Rules and Discretion in International Economic Policy

OCCASIONAL PAPER 97

Manuel Guitian

INTERNATIONAL MONETARY FUND Washington DC June 1992

Library of Congress Cataloging-in-Publication Data

Guitian, Manuel. Rules and discretion in international economic policy / by Manuel Guitian. p. cm. — (Occasional paper / International Monetary Fund, ISSN 0251-6365 ; no. 97) Includes bibliographical references. ISBN 1-55775-237-O (paper) 1. International economic relations. I. Title. II. Series. III. Series: Occasional paper (International Monetary Fund) ; no. 97. HF1359.G85 1992 337 — dc20 92-12943 CIP

Price: US$15.00 (US$12.00 to full-time faculty members and students at universities and colleges)

Please send orders to: International Monetary Fund, Publication Services 700 19th Street, N.W., Washington, D.C. 20431, U.S.A. Tel: (202) 623-7430 Telefax: (202) 623-7201

©International Monetary Fund. Not for Redistribution Contents

Page

Preface

I. Introduction I

II. Rules and Discretion: An Inevitable Seesaw? 2 Basic Issues 3 Spillover Effects of Economic Policy 3 Systems in Search of Consistency 4 Variety of Resolutions 5 Arrangements Under the Gold Standard 5 Arrangements in the Interwar Period 6 Bretton Woods Era 7 Move Toward Discretion 9 Pendulum Begins to Swing Back 9 Final Remarks 10 Appropriate Setting for Policy Coordination 10 Need for Clarity 11 International Policy Surveillance 11

III. The International Debt Crisis: What Have We Learned? 12 Background 12 Sketch of the Debt Strategy 13 Initial Approach 13 Baker Initiative 14 Menu Approach 14 Brady Plan 14 Role of the International Monetary Fund 15 Adjustment, Financing, and Growth 15 Money Packages and Menus 16 Debt and Debt-Service Reduction 16 Practical Difficulties 17 Broad Issues 17 Moral Hazard 17 Public Versus Private Risk 18 Role of Government 19 Importance of Rules 19 Final Observations 19

IV. Adjustment and Reform: Differences Between East and West? 21 General Setting 22 Elements of an Effective Strategy 22

iii

©International Monetary Fund. Not for Redistribution CONTENTS

Basic Principles 22 Pace and Sequence of Reform 23 Stabilization and Adjustment Under the Reform Process 23 Stabilization and Adjustment 24 Structural Reform 26 Balance in the Policy Mix 27 Differences Between Economic Systems—How Significant for Reform? 28 Essential Differences 28 Differences in Degree 29 Final Remarks 29

V. The Route Toward One European Economy: Need for More than One Track? 32 Setting 33 Meaning of Country Differences 33 Fundamental Issues 34 Convergence and Divergence 34 Adjustment and Integration 35 The Single Market: A Positive Sum Game 36 Central Aspects 37 Peripheral Aspects 37 Policy Constraints 38 Exchange Rate Policy 38 Monetary Policy 38 Fiscal Policy 39 Final Balance 39 A Periphery Beyond the Periphery 39 Europe's Continued Contribution to the International Order 40 Final Remarks 41

VI. Conclusions 43

References 45

©International Monetary Fund. Not for Redistribution Preface

Manuel Guitian is Associate Director of the Monetary and Exchange Affairs Department of the International Monetary Fund. Sections II-V are based on papers prepared from December 1990 to May 1991, when he was a Guest Scholar in the Economics Studies Program of the Brookings Institution. An early draft of Section II was presented as a public lecture on February 27, 1991 at the Woodrow Wilson School of Public and International Affairs at Princeton University and has benefited from comments by Peter B. Kenen and William H. Branson. The main points of Section III were presented on March 28, 1991 in a panel discussion at a Seminar on International Economic Policy also at the Woodrow Wilson School. The final version has benefited from the remarks of the other panelists (Angel Gurria, Peter Kenen, and William Rhodes) and the seminar participants (in particular, Paul Volcker and Toyoo Gyohten). A draft of Section IV was presented on April 14, 1991 to a Seminar on International Economics, International Finance Section, Princeton University, and was subsequently delivered as a lecture to a Finnish-Soviet Banking Seminar in Helsinki on September 24, 1991. Finally, an early draft of Section V was given as a lecture at the School of Advanced Interna- tional Studies at Johns Hopkins University on March 28, 1990. The author would like to acknowledge his indebtedness to the Brookings Institu- tion for having provided him not only with an intellectually stimulating environment but also with a most congenial haven for reflection—a quiet corner office at the Institution's headquarters on Massachusetts Avenue. He is also indebted to Peter Kenen, Paul Volcker, and Toyoo Gyohten of Princeton University and David Calleo of Johns Hopkins University for having provided challenging testing grounds for the ideas contained in this paper. The author wishes in addition to express his gratitude to Ann Greasley and Constance Strayer for their assistance in preparing the manuscript and to Rozlyn Coleman of the External Relations De- partment for editing it for publication. The opinions presented in this paper are those of the author alone and do not necessarily reflect the views of the Interna- tional Monetary Fund.

©International Monetary Fund. Not for Redistribution This page intentionally left blank

©International Monetary Fund. Not for Redistribution I Introduction

"Even when laws have been written down, they This paper is concerned with this demarcation be- ought not always to remain unaltered." tween national and international domains from an ARISTOTLE economic standpoint, in particular from the perspective of economic policy. The paper's underlying theme is that, although for purposes of classification ossibly one of the clearest and most persistent it is possible and legitimate to distinguish between Ptrends during the second half of this century "rule-based" regimes and "discretion-based" re- has been the development of an increas- gimes, the distinction can only be one of degree, not ing interdependence among national economies. of essence. All possible frameworks encompassing a Moreover, as the century's last decade has opened, national and an international dimension must in- this trend has broadened and intensified dramat- clude, to a greater or a lesser extent, some rules and ically as most of the centrally planned economies, some discretion. Without discretion, any system of which deliberately had remained outside the inter- rules is likely to become unsustainably rigid; without national economic and financial system, have de- a minimum set of rules, discretion is likely to create cided to undertake widespread economic and polit- a system so disorderly that it cannot endure. ical reforms to end their long isolation. These This paper explores this duality from a variety of reforms seek to establish democratic and pluralistic perspectives. First, a historical road map lays out the systems with economies organized on the basis of periodic swings between those international eco- market forces. As a result of these remarkable nomic regimes that have emphasized rules and those events, the world economy has finally been set on that have stressed discretion (Section II). Then, the the road to becoming truly universal. paper turns to the limits and opportunities facing As has often been stressed, close economic inter- units in an integrated system from the particular dependence offers ample scope for raising world standpoint of the international debt crisis, a problem welfare, though it can also impose severe con- that dominated international economic policy in the straints. In particular, in a closely integrated setting, previous decade (Section III). This debt discussion a country's capability to pursue national objectives stresses the importance of rules and clear bound- can be either enhanced or limited by how well it aries, both internally and externally, for averting adapts to the constraints of interdependence. Fun- moral hazard and other divisive risks. Next, the chal- damentally, this adaptability depends on the setting lenges confronting the former centrally planned of appropriate boundaries to national autonomy, an economies are examined to bring out two important age-old dilemma facing collective units. issues: the extent to which the reform experiences of The challenge of drawing appropriate, that is, these economies differ from those of established sustainable, boundaries between national and in- market economies and the importance of simple and ternational domains is unending, because bound- transparent rules for the efficiency of the reform aries themselves are not immutable; they shift with process (Section IV). Following that, the paper ex- political, economic, and social developments. And amines the continuing effort to create a single Euro- to an important extent, the systems that have pean economy; this investigation underscores the evolved to bring national domains into the interna- extent to which the adoption of broad and concrete tional setting have responded to these variable per- rules, which can cut across national taboos concern- ceptions concerning national territory. From a gen- ing autonomy, has acquired momentum in the route eral standpoint, those systems fall into two main toward a unified Europe (Section V). The paper categories: these that rely mainly on the obser- concludes with a search for the appropriate weights vance of well-established rules to govern economic to be given to rules and discretion for the successful policy and those that give predominance to the use operation of international economic policy of discretion in economic management. (Section VI).

©International Monetary Fund. Not for Redistribution II Rules and Discretion: An Inevitable Seesaw?

