Development through stabilisation and reform can be understood as follows
The reasoning here was that the trade and resource transfer could not, by themselves, lift LICs out of the poverty. Unless LICs’ macroeconomic imbalances (current account deficits high inflation, etc.) were removed (stabilization), and the structural impediments to their growth/development relieved (structural reform), trade and the resource transfer could not translate into long-term development in living standards. This became particularly obvious after the 1980s debt crisis which swept across Africa Latin, America and Asia. It is at this particular point of time that the two international financial institutions (IFIs) – the International Monetary Fund (IMF) and World Bank (WB) – became concerned in macroeconomic stabilization and the structural reform of it, respectively. Importantly, the countries in which the IFIs got involved, did not have a lot bargaining power vis-à-vis the IFIs, because the latter had bailed out these nations (by offering them the soft multilateral loans) out after their liability defaults. As a result which, the IFIs were able to determine the pace and direction of macroeconomic policy and reform in these nations.
Most of the IMF’s stabilization policies were obtained from the neo-classical economics, known since the year1990 as the Washington Consensus. IMF’s main stated the objective which was to ensure both through internal balance (supply=demand, that is low inflation and full employment) and external balance (sustainable BOP and the external debt position). The approach was “stabilization” through “demand” management, the three tools/devices of the latter being:
• Tight monetary policy: “demand reducing”; expected to work through higher interest rates which reduced private sector consumption and the investment demand, suppressed inflation and the boosted domestic savings. High interest rates also gave result higher capital inflows (lower capital flight) and helped to restore external balance through the capital account.
• Tight fiscal policy: also “demand reducing”; worked through higher revenues (increased taxation and broader tax base) and decreased expenditure on subsidies, public sector corporations etc. There was also reduced to demand (including, for the imports) and government’s borrowing requirement (boosted the creditworthiness of the government as a borrower making borrowing cheaper).
• Devaluation: produced “demand switching” from the imports to home produced tradable commodities. Worked through raised competitiveness, export diversification, reduced required for the export subsidies (as exporters became competitive), and increased investor confidence in the local money (preventing dollarization by the people fearing an impending devaluation).
LICs’ experience with the IMF policies has usually not been successful: The above policies have drawn heavy & wide-ranging disapproval. Critics have drawn notice towards
• Short-term policy conflicts: demand management policies compromise internal balance – especially income & employment; lower the government expenditure means less output, jobs. Higher interest rates can lead to the corporate bankruptcies, bad debts and the financial sector crises.
• Devaluation can increase the prices of imports, including necessities, raw materials and the investment goods/commodities. Also, devaluation translates into the inflation when there is real wage resistance that is when a devaluation-induced increase in import prices feeds fully into the domestic price level through the wages.
• Demand-reduction policies are the anti-growth: increased taxation can stifle the productive sector, as widening the tax net proves complex and most of burden falls on a few taxpayers; cutting government expenditure may cause reduced public investment in the infrastructure, education and health; higher interest rates can discourage the private investment.
• Stabilization hurts the poor: expenditure cuts nearly always fall partly on social sectors most relevant to the poor (education health, food/fertilizer subsidies etc.). This can lead to the political instability, jeopardize economic stabilization and the delay or reverse “reform”. Especially difficult for the democratic governments to push the harsh stabilization measures through.
It is now recognized that these policy conflicts required to be integrated into the Programmed in advance through the institution of the proper security nets for the poor, and assurances that all
“IMF-induced” help (or debt relief) is channeled strictly to the poverty reduction programmers.
World Bank’s structural reform policies are as follows:
The World Bank’s structural reform policies have generally involved the following:
• Liberalization of the prices, removal of the subsidies
• Deregulation involving dismantling of the licensing systems and red-tape
• Privatization of state-owned enterprises (SOEs). SOEs were generally considered
inefficient due to the political interference, and the lack of competition, cost awareness and terror of bankruptcy
• Trade liberalization, including ratification of the non-tariff-barriers, harmonization of the tariff and an eventual reduction.
• FDI liberalization, to generate a transparent, predictable environment for foreign the investors to operate in
• Financial liberalization, involving the ending of financial repression policies (credit rationing, artificially low interest rates, restrictions on the banking competition) and government involvement in the investment allocation
• Capital account liberalization that is removing controls on the capital flows
• Governance and administrative reforms: decreasing waste in, and improving reliability/quality of, pubic services; fiscal decentralization; elimination of corruption; strengthening tax administration; enhancing predictability of the legal and regulatory framework; reducing over-employment in public sector.
While most of the policies approved by the World Bank appeared desirable, some of them came with the conditionality’s which were perceived as politically sensitive, “patronizing”, and involving dismantling of strong fixed interest (such as domestic industrialists). Predictably, thus, non-compliance was the major feature of such programmers.
Even in the cases where domestic/local government intended to implement the prescribed reforms, compliance problems happened due to poor sequencing and/or bad timing.
Example 1: relaxing capital controls given a poorly regulated domestic/local financial system exposed countries to greater than before risk of financial crisis.
Examples 2: Trade liberalization or financial liberalization (increasing interest rates) before achieving fiscal consolidation (that is rationalization of government expenditures and widening of the tax base), caused borrowing costs to the balloon and fiscal deficits to widen (Zimbabwe, Zambia, and Pakistan).
Insistence on fast liberalization of all sectors has over-stretched many LICs’ institutional capacities.