1% policy can enrich the Fund's policy and operational framework and that they: can reault in tighter, better and nore effective policy advice, Although a ‘aogern davelopents vill specifically alter the te 1s possible to formal Inquiry on how ehe implications of FP 1s well beyond the scope of this pape {Lluserate how some of these nnovertons may enrich IMF policy analysts In what follovs I will provide three examples that attempt to {llustrate how some of the new developments in acroscoroaice aay help in refining the Fund’ baste model. Naturally I do not intend to lay out « complete agenda for revising FP. The first example & optintzing framework for enslyzing current account behavior.!” within this fs vith the use of an explicit intertemporal Exanevork expectations of future events vill play a crucial explicit role Moreover, in an intertemporal setting {t 12 necessary to recognize explicitly that Funé programs are of a short-term nature and that, as a consequence, meny of the structural reforms implenented under them aay be reversed once the prograns are over. As Calvo (1987), among others Le {2 not at all clear whether tenporsry reforms will be desirable for the country in question. A direct implication of thie result 4s that when giving polley advice epectal care should be taken to provide Long term incentives hhas recently pointed out, that, dently, vill aurvive the program {teelf Also, in an intertemporal setting {¢ te cructel to anelyze both inter and Antuatenporal serging of substitution. The timing of policies becomes very important, af does the dletinceton between temporary and permanent polteie The implications of these sodels for fiscel policy are particularly relevant for the Fund poley advice, For example, Frenkel and Razin (1987, pp. 437-61) hhave shown that, in general, the {ntartemporal model will generate very dif- ferent predictiona, both in terms of directions and magnitude of the effects, than eradiefonal static models. such ss the Fund's baste model described by equations (1) through (11). Although the practical taplenentation of intar- temporal models {a not easy, sone of the new econoaetric attenpts to establish the extent of intertemporal substitution in production and consumption can be particularly helpful. Algo, recent developnente in time-series econometrics ‘re should be noticed that in zany Fund docunencs (Guittan 1961), there is an eaphasis on the distinction between temporary and permanent shocks, However, the model presented above has none of that. On formal intertemporal nodels see, for example, Frenkel and Razin (1987) end Edvards (1989)1s that allov the decomposition of eccnoale sertez into permanent and cyclical tonal eleaence required for 8 conponence, can provide ane of the o satisfactory eapirleal tmplenentation of shese aodels: ‘the second exemple deals with tine emalstency, exedibtlity and juee, The incorporation of these concepts into an explictt Se ostahee on the policymaking process that cannot bt obcatnad with sfaple static models sncerveaporal opeiatzing franavork will ginerally introduce taports fim theoretteel justification for conditlonality. At the sage tise, chey wild clearly indleace what are some of cht main Linttations of ehis type of ble preconattaents on future pollctes will generally result tn asboptinel policy outcones. Under ton, Hine consistency arguments can be used to provide & program. The inability of governaents ro make ere certain clrcunstances, however, condittonaltty of che type iaplesenced by the Fund can be translated into credible precomaltaents and, thus, more desirable venules. However, for condittonality to play chis role {t is necessary chat she Rand has che the Fund's prograne. First, £¢ Ss neces bility, a well as che willingness, to enforce the prosrane, nce the analysis of fenforcenent pover the Fund actually bas, This Se, at the end, an empirical setter that Le currently unresolved. Sache (1988), for example, hes recently daxpund that although threate of cutting fusure credit are a credible sanction they have « Lintted effect on country behavior. !? If chts ts indeed the case, capability. Alvernatively, Af this Ls not po ble the Fund should recognize nforcement ability 1# lev and reform ite aedus operandi accordingly. srding the effectiveness of conditionslity refers to the Fund's perceived willing and ulctnately "weak, condictonaltty {ll not provide che required vehicle 0 enforce the programe, This, of course, has to for aking countries’ policies credible, An tayortant question here 12 Meee, cor exanple, Beveridge and Nelaon (1981) and che survey articie by Seack and datson (1988), The neerteaporsl approach to. the current account tla bas important iaplications for evalunting RER novenenta,, Contrary to the fore traditional vieur bared on che purchasing power pariey theory, it an optinizing intertesporal franevork the equilibriun REX can exhibit Large Fluctus Wie ous not, hovever, provide evidence supporting this assertion,16 whether the recent practice of setting tight targets and then granting waivers reduces the perception of the Fund's "toughness". If this perception 1 indeed, weakened there {e a good reason for revising this practice,?° ‘The ehiré example refere to speculative attacke and exchange ra collapses, This Literature has provided {aportant insights inte the dynanics and the timing of exchange rate erises. One of the aost relevant predictions As that Lf the public antictpates « crisis it would rald the Central Bank and the devaluation will take place before it vould have occurred in a non- forvard-Looking ting, This result, in fact, provides support to the Fund's practice of usually including devalustions as # component of the prior action Packages. Moreover, this framework world suggest that the Fund should be even stricter in requiring chat devaluations are undertaken under full confident: AeLity and before public negotiations on a progran even begins.?> 4 second Aaplication of speculative attack models {s that real exchange rate behavior should be closely monitored in order te avold situations of real exchange rate aisaligneent. In fact, recent enpiricel studte rate aisalignsent 1s indeed one of the most saportant daterainants of speculative attacks (Eévarde 1989), One way of avotéing overvaluation is by ‘Adopting @ nominal exchange rate regine based on a cravling peg, The Fund's record in this area {s somewhat mixed; quite often, in fact, the policy Andteate that real exchange 20s intereating question within the tine consistency framework -- and one for vhich I don't have a full answer ~- refers co the circumstances under Which Fund condittonality prograns should be explicitly contingent on some exogenous variables. In principle, it is possible to chink of some reasonable Seeting under which’ -- dua co informational asymetries, transaction and negotiation costa, of reputational considerations -- the optimal progras will explicitly establish contingent performance criteria, In this case, under certain states of the world the ceilings on the intermediate targets would be automatically revised, without the need to resort to a renegotiation procs ‘The recent eatablishment of the (CCHF) by the Executive Board in august of 1968 is, in fact @ step in this Airection. Hovever, the fact that the activation of the contingency mechanten generally requires the agreeuent of the Executive Board, makes thie facility Tess than fully contingent. On the details of CCPF, including the way {t ix activated, see Pownall ané Stuart (1988). On the theory of contingent. policies see Aizerman (1988) and Canzoneri (1985). “he eaphasis here is on public megottattons. Many polfcyuakers in the Loc’s have pointed out that as goon as the press announces that a Fund a{esion will arrive into the country, the public speculative activities greatly increase introducing unnecessary distortionsv sn to maintain « fixed exchange rate.?? Another recommendation has bs Aaportant {aplication of expectations-based models of devaluation refers to the role of the parallel market rate {2 deciding by how much to devalue the official rate. Very frequently the Fund etaff recomende to devalue the official rate in a proportion equal to the existing parallel market preniue In part, the rationale for this advice { thet in this vay -- and assuning that the correct fiscal policies are implemented -- an exchange rate untfie tion will be achteved. Hovever, Lizondo (1987) hes recently shown that in a franevork where agente have forvard-losking expectations there 1s no reason why the equ{Ltbrius