"An order which is adhered to from motives of economic interactions among countries fall legit- pure expediency is generally much less stable imately and exclusively within the domain of eco- than one upheld on a purely customary basis. . . . nomics, and possibly even better within that of polit- But even this type of order is in turn much less ical economy, must be qualified—such interactions stable than an order which enjoys the prestige of can also exhibit dimensions better studied from being considered binding or, as it may be other academic perspectives: game theory, for sys- expressed, of 'legitimacy'." tematically analyzing the strategic behavioral pat- MAX WEBER terns that develop among two or more interdependent agents;1 political science, for studying the origin little more than five years ago, I went to Prince- and evolution of international regimes;2 and interna- Aton University to talk about international co- tional law, for appreciating the legal issues that can operation and the role of the International Mone- arise under a formal code of conduct among na- tary Fund. At that time, external debt was a tions.3 These other perspectives, while not part of pressing problem confronting the international this paper, can clearly add useful insights to interna- economy. The debt strategy had moved from the tional economic policy discussions. adjustment phase to the growth phase, with the op- The plan of my remarks is straightforward. First tion of debt reduction still to come. On the policy the factors that call for a measure of international coordination front, a breakthrough had just been consistency in national economic policymaking are made in the Plaza Agreement, in which industrial discussed. These revolve around the existence of countries agreed to cooperate closely in their economic interdependence, which gives rise to foreign-exchange-market intervention. "spillovers" from national policy actions into the On a recent return to the campus, I reflected that international economy—or, to use an economist's much had changed. In particular, the prominence language, to externalities and collective or public of the debt question had faded, leaving a set of goods in the international realm. Then it is asked more general issues facing the international eco- how these factors have been handled over time, in nomic community. It is interesting to note, how- particular what means have been developed by the ever, that the larger theme of the international di- international community to cope with economic in- mension in national economic policies has terdependence. These adaptations can be classified remained significant. Thus in five years, only the according to several stages of behavior: "usage" or breadth and depth of the issues—conceptually, his- "custom" (behavioral patterns that have become torically, even geographically—have changed, not familiar or habitual through long-standing prac- their spirit. tice); "convention" (behavioral patterns that are By professional bias, that is, by training, econo- adhered to not only because of usage or custom but mists tend to grasp ideas and analyze events from the perspective of economic theory, and such a 1See, for example, Eatwell, Milgate, and Newman (1989) for vantage point can clearly provide revealing and a representative set of articles; also see Hamada (1985). The useful insights. But it is increasingly evident that interdisciplinary scope of the analysis of the interaction between the issues arising from the interaction between na- national and international forces also shows the extent to which the economic viewpoint has influenced other areas; this point tional and international economic forces extend was brought to my attention by William Branson. beyond the realm of pure economics. Strategic and 2International regimes, as defined in political science litera- political considerations, to name only two, are also ture, encompass the principles, norms, rules, and procedures, important. It should therefore be stressed at the explicitly or implicitly agreed to by partners, that actually guide their behavior in an area of international relations; see Krasner outset that although the argumentation in this pa- (1983), Keohane (1984), and Gilpin (1987). per will be basically economic, the issues do call for 3See, for example, Gold (1979), in which many legal issues an interdisciplinary approach. The argument that concerning international monetary relations are examined.

©International Monetary Fund. Not for Redistribution Basic Issues also to avert disapproval within a social group); and Yet, while it is true that the move toward ex- "law" (behavioral patterns adhered to in order to change rate flexibility helps to isolate an economy, avoid incurring specific penalties or sanctions).4 Fi- it does not render it completely independent from nally, a number of conclusions are presented that the other economies in the system. Such indepen- flow from both the conceptual framework and the dence would require an indifference toward or a historical evidence. Though history may never ac- disregard for exchange rate developments among tually repeat itself, recurrent (though by no means trading nations. This is unlikely because domestic identical) patterns can be identified over time and policies that lead to a persistent depreciation of a they point to a pendulum-like movement in the currency will tend to cause a flight into physical evolution of methods for dealing with economic assets (domestic and foreign) and into financial as- interdependence. sets denominated in foreign currencies; the op- On a last note, these remarks hardly represent a posite will tend to occur in the case of persistently new contribution to the vast knowledge of interna- appreciating currencies. In either instance, it is im- tional economic policy relationships. This paper's probable that governments will be either able or novelty is the particular perspective from which it willing to allow such flows to persist. has been set out. It is hoped that a new approach to It should not be surprising, therefore, that the old material will help enliven an important degree of national autonomy gained by the estab- discussion. lishment of flexible exchange rates in the international economy has proven far more limited in practice than in theory.7 As a result, the central Basic Issues issue of reconciling national sovereignty with the The need for a measure of consistency across emergence of an integrated world marketplace re- national economic policies arises from a fundamen- mains outstanding. No economy is an island. tal characteristic of the world economy: an interdependence that binds together the economies of all Spillover Effects of Economic Policy countries. Thus, from the start, the comfortable as- As has often been observed, the only closed sumption of "a closed economy" is abandoned. economy is the world.8 Thus, countries interact in a However, what that assumption has been able to closed system, and their actions generate effects achieve in economic theory should not be ignored: that spill over among all of them. Such effects, or under its shield many insightful arguments have 5 externalities, have always existed, but their impor- been developed. From a policy standpoint, the as- tance has increased with the growing international- sumption has allowed analysts to isolate the effects ization of economic transactions. A clear conse- of a variety of policy instruments on economic be- quence of this trend has been the tension that has havior in a well-defined domain. For a time, it was developed between the increasingly global nature also thought that the equivalent of a closed econ- of economic relationships and the persistently na- omy could be replicated in the context of open tional character of the system's main political units. economies if the latter operated under a freely An important factor behind this tension has been floating exchange rate regime. Flexible exchange the growing gap between the relevant economic rates, in principle, could provide countries with au- domain of each national state and the more limited tonomy in the use of monetary, fiscal, and other realm of its government's jurisdiction.9 policy instruments, basically by eliminating the balance of payments constraint.6 The market- An immediate corollary of this weakening rela- determined adjustments in the exchange rate tion is that governments have lost importance as would ensure balance in external payments. Thus, masters of their own stage (if, indeed, they ever theory concludes that national economic policies were). The ability of national policy actions to ob- gain a degree of freedom perceived by many as tain given domestic objectives has weakened as the crucial for the unconstrained pursuit of domestic intensity and number of leakages abroad have objectives. 7Witness the concerns in certain sectors of the United States over the strong appreciation of the U.S. dollar in the early 1980s 4See Weber (1964), in which these various terms are intro- (leading to the Plaza Agreement of September 1985) as well as duced and amply discussed. the subsequent concerns elsewhere that U.S. dollar depreciation 5For an illustration of this point in the context of monetary not go too far (leading to the Louvre Accord of February 1987). theory, see Guitian (1973). For further discussion, see Frenkel, Goldstein, and Masson 6In the extreme, with no international capital movements, a (1989). floating exchange rate would keep the external current account 8The implications of this observation were drawn by Mundell always in balance. Put differently, it would keep domestic ex- (1968); also see Hamada (1985) and Home and Masson (1988). penditure in line with income, as would be the case in a closed 9For a broader examination and an excellent discussion of economy. these points, see Bryant (1984); also see Camps (1981).

