Sincronía Spring 2002


Giovanni E. Reyes Ph.D.


1. General conditions

Economic and social environmental basis to carry out the economic adjustment programs existed in many middle income countries by the end of the seventies. In 1979 many small nations had difficulty surviving the second oil price increase after the first in October, 1973. By the end of the 1970s, there were fewer financial resources in the international bank system to continue the lending cycle which had spiraled many developing nations into large national debts as in 1974.

At the beginning of the 1970s, as a result of the increase of in prices engineered by the Organization of Oil Export Countries in October 1973, those nations who lacked the capacity to produce oil had sufficient international financial resources to avoid the pain of economic adjustment. At this time, private international banks were maintaining significant levels of liquidity and were willing to lend to developing nations. These resources generated the problem of external debt and, in immediate terms, they solved the problem of lack of money for many underdeveloped nations.

At the end of the seventies, the international scenario was characterized by the fact that international financial resources were not readily available, the more developed nations were facing recession in their economic systems, and the international prices of commodities -which are the most important exports from many developing nations- were falling in international markets.

In summary, the general situation of middle income countries worldwide at the beginning of the eighties was characterized by: a) dealing with the recession of the more developed nations; b) facing a lack of financial resources in the private international bank system for continued loan opportunities; and c) grappling with the need for monetary funds to compensate for the second oil price increase and the already contracted external debt duties.


2. The main theoretical foundations for economic adjustment

These factors forced many nations to negotiate with international institutions for financial assistance, especially with the International Bank for Development and Reconstruction, the World Bank -WB- and the International Monetary Found -IMF-. These international organizations formulated several terms for lending money to nations. These terms were known as "conditionality", and they established the main framework for macroeconomic decisions to be implemented at a national level. This conditionality was a prerequisite to be carried out in order for a nation to become eligible to borrow financial resources and as a means of guarantee for the payment of previously contracted debt.

In general terms and based on the theoretical foundations of macroeconomics, the main characteristics of borrowing nations were:

a) A significant deficit in the balance of payments, mainly because of instabilities which occurred in the trade balance -more imports with less exports. One of the main factors affecting this situation was the low price of exports due to the economic recession in the more developed nations. In addition, the higher interest rates in the United States automatically increased debt duties. It is important to consider here, as a complementary but not less significant fact, that many middle income countries need to import equipment and several means of production from the more developed nations;

b) High levels of unemployment derived not only from structural economic limitations within each nation, but also from the fact that investments from the private and public sectors were at lower levels than in previous years;

c) High levels of inflation which in turn did not allow for stability in the implementation of productive processes from private and public sectors. It also did not breed confidence in international transactions, but created an environment of uncertainty. In addition, many nations were facing decreasing levels of international monetary reserves;

d) Significant levels of governmental fiscal deficit, which was one of the main factors in causing a rise in inflationary rates in the domestic market. Because governments were receiving lower amounts of taxes, they printed domestic currency and created the internal debt problem, which increased the amount of money at the local level and therefore increased the level of inflation.

This general picture and the interaction of its elements can be analyzed according to a macroeconomic perspective. From this point of view it is possible to say that the higher the level of production of a particular country, the higher is the tendency to increase its imports. When economic growth is low, imports have a tendency to also be low. With a low level of economic growth, a positive situation can be seen in the balance of trade, because exports usually are higher than imports; however, in the case of a stagnant economy, higher levels of unemployment are unavoidable. The opposite situation is evident when there are higher levels of economic growth. In this case, there are lower levels of unemployment, but usually this condition has negative results in the balance of trade since a stronger economy tends to yield more imports than exports.


3. Diagnostic areas and macroeconomic policy "prescription"

When a country has the two "extreme" conditions of either high level economic growth, or low level economic production, there are clear choices in terms of macroeconomic prescriptions. When the levels of national production are low, there are positive results in the balance of trade and negative effects on the employment variable. In this case it is necessary to implement expansionary fiscal and monetary policies which will decrease, at least temporarily, the level of taxation, and provide more money to the national system. All that is being done in this case is to "push" the economy. As a result of these actions it is expected that the balance of trade will decrease, but levels of employment will increase.

When the economy of a country is experiencing high levels of economic growth, it has negative numbers in the balance of trade and favorable numbers in terms of unemployment. In this case, it is important to implement fiscal and monetary contractionary policies, such as increasing taxes, and reducing the amount of money available in the national economic system. Another measure consists of increasing the interest rate, which makes lending more difficult and reduces the total output of the national economy. As a result, there will be better figures from the balance of trade, even when we expect to have relatively more unemployment. The contractionary fiscal and monetary policies aim to avoid an "overheating" of the economy.