unified exchange rate will be equal to the parallel rate 4m fact, 4t may well be above this rate, Consequently, recommendations on the magnitude of devaluations will urually require sophisticated prior empirical analysis? Now can we explain that an institution that was once at the forefront of ‘econoaic research has nov failed to incorporate 0 many of the Important developments in economies to ite basic operational aodel7”* I believe that there are a number of explanations, sove internal to che Fund and others ‘external to 4t, I will concentrate, hovever, on some of the internal factors. think that the ¢ have # lot to do wich the evolving role of the Research Departuent within the Fund Late 1950s to the Late 1970s the Research Department, under the leadership of During the 20 years going from the J.J. Polak, played a key role within the Fund, both by providing intellectual Leadership and by participating actively in mission vork, Menbers of the Research Departuent not only developed original theoretical vork that left an Amprint in the profes ion, but also had an enoracus impact on the vay the rations staff absorbed new ideas ant techniques, It {2 intert eng to 5: 22h should be noticed, however, that more recently, and partially as a consequence of the debt crisis, « large number of the adjustaent prograns include sone kind of exchange rate managenent. 2 op course, im aany countries the required data for the ideal type, of statistical work will be sissing, Still the insights of these godels should bbe kept in aind vhen making use of vhazever date are available 241m the 1950s and 1960s « munber of important theoretical developaents in international economics originated at the Find. These include the absorption approach (Alexander 1952), che theory of forvard markets (Tstang 1959), the theory of floating exchange rates (Fleming 1962), the policy sigaaent problea (Mundell 1961) and che sonetary approach (Polak 1957)8 what Polak hinself has ¢o say about the early role of the Re within the Fund: (Slontor officers of the Research Departaent had by far the most contact with the Board, with sanageaent and vith other departments, ‘They were therefore better Inforsed on the {esues that required Policy responses; they were also quite often better informed about suet that required tev research activities, In some cases policy and Research weren't all that separate «+ xrch Department (Polak 1988, p. 2) [Although not Lacking in arrogance, the folloving stateaent by Polak reflects fatrly accurately the relative position of the Fund in the research world: [i]e were operating at the frontier of international sconoaics. Tt vas very clear to us then, and nev I'm speaking probably about the 19608 or perhaps the 1950s, that we vere vel ahead of the universities in many of these international econonic matcers, (Polak 1988, p. 3) During the first six or seven years of the 1980s and for reasons that are not entirely clear (at least co m6), che Re Anfluence and tes force.?> Research becane 1s rch Departaent lost mich of ite related to polfey work and the revards from being attached to that dapartaent were reduced. Ae & earch and other depart. consequence of this reduced interaction between ments, fever of the nev {deas developed during this period vere actually incorporated into the operational thinking of the Fund. While during thes years people in research continued to do high quality work that found its way ‘to soae of che top professional journile, these nev ideas, models and developaents were not incorporated into the operational thinking of the staff. What makes this particularly tragic {+ thet these years correspond to « period where macrosconoate thinking vent through revolutionary changes Te should be noticed, hovever, that during these years other departaents, ost notably, Fiscal Affairs, did continue to generate taportant work that indeed bad some impact on the way adjastment programs vere designed. Of particular taportance here are the studies on underground econoates, the reformulation of fiscal accounting under indexed domestic cebt (Blejer and chu 1988), and che incorporation of the tax collection lag (the Tanzi effect) inte the study of highly inflationary cases. Since M. Cand wus becane Managing *5re should be noted that other authors date the decline of the Research Department's role before this 1980. See, for exanple, Mundell's (1969) fascinating article.w Director and J, Frenkel took over the post of Director of Research, that department has experienced a clear revival, where new and taportant ideas on 1 buy-back schenes have been developed, Also, nev econometric models explicitly incor- Assues such a8 policy coordination, contingent financing and dé porating rational expectations are being designed in the research departaent. Te te too and other developments will sely to say, however, vhetter the eventually make their way to the operational thinking of che Fund. TIT. The Effectiveness of Fund Proscuma A muaber of papers, books and pasphlets have analyzed vhether Fund prograas have "worked", This Literature 1s of uneven quality, going from wp to tous empirical studies to sheer propaganda. Not surprisingly perhaps now there is no clearcut answer to this question. Part of the reason, of ta that the question iteelf 1s extremely difficult, and that in order to answer it ve have to clearly define vhat {2 neant by a “successful* program (utthén (1981) has proposed three alternative criteria for evaluating Fund prograne, The firet, vhich he calle the positive criterion, 1s based on 4a before-and-after approach. For # particular country the value of key nacrosconomic variables before and after the program are coupered to determine the progran’s degree of effectiveness, Although thie approach 12 easy to taplenent, it haa a munber of methodological shortcomings, including the fact that the conditions prevailing before che prograa usually are unsustainable. ‘The second criterion, called by Gutttin normative, compares the value of the progran’s targets to {ts observed outcones. In a vay, th{s approach compares the actual behavior of the economy to some ideal behavior. Hovever, tt also has some Limitations, including the fact that many tines programs’ goals fail to be met due to external shocks, The third criterion is vhat Guitian called sontectural and consists of comparing the prograns’ outcomes vith the possible ‘outcome of an alternative policy package that, in principle, would have achieved a similar degree of adjustaent, Although thts approach 12 close to the ideal yardetick of coaparison it 1s very difficult to aplenent; defining the alternative program and what te meant by a Tattler degrt of adjustaent” can be highly controversial. ”6 26.1 1tanson (1983) has proposed an alternative criterion on these Lines See also Mundell (1969)» Mose of the empirical studies have been based on one of the fire two criteria; in fact the majority has efther coupared the behavior of key macro- vardabl fore and after a program or have compared program wiehin a country countries vith « control group of no-frogran countries.27 The purpose of this section ts twofold. First, I briefly review the nost important empirical studies on the effectiveness of Fund prograns. Second, I analyze the recent record with condittonality. I do this by investigating how « number of upper eredit-tranche prograns approved in 1983 have fared, HII-1 Gross-Country Enpirieal Studies In this subsection I briefly review « number of cross-country empirical studies on che effectiveness of Fund srograne.?® Many of these vorks have been undertaken at the Fund {tself, Undoubtedly, given the confidentiality of ‘most (or all) of the relevant information, the Fund staff have a considerable advantage in performing this re The Literature on cross-country experiences with the Fund's prograns can be classified into three broad groupe. The first consists of studies based on a "before* and "after” methodology. Kany of these studies have used nonpars. metric statistical methods to evaluate whether there Le « significant change in these vartables through time, To ay knovledge this method vas first used for internal program evaluations within the Fund and the first published version of ir is Refchnan and Stillsor (1978). In thts article 79 upp tranche programs ‘aplenented between 1963 and 1972 are anelyzeé.2° The authors class{fied the programs in tve groups: The first includes tho: prograas that called for restraint in credit creation and the second group *TaLthough most of these studtes have been highly informative they suffer from a number of methodological probleas. See Goldstein and Montiel (1986) 78see WilLiancon (1983) for a musber of interesting country specific studies. See SELA (1986) for recent latin American episodes. *tkesel (1983, p. 53) {llustrated the difficulties associated vith evaluating Find programs by stating that: "Since IMF-standby agreements are Secret... hov { {¢ possible for an aiteiéer to evaluate then 1?" 