©International Monetary Fund. Not for Redistribution II RULES AND DISCRETION

grown. This development would have limited rele- ance if they are to survive. They should not fall vance if the world economy conformed sufficiently prey to political expediency in their search for to the stylized features of the perfectly competitive global harmony and yet they should not lose touch model of economic theory. In a setting of many with reality. Perhaps the complexity of this task is small nations, the policy actions of any one of them best illustrated by its conflicting aspects: on the one would hardly affect the others; decentralized ac- hand the arrangements must transcend political re- tions would tend to lead to optimal results.10 But alities, and on the other they must give such real- the world hardly resembles an atomistic set of uni- ities their due recognition. To add to the difficult formly small and perfectly competitive nations, and balance, national attitudes toward international the influence of large countries on the performance linkages can also vary over time. In any event, it is of the system as a whole is undeniable. It is also clear that no nation can pursue its own interests for clear that in the process the policies of one country long if they conflict continually with those of the or group of countries will likely affect the welfare international community. What is less clear is how of others.11 far nations will allow such conflict to prevail. International interactions, therefore, by rendering In periods when international interdependence is national welfare contingent not only on that nation's clearly perceived, nations are more prone to ac- actions but also on those of others, provide incen- knowledge that spillovers limit their autonomy. tives for cooperation and collective decision making. Consequently, they seek transparent norms to cope Given the "closedness" of the world, other con- with spillovers—norms to internalize the exter- straints also inevitably arise. An immediate example nalities. In such circumstances, the tendency is to is provided by the links among national trade, the arrive at international understandings based on mu- current account, and the overall balance of pay- tually agreed norms or rules, which can then guide a ments: these balances should, in principle, sum to process of integration. Such rule-based systems zero. Another type of constraint binds exchange rate strengthen the predictability of national policies in relationships: in a system with a given number, say n, that at least one of their dimensions is well known: of currencies there can only be (n-1) independent their consistency with international norms. Thus, the exchange rates. These constraints pave the way for apparent loss of national autonomy is the price for potential inconsistencies across national economic enhanced certainty. policies and lend added support to the demands for In contrast, when national considerations pre- international cooperation. dominate, autonomy is stressed and the tendency is to emphasize flexibility in international understandings. At such times, nations are less willing to Systems in Search of Consistency follow arrangements that limit their independence; Arrangements to foster consistency in interna- they seek insulation from externalities. Conse- tional economic policy need to strike a delicate bal- quently, attitudes favor discretion-based regimes. Regimes of this nature rank judgement above well- 10See Corden (1986), Kenen (1989), and Frenkel, Goldstein, defined norms and thus purchase, at the expense of and Masson (1990) for similar arguments. predictability, scope for what may be called na- 11 This is not the only area in which the international economy tional policy adaptability. It remains questionable, departs from the competitive model. Another departure is the though, the extent to which this approach actually presence of public or collective goods and externalities, the relevance of which has risen with the growing openness of national enhances national autonomy. economies. It should be pointed out, however, that even in an The evolution of the international economy has interdependent world of different-sized nations, a number of been characterized by recurrent shifts between model simulations has shown that the cross-effects of policy these two polar sets of arrangements. In effect, the interactions appear to be relatively small. For evidence on the size of gains, see Oudiz and Sachs (1984), Taylor (1985), Fischer shifts often respond to a continuous tension that (1988), Grober (1988), and Guitian (1988a); also see Bryant and seems generated, perhaps inevitably, by the func- others (1989). tioning of the two types of systems. When countries Public or collective goods, once provided, benefit everybody agree on a well-defined code of conduct, they ex- in the system (regardless of whether they contribute to the costs press an intention to abide by common norms, of provision), and their consumption by one person does not detract from the consumption opportunities of others; see Olson thereby fostering national integration in the inter- (1971, 1982) and Olson and Zeckhauser (1966). This notion of national system. They acknowledge (and are will- public good has been stressed by Peter Kenen in contrasting the ing to live with) the spillover effects of national "policy-optimizing approach" to the "regime-preserving ap- policies. However, participation in the system proach" to policy coordination. The contrast highlights the dif- entails benefits and costs that can be exploited ference between the "bargaining" implicit in the first approach and the "rules" perspective required by the second. See Kenen and incurred by individual countries. In a well- (1989, 1990b). The analysis in this paper belongs in the latter integrated setting, costs induced by domestic policy approach and I am indebted to Kenen for pointing this out. can be exported to the system at large and benefits 4 ©International Monetary Fund. Not for Redistribution Variety of Resolutions

derived from other nations' policies can be im- teenth and early twentieth centuries.14 While there ported. Unless commitment to the norms is un- was general acceptance at the time that currencies shakable and enlightened, the possibility of export- should have a metallic content, the agreement did ing costs and importing benefits can weaken the not extend to a consensus on which metal should incentives to maintain appropriate policies at be used. Nonetheless, a gold standard became the home. The resulting moral-hazard risks and free- basis for an international monetary arrangement, rider problems can lead to abuses of interdependence. initially through usage or custom but later through As such, the problems may induce international the establishment of a convention. It did not, how- dispersion as countries seek to isolate themselves ever, achieve the status of a legally binding interna- from what they perceive to be externally induced tional regime. (or systemic) costs.12 The full-fledged theory of the process of eco- As pressure for insulation from the system nomic adjustment under the gold standard empha- mounts—and it will if countries use it for parasitic sizes its automatic nature. Under the standard, do- rather than symbiotic purposes—observance of the mestic currencies were equated with a given code of conduct deteriorates. Given the lack of quantity of gold. The metal was freely coined and effective enforcement of rules at the international traded, and governments bought and sold gold at a level, countries can bend them to take national fixed price. Accordingly, the gold standard can considerations more into account, to broaden the count among those regimes based on rules—that is, scope for discretionary action, and to widen the it offered limited scope for discretion. The classic analysis of the transmission mechanism under the margin for judgmental interpretation. In the pro- 15 cess, uncertainty increases as does the potential for gold standard was provided by David Hume. His policy inconsistencies. Eventually, the costs of un- analysis, in the variant that has been termed the certainty and the adverse effects of policy conflicts price-specie-flow mechanism, pointed out how do- tend to increase the demand for policy coordina- mestic economic imbalances interact with interna- tion as a means both to constrain national auton- tional payment flows to restore balance to the sys- omy and to foster cohesion among countries. tem at large. As excess demand develops in one Under this interpretation of how the interna- economy, incipient upward pressure on prices tional economic system operates, an ongoing os- emerges, rendering domestic goods expensive rela- cillation between discretion and rules may develop. tive to those from abroad. The quantity of imports It is clear that applied in the extreme, neither re- demanded tends to increase and a trade deficit ma- gime can prevail: rules interpreted too rigidly are terializes. Under a gold-standard regime, such a inevitably broken; discretion interpreted too deficit has to be financed by gold sales from the loosely spells anarchy. deficit country. The resulting outflow of gold reduces the stock of money in the country, exerting downward pressure on prices, restoring competitiveness, and eventually wiping out the trade defi- Variety of Resolutions cit, and with it the gold outflow. (The reverse holds true if excess supply develops in a country.) History provides many examples of how international arrangements evolve and respond to inter- This same process can be viewed from a different mittent tensions. Possibly one of the best known standpoint that stresses the role of the money international economic arrangements is the gold market—rather than that of the goods market—in standard. A review of its fundamental features the adjustment. This monetary variant of the trans- must reach back more than a century, to the era mission mechanism, which notes that the counter- 13 part of an excess demand for goods is an excess when the classic gold standard was in its heyday. supply of money, sees the trade deficit as the channel through which cash balance holdings are Arrangements Under the Gold Standard brought back to their desired level. Thus the gold outflow will continue until the outstanding stock of The origins of the gold standard are not easy to money equals the quantity of money demanded; at document because centralized economic and mon- that point, expenditure will once again equal in- etary discussions were uncommon in the nine- come, and balance will have been restored to the trade account. 12A similar point has been forcefully made by Feldstein (1988a). 14See Eichengreen (1989a). For a discussion of international 13The classic source for this period (and the one on which the monetary cooperation in the nineteenth century, see Schumpe- exposition in this section relies significantly) is Bloomfield ter (1954). (1959). But also see Cooper (1987) and Eichengreen (1985, 15See David Hume, "Of the Balance of Trade," reprinted in 1989a). Rotwein (1955).