In both "extreme" conditions there is no controversy concerning the macroeconomic dispositions. However, problems arise in a case where there is an economic system such as those of the small economies of developing countries, which can be characterized in the following manner:

a) Small economies in which market mechanisms are not working "normally" according to macroeconomic models of more developed nations;

b) High levels of inflation mainly due to the printing of new money by the government;

c) High levels of unemployment combined with a negative situation in the balance of trade.

With these characteristics, many underdeveloped nations faced an environment of stagflation, that is to say inflation with economic recession and thus unemployment. In addition they had negative numbers in the balance of trade. Here lies the controversy. If expansionary fiscal and monetary policies are applied, the economy is being "pushed," and thus the problem of unemployment is solved to some extent, yet the balance of trade deteriorates. If the contractionary fiscal and monetary policies are applied, the balance of trade problem is solved, but there will be an increase in unemployment.

In order to solve this problem, it is important to realize the significant limitations of traditional fiscal and monetary approaches. The solution provided through the terms of conditionality of international organizations mainly consisted of the following aspects:

a) To promote exports as a means to improve both the balance of trade and the current levels of employment, avoiding the unilateral approach of the application of traditional fiscal and monetary policies alone;

b) To reduce governmental fiscal deficits. Indeed, at the beginning of the eighties, the IMF established a governmental deficit limit of 3 percent of the gross national product in a particular country;

c) To generate revenues for the government based on indirect taxes, that is to say taxes on consumption rather than taxes on income and property. By implementing this measure an even larger reduction in imports was expected;

d) To depreciate and devaluate national currencies to stimulate investment and to improve conditions in international reserves.


4. Results and social cost of adjustment

All of these terms were factors in generating positive results in terms of controlling inflation, obtaining better results from the trade balance, and increasing employment in some sectors of economic activity. The main problem could be identified in an increase in the number of people living below the poverty level and within conditions of social marginality, due largely to the following principal causes. First, an increase in taxes was supported by social sectors which depended on wages and salaries, because they did not have significant levels of property in fixed factors of production. In addition to this circumstance it is necessary to keep in mind that, even before the adjustment process, a significant part of society was already living under high levels of unemployment.

Second, concerning the trade liberalization processes, the contraction in import levels tended to elevate the prices of basic goods mainly because imports are not only constituted by luxury products, but also of technological products that were indispensable in many cases in national production spheres. In many underdeveloped nations, their industrial capacity of production is usually aimed at producing terminal goods, instead of intermediate products, such as fertilizers, machinery, and equipment parts.

Third, in developing nations conditions of high competitiveness and open market economies do not exist as in more developed nations. This made it possible for functional monopolies to act within the conditions of the domestic market of a particular nation. Therefore, the distortion in prices of several goods was affected by the speculation of a few suppliers of a particular product. This situation is a distortion of the free price movement due basically to supply and demand mechanisms. Again, the result was an even larger contraction in the levels of effective internal demand, and thus another factor which increased poverty levels.

Broader conditions of marginality are defined as the fact that poor sectors are living in the margin of regular economic mechanisms in the domestic market, because they have needs but they do not have the economic capacity to acquire the products to satisfy them. This condition of marginality can be compensated for by the mechanisms of the marginal or informal economy in the urban centers, or by the activities of peasant economy in rural areas, by which families in the countryside can take advantage of family work and can produce for self-sustainment in terms of basic food production.

With a basis in the aforementioned elements, the basic foundations for explaining the implementation of economic and social adjustment programs in developing countries are apparent. These measures attempted to solve problems in the national accounts, but they actually increased the conditions of poverty in these nations. These programs of economic adjustment can be studied as "pragmatic" dispositions, and they can be interpreted in a more concrete sense using the theories of world-systems and globalization. This analysis is possible because these programs were a response to national conditions which were in turn greatly influenced by the international economic state.

Factors from the foreign arena in applying economic adjustment measures included inflationary pressures from the devaluation of currencies, the higher costs of oil, the significant degree of high external vulnerability, especially in small economies, and the low level of value-added for the main exports of agricultural products, which in turn are largely affected by the fact that they are not essential products and they depend on weather conditions for production. These elements lead to the consideration that to have higher degrees in successfulness concerning the results of the economic adjustment processes it is important to change the structure of export for many developing countries.


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Sincronía Spring 2002

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