2, 'an upper tranche program 1s a program that includes condittonal ity clauses. First credit eranche programs, on the other hand, only require that the country "demonstrates" reasonable efforts to overcome balance of payaente ateftculcies. Performance criteria (conéitionelity) are not used in first ‘tranche progransn includes those programs that did not specify « deceleration of domestic credit creation, They used Mann-hitney U-teste to compare the values of the domes tie credit policy variables as well as of some of the aost ‘mportant targets (net foreign assets, prices, and level of economic activity) before and after che prograns, The authors conclude that, overall, 76 percent of the programs ‘succeeded and that 9¥ of the programs failed due to exogenous forces. with respect to the balance of paynents they found that in 268 of the cases there vas an improvement after the prograns shile in 176 there was no significant change Since Reichaan and Stillaon'a ploneering article the before-and-after methodology has been applied by # nuaber of authors to different periods and spect of IMF programs. Connors (1979) looked at 31 programs implenented between 1973 and 1979, Kelly (1982) focused on fiscal intermediate targets and suppleaented the before and after approach with regression analysis, Not too surprisingly, she found that those countries chat met the fiscal target exhibited a greater probability of achleving the current account target: KiLLick (1984) focused on 38 programs between 1974-79; Zulu and Nsoull (1985) restricted their analysis to Africa, vile Pastor (1987a,b) concentrated on fare sonevbat mixed: broadly Latin America. The results from these atudie peaking, they indicate that in over one half of the programs the external accounts either improved or remained unaffected. In teras of inflation the prograns were less successful, and vith respect to grovth even Less #0. 1m an atteapt to overcome some of the Limitations of the "before" and tafter* approach, in the late 19708 the Fund started to implement studi based on the "control group methodology. Here the behavior of the key varlables in the program countries are compared to their behavior {n non- progran countries. Donovan (1981, 1982) used all non-of] developing countries ‘a5 the control group and focused on the period 1970-80, His results were strongly aupportive of Fund prograns. He found that the balance of payments land current accounts improved in the program countries in relation to the control group; exports grev faster ané-inflation vas lover in the program countries. With respect to output the results vere mixed, indicating that there vere wide variations across countries and time. In a highly eritical study Pastor (1987a,b) also used the control group technique to analyze the effectiveness of Fund programe in 18 Latin American countries between 1965-81 He found some improvement in the external accounts of the program countries,2 particularly in the overall balance of payzents. He also found that inflation tneres J to be 1d significantly in progran countries vhlle growth aid not app affected by the prograne themselves. Pastor also adéed income distribution indicators to the traditional List of etcroecont ite variables analyzed by al ‘most every other study, and found chat those Fund prograns had been associated wich significant worsening in the labor share of income. Gylfason (1987) also lused the control group technique to analyze the effects of programe undertaken tn 32 counertes between 1977 and 1978. Mis control group was forned by count: ries vith paynente difficulties that did not have a Fund progran. He conclu- ded that the programs were successful regarding balance of payzents improve- ents. He also found chat in the progres countries’ group the inflation rate was kept below that of the control group and that, although output growth experienced some decline, this was not significant. *> Im an important paper Goldstein and Montiel (1986) criticized the control group methodology. They shoved that by Sgnoring the initial conditions th lectivity bis suggest the use of a *aodified control group” procedure consisting of regres- studies vere subject to 4 sample As an alternative they stons that correct for the differences in initial conditions and in policies undertaken in program ané non-progras countries. They apply this nev approach co a data set of 58 countries during 1574-81, Although they consider their findings preliminary, the results show that the Fund's programs have no significant effects (efther positive or negative) on any of the target vari- ables. More recently Khan (1988) has epplied the modified control group technique to a very large sasple containing 67 countries during 1973-86. In nis analysis he focuses on the one year effects of prograns and found that, on average, the prograns have retulted in a positive (though non-significant) effect on the balance of paynents, ins significantly positive effect on the current account, in « statistically nor-significant reduction in inflation and tn a significant reduction in the rate of output growth, The third group of studies focuses on the relation betveen the programs’ che normative approach. This criterion {s useful in assesring the validity of the targets and the actual outcomes, This corresponds to what Gufttan call: 311m section ¥, T present regression results on the effects of devaluation and fiscal policies on output. The Appendix contains « model that, investigates these Lasuesfrequent criticise that IMF programs sot unrealistic targets. In fact, Jeffrey Sachs (1988) has recently argud that thls approach provides the most lureful yardstick to measuring programs’ effectiveness. Reichaan and Stillson (1978) found that 65.48 of the programs of their sample that specified domestic credit deceleration sctually achieved 1¢; they also found that in 72.28 of tho programs the rate of grovth of credit to the public sector ws also reduced. wveridge and Kelly (1980) focused on the fiscal aide of prograns arranged during 1969-76 and found that the overall fiscal deficit cargete were met only in 48 percent of the cases To sumarize, the existing empirical evidence indicates that vhen compared with the years prior to the program or vith a control group IMF prograns have resulted, on average, in: (1) an improvenent of the balance of payments eituatior (2) a alight -- although not nacessartly eignificant -- reduction in infla- (2) an improvenent in the current account balance: tion; and (4) # short run reduction in output groveh.°? It 4s important to stress, hovever, chat these finding have not been based on the ideal compart son criterion that would compare program outcoues to those of an alternative “counterfactual” program. In fact, the design of more adequate comparison frameworks As one of the most taportant areas for future vork on the evaluation of the Fund programs, Hovever, as Khan (1988) has pointed out, the aleetoultios of this task should not be underestimated, 111.2 Recent Exgecience With Conditionslicy ‘The your 1963 markad the beginning of the IMF involvenent with the debe problem, That year 34 upper-tranche programs involving conditionality (stand- by and EFF programs) vere arranged. In the vast majority of cases the programs involved countries seriously affected by the debe crisis. In this subsection I review the experiences of che 34 programs, concentrating on the prograns’ contents and on the relation between targets and actual outcones, emphasizing the evolution of three final targete: the current account, 32r5 some extent these findings reflect the Fund's traditional priorities; che main objective of Fund programs 1s to improve the country’s Sxcernal accounts. Fund critics from the Third World have often argued thet the Fund pursues these objectives even at the expense of provoking declines in output. See, for example, SELA (1986).En Anflation, and ouput groven.?? Table 1 contains @ ltat of the countries that had upper-tranche prograns arranged in 1983, In 1982 all of these countries faced severe external fabelances, with the average ratio of