©International Monetary Fund. Not for Redistribution II RULES AND DISCRETION

For the domestic economy to interact with the Whatever the position taken on this issue, it rest of the system in this way, governments had to seems clear that countries followed the rules of the conform to the implicit "rules of the game," that is, gold standard with a measure of discretion. Al- they had to avoid interfering with the regime's op- though some of the margin for discretion was em- erations. The term rules of the game actually post- bodied in the architecture of the regime,18 individ- dates the gold-standard period (1870-1914), as do ual judgement played a larger role than had been the following interpretations attached to it, though envisioned. This reflected the importance of do- they are still relevant to this rule-based regime. mestic economic objectives relative to the primary First, the passive version of the rules of the game aim of the gold standard, which was price stability simply requires that governments refrain from at- through the maintenance of convertibility.19 Na- tempting to offset the effects of gold flows on the tional concern over the level of economic activity money market. Specifically, this means that when or the state of business confidence also played a gold coins are exported directly or domestic cur- role and encouraged the need for discretion in the rency is turned in for gold to pay for imports (or implementation of the rules of the game. conversely when gold coins are imported directly Despite (or perhaps because of) this measure of or gold is turned in for domestic currency as a re- discretion, the gold standard tends to be thought of sult of a trade surplus), governments do not take as a regime that worked relatively well. A possible deliberate actions to counteract the effects of these reason for this impression is that in its operation, events on the stock of money and the economy at discretion was not abused to the point of blurring large. For example, when gold flows out, the quan- the existence of rules. Another way of conveying tity of money in the economy is allowed to decline, the same point is to say that the minimalist (pas- with consequences across the economy. Decreases sive) version of the rules was probably sufficient for in the money stock tend to be associated with the regime's credibility and stability. Though not downward pressure on prices, and possibly on out- always followed, the rules were broadly adhered to put and employment in the short run.16 Increases so that the policy inconsistencies across countries in the money stock have the opposite effect. did not result in the abandonment of the standard. Second, the active version of the rules of the The classical gold standard did come to an abrupt game takes a less neutral position toward the con- end, however, with the outbreak of World War I, sequences of gold flows;i t requires governments to when the convertibility of currencies into gold was reinforce those consequences by deliberate policy discontinued and governments geared their eco- actions. In the case where gold flows out, such ac- nomic policies to the war effort. tions typically include imposing stringent credit conditions on the economy by raising interest rates 20 or contracting the central bank's domestic assets, Arrangements in the Interwar Period thus adding to the pressure to lower the stock of After the hostilities ended, conditions in the bel- money and stemming the gold outflow. Under this ligerent economies varied widely and generally version, the rules of the game under the gold stan- provided poor soil for the re-establishment of a dard required variations in the domestic assets of rule-based system. Accordingly, the gold standard the central bank in the same direction as those in 17 was not initially restored; instead, arrangements the gold stock. tended toward national discretion, and, for a As for how nations actually responded, the evi- period of several years (until 1926), exchange rates dence of country adherence to the active approach is were allowed to fluctuate freely. As a general rule, not conclusive. Domestic assets moved in an op- governments abstained from intervention in the ex- posite direction to gold on a significant number of change markets; as a result this episode closely rep- occasions, which could be interpreted to mean that licated a stylized freely floating exchange rate policy action was taken to offset, rather than rein- regime. force, the consequences of gold flows. The evidence is somewhat less ambiguous on the neutral or pas- 18For example, the regime permitted a rise (decline) in the sive observance of the rules of the game. Instances selling (buying) price for gold when specie flowed out (in). The when governments appeared only to avoid coun- scope for such maneuvers, however, was confined by the width teracting the effects of gold flows on the economy of the so-called gold points, which reflected transport and related costs. seem to have been more widespread. 19 For further discussion see Bloomfield (1959) and Cooper (1987). 16See Guitian (1976) for a complete discussion of the various 20This period has been extensively analyzed by Barry rounds of effects on the economy. Eichengreen in particular, on whose work the exposition in this 17This was the interpretation in a well-known and influential section draws heavily. See Eichengreen (1985, 1989a, 1989b, study by Ragnar Nurkse; see League of Nations (1944). 1989c, 1990).

©International Monetary Fund. Not for Redistribution Variety of Resolutions

Nonetheless, different interpretations of the be- were replenished. A second theory focuses on the havior of exchange rates during this interlude have absence of a lead country willing to defend the sys- been given, illustrating the difficulty of reaching tem's stability by becoming a lender of last resort. unambiguous conclusions even with a common set And a third interpretation underscores the lack of of economic evidence. On the one side, there is an coordination in the economic policies of the major influential interpretation that sees this period as countries.22 These three interpretations are not proof that fluctuating exchange rates encourage mutually exclusive and they overlap; for example, disequilibrating capital movements and destabiliz- deviations from the rules of the game can reflect ing speculation, thus hampering rather than foster- the absence of both policy leadership and policy ing adjustment. On the other side, a powerful argu- coordination as well as the lack of a lender of last ment has been made that speculative capital resort in the system. Those deviations, in effect, led movements were stabilizing and simply anticipated to the collapse of the gold-exchange standard. exchange rate changes that would follow from un- For the remainder of the 1930s, a variety of man- derlying market forces.21 This argument empha- aged exchange rate arrangements prevailed. Gov- sizes that the evidence from this period is less rep- ernments actively intervened in the foreign ex- resentative of a system of flexible exchange rates change market to influence currency movements than is often thought. On balance, then, there is with the apparent aim of dampening fluctuations. reason to contend that exchange rates moved These interventions varied in form and intensity freely: the record shows that governments gener- but were often aimed at gaining a competitive ad- ally did not intervene in the exchange markets. But vantage and promptly gained the label of "beggar there were also a few instances of exchange rate thy neighbor" exchange rate management. management, if market intervention is to be inter- Broadly speaking, an overall assessment of eco- preted as a sign that governments acted to counter nomic regimes during the interwar period suggests market forces. that exchange rates tended to vary more when they Whatever the final interpretation, revealed were free to float than when they were managed, preference—that is, the actual behavior of but uncertainty and unpredictability characterized governments—indicates a dissatisfaction with the both types of arrangements. In contrast, fixed ex- flexible exchange rate regime by the mid-1920s, change rates enhanced predictability but required when countries reverted to a modality of the gold strict domestic financial discipline. In effect, then, a standard, or, equivalently, to fixed exchange rates. fixed exchange rate regime makes domestic pol- The new system, in operation until the early 1930s, icies endogenous to its rules of operation. Unless was a variant of the gold (specie) standard—gold there is a credible policy commitment to those was no longer in circulation but domestic currency rules, the regime will tend to collapse. If the inter- was freely convertible into gold on demand. While war period is representative, the general tendency the central banks of the major reserve-currency is for rule-based arrangements to succumb to dis- countries continued to hold mainly gold in their cretionary systems, which seek policy autonomy portfolios, other central banks held a portion of the while paying lip service alone to the importance of backing for their liabilities in other foreign assets, policy coordination. typically in foreign exchange, mainly dollars or sterling claims. Thus, the regime was termed the gold-exchange standard. Bretton Woods Era The operation of this arrangement was flawed The experience of the interwar period contrib- from the outset, and the system consequently was uted to a generally negative impression of flexible unable to foster adjustment and did not last long. A exchange rates; they were viewed as a source of variety of explanations has been given for its un- disturbance rather than as a support for adjust- satisfactory performance. One argument stresses ment.23 This impression significantly influenced the failure of governments to abide by the rules of the re-establishment of fixed—but adjustable—ex- the game, evidence of which is seen in the emer- change rates within the framework of the Bretton gence of a competitive struggle for gold. In this Woods par-value regime, which was adopted to- struggle, countries tended repeatedly to raise their ward the end of World War II. discount rates to attract gold but did not act sym- metrically to lower them when their gold stocks 22Nurkse in League of Nations (1944) is a proponent of the first thesis. Kindleberger (1986) proposes the second thesis. 21See League of Nations (1944, pp. 117ff) for the argument Eichengreen (1985) advocates the third. that speculation can be expected to destabilize capital flows. 23Here again, the comprehensive examination of the period The opposite case was persuasively made by Friedman (1953) in by Nurkse in his study for the League of Nations (1944) was the essay entitled "The Case for Flexible Exchange Rates." most influential.