current account deftett to GHP amounting to more than 10 percent. Moreover, the vast majority of thea faced sertous debt problems; 8 of these countries -- Argentina, Brazil, chile, Eouador, Mexico, Morocco, Phtltpptnes and Uruguay -- are included in the IAP Let of the 15 highly Indebeed countri Im accordance with the Articles of Agreement the prograns sought an adjustment that vould generate balance of payuents viability. Given the slobal nacure of the probles and contrary to the historical experience, these programs could not rely on increased private capital inflove in order to achieve viability. Consequently in all cases rapid and significant current ‘Account turnarounds were sought. For the aanple as a whole the prograns targeted a reduction of the current account deficit froa 10,2 percent of COP in 1982 to 7.1 percent of GDP in 1983, end to 6 percent of GDP in 1984. Of course, for the individual countries the targets varied quite dramatically, ‘The programs also set inflation and output grovth targets. The programs sought to achieve their objectives by # combination of well as by the sntation of structural reforms alsed at increasing the overall expenditure reducing and expenditure avitching policies tmple efftctency of the econontes, Table 2 contains a broad description of the Policy content of these prograas. As cen be seen, sluost every program contained credit ceilings and « devaluatton component. This contrasts sharply with previous Funé programs. According to Reichman and St{llson (1978) only about one half of the upper credit tranche programs arranged betveen 1963 and 1972 contained credit ceflings as performance criteria and one third of the the purpose of this subsection, then, ts not to provide an ideal evaluation of recent Fund prograns. its nore modest objective ie to provide « description of debt-related the program's contents, and to compere targets to actual outcomes, and to follow the evolution of the targets through tise Consequently, these daca should be {ntecpreted with sane caution, since they fare subject {o somo of the limitations associated with the "before” and "after" methodology discussed above. Mr am grateful to Mr. Arizal{ Mohamed for alloving me to use these daca, vaich have not been released to outside analyste until nov. Date referring to specific country programs renain confidential25 TABLE 1 IMF Conditionaltty Prograas Approved in 1983” Soucy Argentina Bangladesh Brazil Central African Republic chile Dominican Republic Eeundor Ghana, Custenale Hates Kenya Korea Liberte Malawi Malt Maurtesue Mexico Noroceo Niger Panana Philippines Portugel Senegal Solomon Islands Sri Lanka Sudan Tog Tutkey Uganda Uruguay Western Sanoa Zaire Zambia Ziababve “*mese are countries that had upper credit tranche prograns -- either standby or EFF -- arranged in 1983. A number of these countries had ‘Programs prior to 1982, and sone aiso had programs approved after 1983 Source: IMF annual Reports.26 prograns included devaluation component. On the other hand, according to Loser (1984) 50 percent of the upper tranche prograns arranged during 1977-80 included a devaluation component? yen from Table 2, in the 1983 programs the traditional fiscal, ‘monetary and exchange rate measures were supplemented by a battery of other including measures geared tovrds reducing the extent of indexation ‘As can be poltet and mleroeconoaic erfented policies. Notice that in only about one half of the cates structural reforms -- that {2 trade or financial Liberalization ~~ were contenplated.° Moreover, in a number of ei the Fund prograns have called for « hike in trade taxes as a wey to strengthen the flscal side and reduce the fiscal tnbalance How well did the 1963 programe fare? Table 3 contatns data on the evolution of three key final targets -- the current account, inflation and ourput growth, As can be sosevhat while inflation increased quite significantly. With respect to out~ yen, on average, the current account improved put growth, after a steep reduction in 1983, there was a snail improvement in 1984 and 1985, However, as mentioned above, before-and-after type of compart pot fully satisfactory. This 1a particularly true for the debe eriele pertod, during which, given the sudden halt {n capital inflove, these countries had no alternative but to engineer « rapid current account turn- around. In fact, countries chat did not have Fund programe also experienced aJor current account Saproveaents. ‘An Informative exercise consists of comparing targets and outcomes. As etscussed above, the comparison of intermediate targets -- many of which are actually performance eriterta -- and the actual behavior of the policy vari- au provides {aportant elements to evaluate conditfonality, Table 4 coupares the compliance percentage of three key policy variables -- the ratio of government defictt to GDP, the rave of grovth of domestic credit and the ctor. As can be seen these rate of grovth of domestic credit to the public debt-related variables experienced a fairly low rate of compliance. This 4s te ts smportant to noce that in aany cases devaluations are part of the so-called pricr-actions, of measures the country has to undertake before the progran Ls approved. 3Stnis contrasts with the structural adjustaent prograse of the Vorlé Bank which have contained trade liberalization conditions in the majority of casesTAME 2 Policy Content of High-Condi:tonality Programs: 1963-1985 Cam percent) Percent of Programs to Mich Bolicy Anplies (out of 34 Progress) A. EISGAL pouicy ‘A. Control of Public Exmendicures + Current Expenditures 1% S (Public Sector Wages) may © (Gubstdtes) (aay + Invertnent Expenditures eo A? Revenues + Enlarging Tax Base so 1 ligher Tax Raves 7% Ad Public Enterprises + Prteing Reform A 1 xdminieeracive Reforae a 1 General Reform 38 3. MONETARY poLicy + control of Money and Credit Aggregates 97 1 control of Credit to Governaent and Public Sector 100 1 dike in Interest Rates 7% + Devaluation rt + Wage indexation 4 1 Pricing Rationalization 2 ‘ Agjustaent of Producer Prices 38 (continued)2 Percent of Prograns to Which Rolicy Ampiies (out of 34 Programe) 2. DEBE MANAGE + Rascheduling 36 + Coordinated Financing 38 + Regularization of Arrears! 2 F. TRADE REFORY + Tarift Liberalization 35 + Relaxing Exchange Restrictions a ©, EIMANGIAL secToR poLicy + Financial Liberaltzatton 4 TAK proms + Tax Reform 39 “Programs that 41 not include exchange rate component corresponded to those with ingeitucional constraints, suchas belonging to « sonstary union oF not having a national currency, Yall countries vith arrears are included here, Source: IH.curzeos Account, Inftesten and Grovth for she 1989 Progtane i te it it iss fvacase Median Averase Median Acarase Median Avazage Median avarase Yedien feseent/ Source: ow Gonpitance With Cond:tLonal ity percentage of couneetes that comply) am a a 1. Goverment DetteLe £0 oD? 30.3843. 3820 “particularly the case for the defete carget, hich in no year reached « 50 percent rate of compltanc Te te interesting to compare the rate of compliance of fiscal targets in 1983-85 to those obtained in the past. Beveridge and Kelly (1980), for example, report that in 48 percent of upper credit tranches programs inple- ented between 1969-78 the target of overall flacal deficit as percent of GDP was achieved, This figure 4s higher than that for 1963-85 reported in Table 4, There are a muber of pot ble explanations for this difference in the ate of success of the programs. First, « large susber of program countries were affected by negative terms of trate shocks in 1983-85, vhich made che achievezent of the targete more difftcslt then anttetpated.