©International Monetary Fund. Not for Redistribution II RULES AND DISCRETION

Although there had been earlier attempts at lay- on trade and current account transactions, thus es- ing down principles and conventions to steer inter- tablishing current account convertibility. In its national economic relations,24 not much had been basic framework, the Bretton Woods regime made attained in the way of formal understandings. As no specific provision for the secular rise in the de- pointed out earlier, the widespread belief that cur- mand for international reserves. Over this early rencies should have a metallic content developed phase, reconstruction needs in Europe and into a broadly observed custom and the gold-specie elsewhere meant high demand for capital goods, standard then evolved into a convention. But the and the primary source of capital was the United Bretton Woods regime approached the status of States. This translated into a strong demand for international law and represented the first formal U.S. dollars and led to concern over the tendency international agreement on a code of conduct to toward a chronic "dollar shortage" within the sys- govern international economic relations. In its tem. This was seen as an inevitable outcome of the global conception, this post-World War II framework for the international economy was both international monetary system, since initially no comprehensive and ambitious. It encompassed forces were seen to contain and reverse the U.S. three main areas: exchange and financial matters— balance of payments surplus. In the event, this governed by the Articles of Agreement of the In- overall payments surplus proved to be relatively ternational Monetary Fund; the reconstruction of short-lived, and the dollar-balance accumulation abroad was substantial in the first decade of Bret- the war economies and the development of other 27 areas of the world—the mandate of the World ton Woods. Bank; and international trade relations—the in- The code of international financial conduct was tended purview of the International Trade Organi- adopted by all the major countries during this early zation, which never materialized. In its place, a part of its existence. This phase was followed by a somewhat more limited multilateral trade arrange- period during which the consolidation of the rules ment, called the General Agreement on Tariffs and of the game was accompanied by an enlargement Trade (GATT), was put into provisional applica- of their scope of operation as new nations entered tion a few years later, in 1948; though provisional in the international scene and subscribed to the re- origin, the GATT has proved lasting in practice. gime. Demand for international reserves was pro- The focus of this section is the development of gressively met by accumulation of U.S. dollars, and the monetary code of conduct, that is, on the inter- international concerns moved from the specter of a national monetary system that evolved with the es- dollar shortage to the threat of a dollar glut. By the tablishment of Bretton Woods.25 Two distinct early 1960s, a well-known dilemma arose which phases can be distinguished within the life of the pointed to a systemic inconsistency. The interna- Bretton Woods par-value system: an early stage tional economy demanded growing reserves, which spanning the recovery and gradual opening of war- were being satisfied by increased issue of U.S. dol- torn economies, as well as their progressive adop- lar-denominated assets. These represented lia- tion of the rules of the game (1945-59); and a sub- bilities for the United States, and they continuously sequent stage that witnessed the consolidation and grew relative to that country's gold stock, thereby rapid expansion of this rule-based regime across a 28 26 threatening convertibility. The dilemma antici- growing number of countries. pated the strains that would lead to the collapse of The early stage was characterized by progressive the Bretton Woods regime. Indeed, what had pro- liberalization of the tight trade and payments re- vided the solution to the earlier liquidity shortage strictions that had been established by most nations (U.S. balance of payments deficits) became a prob- during the hostilities. The process was a lengthy one and it was not until the end of the 1950s that lem when the United States began to depart from the Western European nations abandoned controls the rules of the game (when a dollar glut was allowed to develop). This predicament can also be seen from another 24See Schumpeter (1954, Part IV, Chapter 8) and Eichen- perspective, a perspective that, rather than stress green (1985) for further elaboration. the systemic inconsistency, links the origin of the 25The term international monetary system is used in the dilemma to a disregard for the rules of the game by broad sense of "a set of rules or conventions governing the economic policies of nations"; see Eichengreen (1989a, p. 255). 27 For a complete description of developments in the international See Cooper (1990) and Eichengreen (1989a). Factors that monetary system from the mid-1940s to the 1980s, see Solomon contributed to the provision of international reserves in the (1982). form of U.S. dollar balances held abroad were varied indeed. 26Extensive examinations of this period, its various phases, They included Marshall Plan grants and Korean War-related and the immediately subsequent years can be found in Horse- outlays, but also devaluations against the U.S. dollar and other field (1969) and de Vries (1976,1983). Also see Group of Thirty incentives for exports to the United States. (1988). 28This dilemma was formulated in Triffin (1960).

©International Monetary Fund. Not for Redistribution Variety of Resolutions the center (or anchor, to use contemporary termi- A lack of clear rules and the escape from a nology). From this standpoint, the dollar glut re- closely connected system to a regime of autono- flected a supply of U.S. dollars to the rest of the mous national units caused different reactions in world in excess of the latter's demand for interna- the international economy. Solutions (recycling tional reserves. Disregard for the excess-supply sit- and large capital movements) contributed to the uation inevitably had to undermine confidence in debt crisis of the 1980s and led to a protracted the system and impose a progressively tighter con- search for resolutions that would distribute bur- vertibility constraint on the United States, the dens of adjustment equitably. Also, the growing reserve-currency center. It also meant that other risk of policy conflict in the 1970s stimulated grow- countries perceived their adherence to the code of ing demands for policy coordination on the part of conduct as potentially, if not actually, inflationary industrial countries, and the phase of summitry and and consequently began to seek more policy inde- country groupings came to the fore. Economic pendence than was permitted by the code of con- summits of the major industrial countries—which duct. Such independence proved to be incompat- began in 1975—became a popular substitute for the ible with a fixed exchange rate regime; something rules that had been found so constraining during had to give and in 1971 the par-value system was the Bretton Woods era. Summits began to serve as abandoned. a means to exchange information, announce common policy intentions, and seek and negotiate mu-

29 tually reinforcing policy actions among partici- Move Toward Discretion pants. In most parts of the world, then, the The world economy entered into a period of gen- automaticity of rules had been replaced by the bar- eralized exchange rate floating in the early 1970s. gaining of discretion. Once again, the international code of conduct shifted from a rule-based framework toward one in Pendulum Begins to Swing Back which discretion dominated. In itself, the demand for greater independence represented dissatisfac- However, while these developments were under tion with the growing integration among econo- way, a subgroup of industrial countries decided to mies that had been attained during Bretton Woods. return progressively to the automaticity of rules. In Thus a revolt developed against the constraints im- 1979, the Western European countries formed the posed by economic interdependence. Both the re- European Monetary System (EMS), which was emergence of protectionist pressures and the move based (like Bretton Woods) on the concept of toward flexible exchange rates were evidence of fixed, but adjustable, exchange rates. Participation such a revolt, since these two developments aimed essentially committed these countries to subor- at closing off economies. But not all factors sup- dinating their national policies to the requirements ported the dispersion in the international system. of the EMS. These governments decided to ex- Growing capital movements tended to offset the ercise their sovereignty by submitting their policy trend toward disintegration and kept economies fi- autonomy to the constraints of an interdependent nancially interconnected; indeed, capital flows system. In the process, their economies' integration helped contain protectionism in trade and the vol- has progressed apace, the frequency of exchange atility of exchange rates. realignments has decreased, and the number of This period, the 1970s, can be described as one participants in the EMS has increased.30 characterized by events, such as sharp changes in There was also another development in the inter- terms of trade and corresponding shifts in current national economy that, while falling short of the re- account imbalances; by problems, such as high in- establishment of rules, sought to impose some con- flation and faltering growth; and by solutions, such straints on national discretion. It was made explicit as the recycling of oil-export earnings and large in the Plaza Agreement (September 1985) and the capital flows, particularly from commercial banks Louvre Accord (February 1987), both of which, to sovereign lenders. Yet, just as was the case with among other things, advocated coordinated indus- some of the solutions found in earlier periods, the trial country intervention in the foreign exchange solutions to the difficulties of the 1970s not only markets. Thus, although national discretion contin- proved less effective than had been anticipated but ued to prevail, its exercise was to be confined by the also became a problem for the following decade. requirements of international policy coordination.

29For ample discussion of events in this period and of issues 30Elsewhere I have called the EMS a regime that provided a of exchange rate management and policy coordination, see reasonable balance between rules and discretion. This balance is Polak (1981) and Kenen (1988, 1989); also see Solomon (1990b) dynamic and has moved more and more toward rules. See Gui- and Putnam and Bayne (1987). tian (1988b).