*” A second possible explanation for the poor recent rate of achlevenent of intermediate targets 1 related with the debt crisis. There is « wide agreement nov that for the highly Under the current situation of debe overhang, while the costs the debt crisis has introduced « serious incentive probl indebted LDC of the adjustment are fully borne by the highly indebted country, ite benefits jort) fully received by the creditors in the form of higher debt repayment. °° Naturally, under these ctrounstances the program im the short run are (al counted have Little incentive to comply with conéitionality, In this context 4t may be argued that many recent Fund prograns have failed to recognize that under thie type of incentive problem a revised type of conditionality {s called for. In Section IV below I dtacuss in sone detatl tthe Fund's strategy with respect to the debe erists [A serious consequence of the Lov rate of compliance has been that in the recent years there has been a significant Increase in the munber of prograns thet have been interrupted, as well at in the number of waivers approved by the Fund, ‘Table 5 contatns {nformation on the percentage of final targets that have been achieved in the perfod 1963-85, These results indicate that programs of Latin Anerican countries, for example, the depressed terme of trade persisted for a mich Lenger tine than expected. Also, the industrial economies aié not recover as fast or az strongly as originally expected by the authorities and the Find staff 38rye extatence of this type of incentive probles has been recognized by a very large nunber of participants in the debate. See, for example, Corden (2988), Sachs (1986), Krugaan (1988).” TABLE 5 Conditionality and Program Results Percent of Countries That Met or Exceeded Progean’s Target® 20mg gee 1885. 1. Current Account Target 58 32 50 2. Inflation Target 48 a 36 3, Groweh Target cry 39 32 *me musber of countries included are 27 in 1983 and 1984 and 22 in 1985. Source: International Monetary Fund.2 have recently been less successful than in the past, In relative terms, the current account target vas net more frequently than the inflation targets, and 4m turn, vere met gore often than the grovth targets 1 of the debt crisis the Fund played # crucial role in Leading the efforts to coordinate the actions of private banks, creditor sovernments, and debtors, It is not an exaggeration to say that the Fund was Anserumental in avoiding generalized default that vould have resulted in « ‘aajor collapse of the international financial eyates, Even some of the ardent critics of the IMF have praised ite role during this early period, For example, in an othervise highly critical document the Group of 24 (1987) recognizes that "(t]he Fund played an important role at the tine of the Gabe crisis in 1982 mot only by organizing financial support for countess with debt servicing problens, bur also by Sncreasing its own lending” (p. 35) The purpose of this section is to briefly analyze the Fund's strategy coverds the debe crisis, Due co space Linitations I concentrate on some political- econoay aspects of this strategy vhich I think are particularly relevant. important 1 between structural reforas and sacro-atabilization, the sequencing of Liberal- Consequently I don't deal vith sot such as the relation Seation, devaluation and global adjustment, and the need for symetry in ‘resting deficit and surplus countries 2? By and large since 1982-83 the IMP hi approach regarding the debt crisis the © Adjustaent in the debtor countries, rescheduling agreements vith the banks and aintained @ very consletent The corneretone of the Fund's position is -by-ease approach, and the belief that « combination of sacroecononie free-market ortented structural reforas in the LDCs will, in most ca: follow the "right" policies, the approach goes, they vill get fresh monies and vill be able to "effictent- suffice to solve the crisis, If the countrie Ay" grow out of the crisis via export expansion. In fact, in the early years of the crisis, once « country reached an agreement with the INF, the banks cheduling. At time has passed the Fund has endorsed additional measures, including the use of secondary markets, and be vould move in, providing funds or agreeing to some form of ri encouraged concessional aid by the industrial °°1 have dealt with some of these issues elsevhere (see Eévards 1968)2 countries. Needless to say the Fund hat opposed the granting of generalized debe forgiveness.“ This, at least, has been the offictal position of the snacteutton In early 1963 the Fund staff, Like wost observers, sav the crisis cenporary Liquidity problea only affecting # handful of countries. In fact during 1963 and 1984 the Fund had high expectations for # quick and relatively patnlese resolution of the problem. As part of the adjustment effort in 1983 the Fund arranged a record nunber of upper credit tranche prograns, and the use of its resources increased significantly.“ The Fund's optintstic view vas clearly reflected in the 1984 issue of the Horld Economic Outlook. Thar report included highly optimtetic projections of the main debt-related indicators, predicting « steady decline of the debe export ratio until 1990. ‘Things, hovever, did not work ax expected and in the folloving years the Fund cane to recognize that it had badly underestimated the magnitude of the prob- les. In fact, in the 1986 Yorld Econoaic Outlook the staff expresses surprii at the lack of progress attained in spite of the aajer current account adjustments that had taken place, Starting in 1985 the Fund emphasized sore and aore the importance of structural reforas in solving the eriets, and from 1986 onwards the Fund has strongly endorsed the Baker plan calling for free market oriented polict 's precondition for providing nev monies to the ighly indebted couneries, Pechape the main Lieitation of the Fund’ ertete te that Se be approach tovards the debe Eatled to recognize, in practice, that the nature of the changed, The crisis h and has, for aoat debtor countries cortets bs ceased to be a global financtal problex ‘become developaent problem. With the world financial system no longer at risk, one of the aost urgent outstanding Issues is to work out packages that vould permit the developing countries to “yocice, however, that the BolLvian buyback vas supported by the Fund im fact, the trust account used for this operation was set at the Fund, 1 have deliberately used the vord “forgiveness” and not "relief". There is sore Gtscuseion on what debe "relief" exactly means. Some authors have argued that ve have already seen a significant anowt of rellef. “since mid-1984, hovever, the use of Fund resources has declined steadily, Today the Fund 1s a net recipient of capital from che LDCs Moreover, a fairly large number of countries have been building arrears vith the Fund.Ea recover and grov.'? For a large -- indeed a very large -- number of countrte the debe problem Ls not one of temporary liquidity. Tt is a deep structural problen that should be treated at such. In many cases, by approving standby prograas whos ‘targets everyone knove will not be met, the INF is partictpat- ing in a big charade; it 1s impltetely saying that, according to the Articles: sf Agreement, the resources have been provided on a Saapersty basis, and th As a high probability chat che country will attain balance of payments viability in che near future. For sary countries this {2 net the case, and everybody knows it. The Lesue, of course, 1s not whether these countries should undertake reforns and prudent mucrosconoafe policies -- they certainly should will suffice for solving the criats not participated in chis delusion willingly. In many cases ite parctetpation was the result of political decisions made by the largest. jexbers, in particular by the United State: For political x Atetated by geopolitical or ether considerations -- end Fequest (force?) the Fund co approve unrealistic prograns for Egypt, che Su: dan, Nicaragua, Argentina and Brazil. Vhat he happened is that concessionary development funds have been given through che IMP. Of course, there {s per se nothing wrong with providing ald. Quice the contrary, given these countries positions, aid is a good step. What {# questionable {s the wisdoa of using Etnancial institution such as che Fund for chis purpose, David Pinch, the former director of the Exchange and Trade Restrictions (BTR) departuent at the Fund bi He rightly points out chat che Rind, by approving programs that evezyene knows fare destined to fatl, will not only lore credibility but also will see {ts om strongly argued ageinse the use of the Fund for political purpo Fesources imperiled, in che not 20 unlikely event that some of these countries uleinately default on the Fund. He asks politicians that they “Let the THF be che mip, *43 Of course, it 14 naive co ask that the large meabers don't try to influence IMF policy in ways that favor their global ince ea; a Le would be “through the combination of reduced exposure to highly indebted countries and an increase in provisions for bad LDC loans, che vast majority of the major banks are nov in'a fairly solid position “pinch (1988a,b,¢)35 chat reduce ics om pover.‘* re ts not clear, hovever, whether the long term interests of the major countries are indeed enhanced by these policies. Vay do they risk damaging the Fund in eis process? These are difficult questions and I don’t have full anavers to he naive to ask the staff not co oppose mexsure (One can speculate, hovever, that this is at least partially motivated by a desire co salvage the Baker plan.‘? Nevertheless, more and more observers are nov arguing that in sany countries structural reform and aacro adjustaent are not enough to get out of the current debt trap (Sach (1988) V. The International Monetary Fund and Some Devaluation Controversies Undoubtedly, devaluations constitue one of che most controversial components of Fund's programs. They are not only vehemently resisted by the 10Ce authorities, but they have also been severely criticized by a nunber of observers. Ariel Bulra, a former Executive Director for Mexico, 12 one of the most respected Third Worlé critics of the Fund, In many vays his views are shared by a wide group of aconoaiste in the developing world, Te is eéuc- ational, then, to cite at some length from Butra (1983). With respect to the incorporation of devalustions in the set of Fund's policy tools Butra says: Devaluation vas introduced a2 an ad hoc measure to financial programs... [I]nstead of developing an analytical framework Gevaluation vas often requested az a prior action ... Thus, che existing finenctal techniques could be applied vithout any modifteations: (p. 122) Fundasencelly, he questioned the supposedly beneficial effects of devaluation [A questionable assumption underlying aany Fund-oriented Gevaluations is the belief in the rxietence of a positive correlation betveen devaluation ani output based on an implicit Nelasciciey optiatea" ‘The view of a general positive relattonchip between devaluation and output Ls questionable on theoretical grounds: (pp. 126-125) “4500 Vaubel (1986) for an interesting analysis of international organizations vithin the framework of the public choice theory. “Satcer this paper vas presented a: the Carnegie-Rochester Conference there have been some indications that the nev Bush adainistration vould be willing to revise the Baker plan36 ‘The purpose of this section {¢ to investigate empirically two controver- sial aspects of devaluations within the context of Fund programs: che relation between devaluation and outpu: -- the so-called contractionary deval- uation issue -- and the relation between devaluations and income distribution WL Deve [Although the theoretical possibility of devaluations being contractionsry hhas boon recognized by « nuaber of autvore, here har been very lintted expirical work related to this tsaue.“? In chis section I present empirical results dealing with the contractionary devaluation issue, The analysis ts based on a minimal model of a country that produces three goods Amport- ables, exportables and nontradables -- and uses {nported inputs in the production of the nontradables. The model, presented in detail in che ‘@ Include the results of Cooper (1971b) Krugman and Taylor (1978), Hanson (1983) and Branson (1986) as spectal case The following equation based on the model in the Appendix is the basis of the eattnatton: ” Appendix, is suffletently general Log 6, — YTIME + 284, Hey + Wyy 10B TOT, « + Figg os OCODP,. Fy Loe Beg Huy aay 1 GDP; H Ae "noney"; TOT ts terns of tra voere g, ter ccanr te the ratio of governaent consumption over GDP; E is che nominal exchange rate and ue the error tem, “Sxodern theoretical discussions on contractionary devaluation go back st Least to Hirachnan (1949) and Diaz Alejandro (1965). Cooper (1971a,5) provided iaportant empirical evidence in his cross country studies. More Fecently Krugean ané Taylor (1978), Gylfason and Schald (1983), van Wijrbergen (1986), "Bufete (1984), Branson (1986) and Larrain and Sachs (1986) have provided further theoerical refineserts. Empirical studies based on the Spefore" and “after” approach include Cooper (1971b) and Krueger (1978) Gylfason and Schaté (1983), Cylfason and Risager (1984), and Branson (1986) presented results based on simulation analyses. Edwards (1986) provides one Of the very fev regression analyses. “Tris equation differs fron the reduced form in an Appendix avetlable from the author:3” In the estimation of equation (14), three alternative concepts for the monetary variable were used. First, as indicated by the model, actual chang {in the log of noatnal money -- which were denoted by all, , -- were included. Second, equation (14) also incorporated the role of monetary innovations (5,). And third, changes in domestic credit vere algo included. The most plausible assumptions regerding the effects of terms of trade (TOT) changes on ouepu indicate thet 2, should be positive. On the ether hand, the coefficients Ay, odel it 1s expected chat they will be positive. However, the main interest of thls analysis 11 If devaluations are contractionary as suggested by the IMF oritie: sasure the role of fiscal policy and according to the in the coeffictents of the exchange rate -- the A,s sete expected that their sum vill be significantly negative, Tf, howaver, davalua. tlons are expansive as suggested by the nore traditional theories, the sun of the pis will be positive. Finally, {€ output 1s independent of exchange rate, monetary and fiscal policies, as suggested by the Fund basic model in ‘equations (1) through (11), the ‘8 would not be significantly different from zero, Te As possible, hovever, co have « short run effect that goes in fone direction and a long run effect chat goes {n the opposite direction, For this reason {n equation (14) # number of lage have been incorporated Equation (14) vas estimated using pooled data for 12 developing countries s+ India, Malaysia, Philippines, Sri Lanks, Thailand, Greece, Tarael, Brazil, Colombia, El Salvador, South Africa and Yugoslavia, These countries were chosen because of Gata availability: they were the only developing countries ‘hat had long enough time series for all the variables of interest (Elscal deficits and corms of crade are the most difficult data to obtain). The tice period covers 1965 through 1984 for most countries, ALL of th have experienced important real exchange rate changes ({.e., real devaluations countries and apprectations) during che period under consideration, and all but EL Selvador had also gone through episodes of major nominal devaluations, Many of the have also been subject co Fund prograns during the period. The List of the upper-tranche Funé programs of ie sample countries and the exact definition and sources of the data are slso given in the Appendix Before estimating the versions of hese equations that include monetary “Innovations, Lt is necessary to find adequate tine series for the unexpected money cerm HS, As in a muaber of other studies, this unexpected money grovth term {x constructed, for each individual country, by taking the differencesa between actual money grovth and the estis eed rate of grovth of monay obtained from a noney er: scion equation. In a large number of developing countries the printing of money {s an inportant source of fiscal deficit financing (Edwards 1983). Consequently, in the money ers scion equations ured in this study the ratio of the fiscal deficit scaled by lagged high-powered acney ws used explanatory variable. Adéittonally the equation included lagged values of atog 4% che x gure that they were white noise, and consequently qualified as proxies for In all cas {duals were closely exasined in order to make aoney surprises in the estination of the real output grovth equations In the estination of equation (10) the 7 coefficient was alloved to Alffer across countries, In this way the differences in trend growth of real output across countries {# accounted for, Also, country dumay variables that capture those elements that a apectfic to each country, such as country Although fone of che coufficients are not significant at conventional levels, these results provide aize, were included.