©International Monetary Fund. Not for Redistribution II RULES AND DISCRETION

At present, then, there is a hybrid international evaluation it is critical to acknowledge the limita- economic and financial system combining rules (al- tions of both policy coordination and policy auton- beit applied with a measure of flexibility) and dis- omy. It is clear that the pursuit of global economic cretion (albeit exercised within defined limits). In objectives, even when these have been agreed upon addition, the international economy includes a va- internationally, cannot be expected to endure if riety of country groupings with diverse concerns. these objectives conflict with legitimate domestic Apart from the long-lasting distinction between de- aims; conversely, the pursuit of domestic objectives veloped and developing economies, subgroups that run counter to those sought elsewhere in the among the latter countries are now classified ac- system cannot be sustained. From this standpoint, cording to their income and the size of their debt. the choice available to countries is not whether to The distinction between creditors and debtors is coordinate their policies but how best to do it. also proving to be less transitory than anticipated. Needless to say, it is unrealistic to expect nations to And among the industrial countries, diverse bal- coordinate policy solely out of altruism. But it is ances have been struck between rules and equally unrealistic to assume that nations always discretion—some nations incline toward discretion approach coordination out of pure self-interest. buttressed with policy coordination; others seek automaticity and transparent rules of behavior. Appropriate Setting for Policy Coordination It should not be surprising, therefore, that there is ample scope for conflict between the various In general, coordination requires that countries do their best to keep their own economies in order groups: the low-income countries seek aid flows; 33 the debtor nations struggle to obtain debt relief; (the "Fischer standard"). Such a standard allows the creditor countries try to safeguard their assets governments to earn a reputation as able coordina- and contain moral hazard; Western Europe seeks tors of domestic policy, this being no mean en- predictability; and other industrial countries favor deavor in itself. With the domestic agenda secured, adaptability. Indeed, the code of conduct since the global policy objectives and priorities can be estab- demise of Bretton Woods has varied continuously: lished for internationally coordinated policy action. exchange rate flexibility (1973-78), first generalized Thus, reputations for domestic policy coordination and then with country groupings (the European can help to build equivalent reputations in the in- snake); flexibility accompanied by a set of countries ternational domain. What should be clear, though, operating under relatively fixed exchange rates is that international coordination is no substitute (1979-84); and managed flexibility among major for appropriate national policies. currencies and virtually fixed exchange rates in the The preaching of policy coordination is best European Monetary System (since 1985). To an ex- done by example, with such coordination beginning tent, this margin for conflict may be behind the at home. However, a measure of policy coordina- growing interest in policy coordination, even tion on the international front is unavoidable, and though views still differ considerably on the merits its effectiveness requires both transparency and and demerits of coordination.31 clarity. In this context, rules—clear rules—are preferable to discretion as the means for ensuring policy consistency. Nevertheless, the appeal of discre- Final Remarks tion is not about to fade completely, and the As in many other economic policy areas, the is- international economy will continue to confront a sues at stake in the controversy between rules and difficult challenge in its recurrent moves between discretion involve intertemporal choices nationally rules and discretion. When rules prevail, a measure as well as internationally.32 Such choices, unfor- of flexibility in their implementation will be re- tunately, are rarely straightforward, and in their quired if they are to last. And when discretion prevails, some norms or guidelines to clarify its exercise and direction will be imperative; otherwise, 31They range from a belief that coordination will likely damage independent (or even "enlightened" interdependent) discretion will be tantamount to disorder and will action or that the gains to be reaped from coordination are prompt restraining action. It is in this sense that the small (see, for example, Feldstein (1988a, 1988b) as well as international economy tends to oscillate between Fischer (1988) and Frankel (1988)), to arguments that coordina- regimes of "flexible" rules and "rigid" discretion. tion, though a second-best substitute for rules, is necessary in an interdependent system. The literature on the subject is ample, and for the time being the appropriate position on policy coor- C. Simons, "Rules Versus Authorities in Monetary Policy," in dination may be one of agnosticism; for an excellent discussion Journal of Political Economy. Also see Simons (1948). On the of these issues, see Bryant (1987). intertemporal nature of policy choices, see Guitian (1987b). 32This controversy has also arisen in the domestic economic 33This standard refers to Stanley Fischer's statement that "the policy context. See, for example, Friedman (1959), where refer- best that each country can do for other countries is to keep its ence is made to the classic 1936 article on the subject by Henry own economy in shape"; see Fischer (1988, p. 13).

©International Monetary Fund. Not for Redistribution Final Remarks

Need for Clarity action elsewhere. Moreover, as on the domestic front, the adoption of a policy mix on the interna- There can hardly be any doubt that delicate bal- tional level which seeks to compensate for policy ances need to be struck between national and inter- errors in one region with policies in other regions (a national objectives and between the predictability modality of fine-tuning) rarely leads to balance any and the adaptability of policies. In a real sense, the more than a combined set of wrongs leads to a right. choice is not between rules and discretion but between enlightened rules (with some discretion) and enlightened discretion (with some rules). International Policy Surveillance By way of characterization, approaches that em- Institutionally speaking, means have been de- phasize rules are cosmopolitan in nature; those that veloped to monitor international interactions and uphold discretion are local in character. Both out- assign corresponding policy responsibilities. This is looks have their merits and the challenge is to find true whether rules or discretion are the order of the a mix that maximizes their respective advantages. day. Policies and procedures for international pol- This requires clarity: transparent signals in the icy surveillance have evolved on various levels: reg- blend of rules and discretion. For example, a clear ular reviews of a jurisdictional, advisory, or con- signal is necessary to avoid the Scylla of symmetry: sultative nature (Article IV consultations with a desire for ex post symmetry among certain eco- member countries and World Economic Outlook nomic variables that dictates that ex ante symmetry discussions at the International Monetary Fund; must also prevail. Another clear signal is required meetings in other fora such as the Organization for to avoid the Charybdis of policies aimed at fine- Economic Cooperation and Development and the tuning the economy, not only domestically but also Bank for International Settlements); reviews con- internationally. A system of limited but transparent nected with conditional international support (for rules, which assigns responsibilities clearly, is the example, IMF financial assistance);35 and possible most likely way to resist the siren calls of disorderly sanctions for a serious and persistent lack of obser- policy. vance of agreed international norms. Needless to An immediate illustration of the need for clarity say, the operation of these policies and procedures in these areas can be seen in the responsibilities of is much simpler under rules than under discretion, deficit and surplus countries in the international but it can be effective under both, provided there is system, which typically are anything but symmetri- enough international spirit. cal (even though, ex post, there is symmetry of defi- In conclusion, a question that often arises in dis- cits and surpluses). Primary responsibility for cor- cussions of economic organization is whether the rective policy action falls on deficit countries; such international policy system must be based on the action will result in changes in price and quantity presence of a dominant actor, a hegemonic power. variables in the system. The responsibility of sur- This argument is debatable and its political im- plus countries is to allow such price-quantity plications are worth analysis. But from the stand- changes to operate in their economies and influ- point of this paper, a belief that international order ence behavior.34 Clarity regarding respective re- necessarily requires a hegemon is equivalent to a sponsibilities would minimize the likelihood of belief that domestic order calls for a despot. Even those frequent impasses observed in the interna- though economic policy analysts often contend that tional sphere that result from policy inaction by difficult policy decisions are more likely to be un- one party on the grounds that there is no policy dertaken in a dictatorial setting, it is not a given that a dominant power is needed for the establish- 34A necessary condition for symmetry of deficits and sur- ment and prevalence of order. In the end, the pluses is that global demand in the world economy be at an proper occupant of the role of the hegemon is the appropriate (equilibrium) level, the imbalance would then cor- rule of law. respond to an inadequate composition (or distribution) of global demand among countries. Such a set of circumstances is not particularly likely, and even if it were, there would seem to be 35See, on these questions, Kenen (1986, 1987) and Guitian no reason why a reduction of demand in deficit countries, (1981, 1989a). For an extensive discussion of the role and de- through its impact on variables like interest rates, prices, and velopment of rules of the game in the international monetary exchange rates, would not be sufficient to restore balance. system, see Dam (1982).

©International Monetary Fund. Not for Redistribution Ill The International Debt Crisis: What Have We Learned?

"Let us live in as small a circle as we will, we problems of external indebtedness. One significant are either debtors or creditors before we have insight gained from the evolution of the debt strat- had time to look round." egy is the difficult balance between national auton- GOETHE omy and the need for international rules. In order to lay out these lessons, it is first neces- he 1980s will almost certainly go down in eco- sary to go briefly into the history of the past two nomic history as the decade of the international decades. This is well-trodden ground, but when ap- Tdebt crisis, a period during which the debt-servicing proached from a new perspective it reveals the difficulties of the developing world became a vir- need for balance between rules and discretion. This tually constant feature of the international economic historical setting also provides the canvas for a styl- scene. Since the crisis erupted, much has been done ized sketch of the debt strategy in its various to redress those difficulties, though a definitive res- phases. This sketch is followed by a summary out- olution to the indebtedness problems has remained line of the role of the International Monetary Fund elusive. and the adaptations made to the institution's pol- A good amount has been written about the debt icies and procedures in response to the evolution of crisis since its abrupt entrance onto the interna- the debt strategy. Finally, a number of critical tional stage in August 1982, with the announce- lessons are drawn that should help the interna- ment by Mexico of its inability to continue servic- tional economic system cope with similar problems ing its external debt obligations.36 The bulk of this in the future. The section concludes with a few final literature has focused on the genesis and develop- observations about the debt crisis and the need for ment of the debt crisis,37 proposals for its resolu- certain basic norms of behavior. tion,38 and the examination of analytical issues in external debt management as well as of a multi- Background plicity of financing modalities and techniques.39 This section does not add to the variety of these A striking feature of the 1980s is the extent to topics so much as develop a number of essential which the decade was dominated by events that lessons from the protracted struggle the interna- took place in the 1970s. Even more striking is how tional economy has been waging with the obdurate the factors that complicated the 1980s included not only the problems of the 1970s but also their 40 36The full list of articles and books on external debt issues is solutions. extensive and cannot be included here. A sample of volumes on In a nutshell, the 1970s will enter economic chron- the subject includes Mehran (1985), Smith and Cuddington icles as a difficult decade, one that saw sharp (1985), Kahler (1986), Frenkel, Dooley, and Wickham (1989), changes in the terms of trade and corresponding Dornbusch, Makin, and Zlowe (1989), Calvo and others (1989), Husain and Diwan (1989), and Stoll (1990); also see McDonald shifts in current account imbalances as well as high (1982). inflation and faltering growth. Attempts to resolve 37See, for example, Cline (1984) and Guitian (1987a); also see these problems with the recycling of petrodollars Dornbusch (1987, 1989); John Cuddington's essay "The Extent and large capital flows, particularly from commercial and Causes of the Debt Crisis of the 1980s," in Husain and Diwan (1989); Nowzad (1990); and Solomon (1990a). banks to sovereign borrowers, only confounded 38See Kenen (1983, 1990a), Feldstein and others (1987), Dornbusch, Makin, and Zlowe (1989), Cohen (1989), Dorn- 40For brevity's sake, only global developments are discussed busch (1989), and Sachs (1989). and no reference is made to the role played by policies pursued 39See K. Burke Dillon and David Lipton's article, "External by specific countries. The importance of this caveat cannot be Debt and Economic Management: The Role of the Interna- overstressed because in many respects the global trends out- tional Monetary Fund," in Mehran (1985), as well as the collec- lined in the text are the joint results of all those policies. An tion of papers in Frenkel, Dooley, and Wickham (1989); also see extensive discussion of the genesis of the debt crisis can be Sachs (1984) and Guitian (1987b, 1989a, and 1989b). found in Cline (1984); also see Guitian (1989b).