“ Table 6 contains the results support te the view that devaluations have at least « short-run contractionary effect on reel output. In both equations the coefficient of the contemporan ous exchange rate variable is significantly negative. Moreover, tes magnitude te quite large, indicating thet with ether things given, devaluations in these countries have exerted important short term negative pressur% fon real output “Sror each individual country, the folloving money creation equation was sctnated! Ting'H, = 4, + 4, Slog He + ay Slog, vara at "hs ottalgtaetibed® (ha) Sletnal abi ion ant ge Ga acebtan telve corny EARN In 10 of thé 12 cas 4 ay slog Hey + a, EH, + Jen, ts"the steal dettEte 12 che Fits were quite good, ‘the coofficlents of the fiscal deficit tera DEH,” are positive as expected, Hovever, in only four carer ~- Greece, Israel, Brazil nd Colosbia -- this coefficient ix significant at conventional levels. The Spproach folloved here has well-known shortcomings, including che fact that by sing date on all the sample to generate the money creation equation parateters too mich information ir belng considered (Barro, 1977). In the present cese, hovever, che Lack of loag enough data series makes the use of Polling regresrions of sinilar procedires iaposrible, Az in much of this Literature, the equations reported hece are subject to the problens stening from using generated regressors (see Pagan (1964, 1986)) “sence the muaber of time series observations vere not the sane for each ‘country, {t war not possible co estimite these equations using « random coefficient procedure. However, when sone observations vere dropped and the Puller-Batesse (1914) procedure vas used, results Very sintlar to those reported here vere obtained.» 06.2 0.153 6:73) 0,008 cola) 0,033 calor 0.024 (01375) on 36) 0.1% «2is7) 0.200 138) 0.016 (0.420) -0,007 0'349) -0.026 11363) 230 0.053 TABLE 6 evaluations and Real GOP (ois) i" tog & 6.199 i019) 6.019 (0-445) 0.032 (0.399) 0,086 687) a, 0.021 = (01353) ae 0.092 : 825) Xs, : MS. : 5,9 . tog ToT, 0.103 (3.340) og TOT, 0.019 (01587) og ccoor, 2.010 cUs27) Log GeopP,., 7.029 cLsa7 x 230 Root MSE. 0.044 ® 0.99 These equations were estinated using OLS. The musber in parentheses are e-statisties, Root MSE {s the Toot gean square error cquations vere estimated using « fixed effect procedure here country specific dunay variables were included.“0 With respect to the long run effects of develuations on real output, it is not possible to reject the hypothesis tha: the sun of the exchange rate coeffic- tents ts zero, This suggests that alshough devaluations have a negative impact effect on output, they are neural in the long run. Regarding the other variables the results are also quite revealing. Algost all the coefficients of the change of actual money in (14.1) turned out fe be nonsignificant at conventionsl Levels and at least ont of the coeffict- ents of the monetary surprises were significantly positive at conventional levels im (16.2), The teras of trade coefficients are significantly positive fand quite Large, This indicates chat a teras of trade deterioration will result in a reduction of real GDP relative co its trend. It should be noted ‘hat when actual money grovth vas replaced by growth in domestic credit their coefficients turned out to be non-significant: the coefficients of che exchange rate, hovever, did not change in eny significant vay Most discussions on contractionary devalustions, including the model developed in the Appendix, do not specify vhat are the alternatives to evaluations in conditions of disequilibrium. In reality, hovever, vhen faced with adverse externsl sector conditions economic authorities face the dectston of whether to devalue or to implenent other policies. As is shown in Edvards (1989), in most historical episodes the developing nations have resisted Gevaluation and have instead imposed exchange and trade controls. Moreover, wsany of the critics of the Fund have argued thet trade restrictions could be key components of alternative adjustaene packages. An important issue, then, is vhecher ene Policies considered to be alternatives to develustions, have also had negative effects on real outyut, In principle, the aodel in the Appendix can be easily amended to incorporate (some) real output effects of ‘rade controls. In fact, in chat model tariffs on iaported intersedtate inputs vill have a contractionary effect atmilar to that generated by a devaluation. Moreover, in more complete aodels distortions will generally Ihave their own negative consequences en output.2? In order to test the hypoth 8 that increased trade {npedinents, ‘exchange controls and other variables negatively affect real output, equation *rmis is a much more controversial statement chan vhat it may eppear at first. In fact, it 1s not that easy to generate thet hind of Tesule with standard neoclassical equilibriun growth aodels. The probles, of course, relates to the difference between levels and rates of grovth. See Luc casesa (1A) was revestinated adding # Tcatchell™ proxy for the level of distortions tn an open econoay. In Edvards (1989) I have argued that the prenfun in the black market for foreign exchange (BMPR) {2 a good proxy for these distor tons. Estimation using instrumental verlables yielded the following results 10g Yq ~ -0-212 Log E, - 0.056 log B,_, + 0.107 tog E> Re (6°295) (1.080) 2538) 0.195 BMPR, + 0.105 AH, - 0.045 AH, + 0.012 aH» 3.352) 9s) Coy 2353) + 0,073 10g TOF, + 9.001 tog TOT,» + 0.003 Log GcoDP, (2/324) «0°003) couissy 0.008 tog cconr, Root MSE = 0.043, Coats) N 2 207 [As can be seen the coefficient of MPR turned out £0 be significantly negative at conventional levels, These results chen provide sose preliminary evidence supporting the {dea that increased distortions in these econoates have Bletorically resulted in declines in reel output relative to trend, Moreover, these estimates support reaulse reported in Eévards (1989) that suggest that {n a number of developing countries exchange controls are at Least partially responsible for the observed deterioration in real output before the devaluation. In sum, these findings provide sone preLininary results regarding the contractionary devaluation {asue. They shov that, contrary to the sumpeion in the Fund basic model represented by equations (1) through (21), real output does respond to changes in sone of the cst iaportant policy variables. More specifically, these results provide some support to the hypothesis chat devaluations have a shore run contractionary effect on output. Hovever, the results presented in this section go beyond the narrow question of che effects of devaluation and output, suggesting that the policies usually recommended as alternatives to devaluation and Fund-type programs also exert significant negative effects on cutput. Moreover since, contrary to devaluations, these policies usually fail to bring eround a1 (uprovesent in the external accounts, there As evidence suggesting that the exchange rate adjustzent roure {¢ a sore2 efteccive one. ¥.2 Devaluation and Income Distribution For aany years the IMF has been sritictzed for ignoring the social effects of Ate policies, In particular, s musber of authors and politicians in the Third World have rep} thelr devalussion component -- have negative effects on income distribution. 1»), has recently ecgued that, although INF policies say, and soue tines do, {aprove countries’ external positions, they do it at edly argued that Fund policies -- and espectally For example, Pastor (1987 the cost of generating poverty, For sany years the Fund did not 2+ 32 Line of eritteten.®? However, recently -- since the appointment of M. Candes the Fund has explicitly expressed concern on the distrtbuttonal aspects of its programs, arguing that in fect sua as Managing Director, I would say od progcame tend to help the poor espectelly the landless rural poor Surprisingly, perhaps, this debace has been characterized by a lack of eupizieal inquizy. Most of the dtscursion hi remained at general, and not elways ae analytical levels; there have bean vixtually no eapirical studies on the subjece.5? of deval im ths section soue 9 the income distribution rant fications \slons are Investigated for 36 devaluation epleodes that took place bowen 1960 and 1962, The analysis concentrates on labor shares In income and should be considered prelisinary; there are very Limited data on primary income distribution indicators, In fact, according to data in the World Bank Eorld Tables most of che developing countries have data on the personal Gistribucion of income for at gost two out of the last 25 years. Table 7 contains the evolution of Labor's share in GDP for the period surrounding these devaluation episodes. These figures provide sone informs: ton chat can help solve the jigsaw puzsle of the relation between Gevaluations and incose distribution, Many of these devaluations were in fact Undertaken a5 part of a Fund-supported program. The gain characteristic that Slwacurally, devaluations vill only help the adjustment if undertaken tn conjunction with demand managenent pa:kages, On these iesues see Edvarde cases) 5am exception is the paper by Johnson and Salop (1980) °sesides Johnson end Salop (1980), and