©International Monetary Fund. Not for Redistribution Sketch of the Debt Strategy matters. In a fundamental sense, it can be argued Sketch of the Debt Strategy that the 1970s witnessed a revolt against the close interdependence and integration of the interna- The large accumulation of external debt lia- tional economy during the previous two and a half bilities by developing countries in the period decades. This revolt was made particularly evident through 1981 and the abrupt interruption of capital by a surge of protectionist pressures in many coun- flows in 1982 called for a prompt response from the tries, but it was also clear in the generalized move international community to contain potential dis- from fixed to flexible exchange rates, which re- ruptions to international economic relationships. flected the search for autonomy in national eco- The immediate aim was to avert irreparable nomic policymaking. Another important trend damage to the fabric of the international economic tended to counter these two effects, however: the and financial system. The general perception was emergence of growing capital movements, which one of impending systemic danger, the avoidance for some time, at least, provided cohesion to the of which required contributions from both creditor international financial system. It was therefore un- and debtor countries, private and official entities, derstandable that the expansion of the interna- and national and international institutions. tional lending-borrowing process was perceived as part of the solution to some of the period's problems; after all, the growth in lending had kept trade flowing more fluidly and made exchange rates less Initial Approach variable than would have otherwise been the case. When the debt crisis erupted, time was of the Yet, by the early 1980s, strains began to show; in essence, and in its initial conception the debt strat- fact, a better illustration of the intertemporal inter- egy sought to lift the obstacles that blocked interdependence of economic phenomena would be dif- national financial flows. The central aim was to en- ficult to find. Those years show clearly the ease sure an amount of external financial support that with which the correction of one imbalance can would permit debtor countries to undertake adjust- thwart the solution to another. Among the indus- ment efforts which offered reasonable assurances trial countries, the negative experience with infla- that debt service could and would be eventually tion in the 1970s swung the pendulum toward do- resumed. The requisite amounts of financial assis- mestic policies aimed at bringing the price tance included new funds as well as the refinancing increases rapidly under control. In turn, the resolu- and rescheduling of old debts on traditional terms. tion of the inflation problem was accompanied by It was promptly realized, however, that, impor- the emergence of high real interest rates and a slow- tant as an appropriate amount of financial support down in economic activity. As a result, decisions was, it would not be sufficient. It would also be made in borrowing countries when real interest necessary to make the terms of foreign financial rates were negative became untenable, and the con- assistance compatible with the prospects for bal- sequences soon surfaced: creditworthiness concerns ance of payments recovery in debtor countries. A among lenders mounted and the flow of international loans and capital accordingly and abruptly primary feature of this second element of the origi- dried up. nal debt approach soon appeared in the form of multiyear rescheduling arrangements, which credi- In effect, the legacy of the 1970s included prob- tors began to make available to debtors as their lems, such as inflation, which called for decisive pol- adjustment progressed. These multiyear arrange- icy action, and solutions such as recycling and large ments extended the coverage and maturity of re- capital flows, which resulted in significant external scheduled loans over significantly longer periods asset-liability accumulations across countries. Al- than those traditionally granted in the past. though other factors—most notably, the quality of countries' domestic policies—were also accountable, The essence of the initial debt strategy was to the actions required to control inflation in the indus- assign to each of the various actors a specific and trial world in the early 1980s (measures that were mutually supporting role, rather than let the outcome of the debt crisis be determined solely by absolutely necessary to restore a critical element of 41 balance to the international economy) contributed market forces. There was a fundamental logic be- to the emergence of debt-servicing difficulties. The hind the original debt strategy: adequate financial experience since the 1970s has thus shown not only how elusive autonomy in national economic policy 41The view that governments should not interfere in the debt can be—that is, flexibleexchang e rates fell far short process and that the solution of the debt problem should be left of insulating country economies—but also how the to the market has been advocated by some authoritative econo- mists; see, for example, Friedman and others (1984), in which cohesion fostered by capital flows and recycling can Friedman states that the solution to debt problems is "to require suddenly give way to the dispersion of the debt cri- the people who make the loans to collect them. If they can, fine, sis, a disorder reminiscent of the absence of rules. and if they can't, that's their problem" (p. 38).

©International Monetary Fund. Not for Redistribution Ml THE INTERNATIONAL DEBT CRISIS

support for the adjustment efforts of debtor coun- Menu Approach tries would help restore their debt-servicing capacity. With it, their creditworthiness would improve, Though effective in removing the systemic threat and spontaneous capital flows would correspon- to the banking system and to the international dingly resume. The strategy did prove effective in trade and financial network, the debt strategy up defusing the threat posed to the international fi- through the Baker initiative was still unable to nancial system by the debt crisis. But the resump- eliminate the debt problems of individual coun- tion of spontaneous capital movements did not ma- tries. In addition, the flow of international capital terialize as quickly as had been expected, and remained constrained, and many debtor countries modifications in the debt strategy therefore be- continued to confront debt-servicing difficulties. came necessary. Further adaptations to the debt strategy became necessary to prevent the process of debt resolution from stalling. These took the form of innovations in Baker Initiative financing modalities and techniques. Emphasis on the market-based nature of the adaptations led to The first adaptation of the debt strategy came in the introduction of a "menu approach" to new 1985 in the form of an initiative by U.S. Treasury lending in 1987 and the cautious acknowledgement Secretary James Baker; it recognized that the debt 42 of the option of voluntary debt reduction. problem would take time to resolve. The basic The menu contained a variety of options includ- philosophy of the original strategy remained un- ing debt-equity swaps, debt buybacks, debt ex- changed in that the central aim was to restore changes, exit bonds, and the like.43 These options debtors' capacity to service debt, their credit- have proved useful in specific countries, but like worthiness, and their access to spontaneous capital the Baker version of the debt strategy they failed to flows. In addition, though, the resolution of the provide a definite solution to the problems of in- debt difficulties was seen as requiring the promo- debtedness and limited access to capital markets; tion of economic reforms in debtor countries to both problems remained. foster development and growth. The process of debt resolution was thus broadened to encompass, besides balance of payments stabilization and res- Brady Plan toration of creditworthiness, longer-term develop- Given the insufficiency of the preceding ap- ment and growth objectives. proaches, U.S. Treasury Secretary Nicholas Brady This broader agenda for solving external in- proposed further changes to the debt strategy in debtedness had implications for both debtors and 1989. The Brady plan endorsed the existing debt creditors as well as for other sources of capital and strategy in all its key aspects--adjustment-cum- financing. On the part of the debtors, the extended reform in debtor countries, continued external sup- time horizon and the consequent emphasis on port, and a case-by-case approach to debt resolu- growth led to structural reform to promote effi- tion. The central innovation of the plan was its ciency in the economy. As for creditor countries, focus on the actual reduction of debt stocks and their contribution was to be made mainly through debt-service flows as a complement to external fi- the multilateral development banks, which were to nancial support. In its first three phases, the debt increase their lending to debtor countries signifi- strategy had focused consistently on the impor- cantly. The initiative also called for continued com- tance of new lending and more lenient repayment mercial bank lending. schedules for past borrowing; voluntary debt re- The Baker initiative emphasized several impor- ductions had also been considered, though clearly tant aspects of the resolution of debt difficulties. as a secondary possibility. The longer time perspective meant that macro- The Brady plan brought debt and debt-service economic management would have to be sup- reduction to the fore. In effect, it acknowledged ported by microeconomic measures to enhance that such an option properly belongs within the efficiency and productivity, and thus growth. The debt strategy. To this end, the plan envisaged that initiative also highlighted the importance of contin- official resources be used to facilitate such reduc- ued external financial support over an extended tion. It is clear, however, that the reduction of debt period to give economic reforms sufficient time to and debt service by external parties will not solve yield results. the indebtedness problems. The debt strategy

42For a detailed exposition of this initiative, see William 43For a description and analysis of these various options and Cline's essay, "The Baker Plan and Brady Reformulation: An modalities, see Regling (1988), Dooley and Watson (1989), and Evaluation," in Husain and Diwan (1989); also see Sachs (1989) the collection of articles in Frenkel, Dooley, and Wickham and Solomon (1990a). (1989).