Pastor (1987a,b), Blejer and Guerrero (1968) constitute an exception te this feature of the discussion43 energes from these data ie that for most countries Labor shares aove very slovly through time, making the analysis of the effects of devaluations on factoral distribution of income rather difficult. For this reason in this section I compare the average for che four years prior to the crisis with the four year average for the year of the evaluation and che three years chat follow. This comparison ts done in eve vays: first T have arbitrerily defined « significant change in the lator share as any aoveuent that exceeds, ‘either up of dovn, 1.5 percentage points. Second, T have used non-paranetric certs (x2) to anslyze vhether there bas been a statistically significant ‘change in income distributton in the years surrounding the devaluation Using the first criterion the dats from Table 7 show that in 15 out of 31 eplsodes there were no significant changes in income distribution in the period surrounding the devaluations; in 9 out of 31 cases the Labor share was reduced -- Bolivia 1972, Egypt 197%, Israel 1971, Jazeice 1967, Jansica 1978, Peru 1975, PhéLippines 1962 and 1970, and Sei Lanka 1961; and in 7 out of the 31 episodes there were significant gains in the Labor share of GDP ~ Bolivia 1979, Colosbia 1962, Egypt 1962, Indie 1966, Korea 1980, Mexico 1976, Pakistan 1972 These findings are remarkably inconclusive, indicating that, from a historical point of view, and given the avatluble {eformetion, 1¢ ts not possible to fe sweeping state snes regarding the relation between devalus- ‘elons and income distribution, Again, this analysis clearly suggests chat ‘an improvenent of our knowledge on there {aportant matters vill not only require additional analysis but, more iaportantly, che construction of appropriate data With respect to the nonperanetric tests, I compared each of che years following the devaluation chat app co the celels. hat this does 12 provide a very broad "before and after 1 in Table 7 to each of the years prior view where no aprderi commitment is aide on sny one pair of years providing the most relevent comparison, The x? obtained ranged from 0.6 to 3.0, These acatistics are dtetributed vith tvo degre consequently these tests clearly indicste chat for thes episodes ag_a group there was no significant change in incowe distributionURE 7 Devaluations and Incene Disertbucten (percentage of conpensation to enpleyees with respect te GOP) Argentine Bolivia coite colenhta, Costa Rica 1 cyproe —_ Egype ouyana india indonesia! Lerael Jamaica Konye, Year of Devalua- son 1970 40 17237 197933 198235, 198239 1962 na, 196s “36 196738 17647 196787 1961 naa. 1970 "a7 1982 28 1962 na i979 “ig 196747 196673, 17889 i962 1967 wn 16750 17854 ran 32 198032 196749 7 Er 36 26 ey 36 as 0 3 28 a n a ro 46 30 56 4 32 so a uM 3 3 38 au 38 7 48 oy 28 2 9 38 os % 9 44 a8 a 30 35 37 40 26 Fr 3 4s "7 2 28 30 a 7 a n 0 44 Py a 46 36 a 36 a Dev. Ye, pat a a ke ps a2] 3% 38 oe 376 376 a6 see 28 2 30 2 ona. awe 33k a ag nm on ap uw sous we as rs en ow 26 37 Fs a i 29 2 4 “a 1s 90 4s as 49 5 38 a “8 28 Fa a 4s 90 48 a7 aTable 2 (eons) eax Mexico 1976 1982 Mearegua 1979 Pakistan’ — 1972 i982 Peru ass Philippines! 1962 i970 Sri Lanka 1967 Venezuela 1960 ahah no OB uss a on ae my *e ato asus 4s a 7 Ea 56 85 a ” ” a6 a a 85 ae ” a a Xcoapensation to exployees + operating surplus) /CDP. Pyear beginning July 1 Source: a ” a6 8 »” United Nations, Yeasbook of National Accounts Statistics. a 2 86 8 4s46 YE. Conclusions ‘The Internacional Monatary Fund is an important institucien, Throughout che years St has played a crucial role in helping maintain an efficient international financial system and io bringing about an orderly adjustment to che world economy, In particular, the Rind’s role in coordineting the first stages of the debt crisis vas inetrutental in helping avold the collapse of the incernational financial system, In weny areas the Fund has shovn dynaisa and flexibility, adapting to new tiges and efrcunstances. However, in other areas, and in particular with respect co its ovn operational analytical frane Work, At has shown itself to be slow to change, The analysis in this pap: thas actually shown that the baste model used by the Fund for program design is basteally the sane developed by J.J. Polak 30 years ago In aany ways the TMP Ls now facing cructal period in its existence. 4 wide consensus has nov daveloped regarding the need co move co anew stage in the managezent of the debt crisis, which vould include some debt forgiveness foe sume countries. This step will probably require that all che agents involved recognize this, and that countries and banks start serious bilateral negotiation processes. It 42 still to be seen whether the IMF ufll take tn process the sane kind of Leadership 4 took in 1982-83, or if dt will scat. Crerall, the main conclusions of this study can be summarized a6 follows (0) The IMF advice, and sore specifically IMF prograas, have show FlexibiLtey ané a somewhat eclectic view of che vorld. Contrary to the most popular and simplistic critictans it ¢ not true thet the IMP has aleays imposed the seme policy package, Lrrespective of the specific charactoristics of the country, However, the generl framework used to design prograns -- the so-called financial programming -- is badly outdated, There 12 an urgent need co seriously revise chis franevork incorporating some of the most inportant developments in the theory of econonte policy that have taken place in the asc 15 years of #0, The analysis in Section II provides three examples on how these modern developaents could affect the IMF advice. There are, of course other a © of IMP policy advice that would be affected by new developaents. (2) The historiesl evidence indicates that in « narrow sense IMF prograue have worked, This aeans thar, on srage, the external situation of program countries inproved relative to the situation prevailing before che progran. Existing studies also suggest that Fund prograns have hed sonoa in terns of success with respect to lovering inflation and less ace achteving grovth targets. In a deeper tense, hovever, the existing empirical Leerature has fatled to develop fully satisfactory analyses on the effectiveness of Fund programs, The preblem, of course, has to do vith constructing adequate comparison benchasrks; ideally one would vant to know whether Fund programs are able to indice adjustaent in « more efficient vay han alternative packages without condittonality (or maybe with « different xy, and we vould probably have type of conditionality). The probles 1s not co walt for sone Cine before ore adequate eapirical evaluation of Fund's prograns effectiveness is developed. (3) The relatively lov recent rate of compliance of the Fund's Lncermed- late cargets -- and the profuston of waivers -- provides sone indication that recent conditionality programs may not have been fully adequate to deal vith the debt crisis. Moreover, there { direct evidence that some of the recent programs have been approved under political pressure, and under conditions where the staff strongly doubted their viability.>* There are a muaber of undesirable consequences of this practice of approving unrealistic programs First, the Fund's resources are imperiled: second, the auch-needed direct negotiations between barks and countries on possible vriteoffs 1 postponed. (4) Tradietonally, Fund programs bave paid Little attention to tesues related to the supply side and in particular to incose distribution. Hore specifically, critter of the Fund have pointed out again and agein chat Fund policies, and in particular it devaluation components result in output contraction, in increased unemployment and in « worsening of income distribu tion. In th{s paper I developed a mintzal framework to analyze the effects of devaluations, and other Fund-related policies on output and exployment. Eopirical results obtained for a group of 12 countries and reported in Section V indicate thet, contrary to the asunption made in the Fund basic model evaluations have indeed had a negative short run effect on output. However, the analysis algo suggests that alternative poliet auch as exchange and trade controls also have negative effects on output growth, In thet section I ‘Also provide preliminary results on the incoue distribution effects of evaluations; chis analysis shovs no significant effect of devaluations on the labor's share of national incoze. 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