©International Monetary Fund. Not for Redistribution Role of the International Monetary Fund

continues to treat the policy efforts in debtor coun- ment, financing (including external debt flows),an d tries as the crucial ingredient for the resolution of growth. Strengthening this relationship in a univer- the debt crisis.44 sal setting and in accordance with well-tested norms of conduct can only occur if all major parties participate. Thus, although the IMF has contributed di- Role of the International rectly with its own resources to the financing pack- Monetary Fund ages arranged for debtor countries, its primary responsibility and attention has focused on their ad- Any examination of the role of the International justment policies. This emphasis has enabled the Monetary Fund in the resolution of the debt crisis IMF to become the vehicle to which all the other must take account of two fundamental institutional elements of a cooperative approach can be attached. principles. First, consideration has to be given to A basic rationale behind the approach has been the universal character of the institution. Its mem- that there is no substitute for the pursuit of sound bership includes all varieties of countries: develop- domestic policies in the debtor country. While per- ing and developed; debtor and creditor. This prin- haps not sufficient, sound economic policies have ciple of universality makes the institution responsi- been seen as a necessary condition for the resolution ble for protecting the interests of all countries, not of debt-servicing problems. The IMF has sought to just those of particular groups among them. Sec- ensure observance of this necessary condition ond, recognition must be given to the advantage to through its specific policy understandings with all countries of the free flow of trade in goods, ser- debtor countries in the context of their financial ar- vices, and capital. This principle of freedom of rangements with the institution. Policy condi- trade, a cornerstone of the IMF, explains why the tionally has therefore been an essential element in institution has always sought to encourage the inte- the debt strategy. Not only can it correct imbalances gration of member countries into the world in the economies of debtor countries but it can jus- economy. tify financial support from lenders and, in time, it These two principles are imbedded in the Arti- can pave the way for the resumption of international cles of Agreement of the IMF, which outline a code saving flows in response to market incentives. In this of international economic conduct to which all fashion, countries have a measure of national discre- members have subscribed. These principles, which tion to pursue their own interests (the correction of partake of the nature of rules, represent certain imbalances) by means consistent with agreed inter- constraints the institution must observe in the dis- national rules of behavior. charge of its general responsibilities and in its in- In the early phase of the debt strategy, condi- volvement in the debt process. In this latter en- tionally focused mainly (though not exclusively) deavor, the challenge for the IMF has been to on macroeconomic management aimed at balanc- contribute to the resolution of debt problems in a ing the demand for and the availability of re- manner that fosters efficient economic expansion sources. As the horizon for policy formulation and promotes interdependence and integration, lengthened to include the medium run, macro- thus strengthening the code of international eco- 45 economic management was explicitly supple- nomic conduct. mented by structural reform and microeconomic policy actions to ensure efficient resource use. These measures included the liberalization of trade Adjustment, Financing, and Growth and the opening of the economy, both of which The essential challenge for the IMF and its mem- were to enhance efficiency, strengthen competition, ber countries has been to buttress the critical—but and encourage the resumption of capital flows. To- elusive—relationship that binds together adjust- gether with the re-establishment of a balanced macroeconomic framework, they were also ex- 44 pected to arrest the outflow of domestic resources Analysis of debt-reduction schemes can be found in 46 Williamson (1988) and in Paul Krugman's "Market-Based and help reverse capital flight. Debt-Reduction Schemes" and Elhanan Helpman's "Voluntary With regard to creditors in general, a key aim of Debt Reduction: Incentives and Welfare," in Frenkel, Dooley, and Wickham (1989); also see Jeffrey Sachs's essay, "Efficient the debt strategy, as noted above, was to reverse Debt Reduction," in Husain and Diwan (1989) and El-Erian the abrupt interruption of capital movements. Cir- (1990). cumstances at the time did not encourage lenders 45For additional views on the role of the IMF in the debt to provide further resources to indebted countries, crisis, see de Larosiere (1986, 1987); Richard Erb's "Current Developments in the Debt Crisis" in Stoll (1990); Jeffrey Sachs's "Strengthening IMF Programs in Highly Indebted 46For a discussion of issues of capital flight, see Cuddington Countries" and Guillermo Ortiz's "The IMF and the Debt Strat- (1986), Khan and Ul Haque (1985, 1987), and Ize and Ortiz egy" in Gwin, Feinberg, and contributors (1989). (1987).

©International Monetary Fund. Not for Redistribution THE INTERNATIONAL DEBT CRISIS

and this situation called for an important innova- burden of debt service by extending the maturity of tion in IMF policies and procedures—the introduc- loans or by refinancing outstanding debts. tion of "concerted" lending packages.47 The IMF began to require creditors to provide firm assurances of the availability of external financing be- Debt and Debt-Service Reduction fore it would move with its own support of the With the introduction of the Brady plan, and its debtor adjustment program: a "critical mass" of focus on the actual reduction in debt stocks and commitments of external assistance became a pre- debt-service flows, arrangements with the IMF be- requisite for the completion of an arrangement gan to include such debt and debt-service reduction with the IMF. In this way, the IMF moved to cata- options. Indeed, it was soon decided that IMF re- lyze capital flows toward countries willing and able sources could be made available, albeit on a limited to undertake an adjustment in their economies. In scale, to finance these operations. turn, international lenders linked the availability of In addition, a number of other important steps resources to progress made under the adjustment were taken by the institution to increase the useful- programs. Thus, a balanced distribution was sought ness of its participation in the debt strategy:49 a between the efforts required from debtors—that is, modification of the policy of assuring financing,s o adjustment—and those required from creditors— that arrangements with the IMF could become that is, financing. In the process, a measure of con- effective even before the completion of negotia- ditionally was exercised on creditors as well as on tions with creditors on a financing package; the en- debtors, and a fine balance between international hancement of the Extended Fund Facility (EFF), rules and national discretion began to emerge. both in the duration of and access to IMF resources; the expansion and adaptation of a financial Money Packages and Menus facility to deal with unforeseen contingencies (Compensatory and Contingency Financing Facil- The financial arrangements of the IMF with ity (CCFF)); and a cautious tolerance of arrears, debtor countries increasingly became the instru- typically linked to a well-defined plan for their ment around which the collaboration between eventual elimination. debtors, creditors, banks, and multilateral institu- The various changes made in the debt strategy tions was built. As the debt strategy developed, the arrangements were adapted to encompass the new represented a simple recognition of the intrac- elements. Thus, with the Baker initiative, emphasis tability of the problem of international indebted- was placed on the growth and structural reform ness. The IMF contributed with the instruments at aspects of the adjustment process;48 this initiative its disposal—conditional financial assistance and focused attention on the adjustment and structural the requirement that other lenders also participate reform efforts to be undertaken by debtors, that is, in the joint effort. In addition, the institution it broadened the policy conditionality of the sought to tie the effectiveness of the debt strategy strategy. to the quality of economic policies in the major Adaptations were also made on the financing creditor countries. This line of activity went beyond side. The concerted lending approach, which had the institution's specific aims of encouraging trade envisaged the provision of new loans and the refi- openness, which provided debtors with an oppor- nancing or rescheduling of old loans, evolved into tunity of earning foreign exchange, and of seeking broader and more sophisticated money packages a resumption of capital flows and external financ- and menus, which, as described earlier, added a ing. There was more at stake in the debt crisis than variety of novel financing techniques, including vol- the consistency of the cooperative approach with untary debt relief. Still, the principal focus of the respect to the trade and capital accounts. Accord- debt strategy remained the restoration of credit- ingly, the appropriateness of industrial country pol- worthiness through policy corrections in debtor icies was seen as instrumental to the stability of the countries—to reduce imbalances, enhance produc- world economic environment. Enhancing the tivity, and foster growth—and through easing the quality of those countries' policies would help debtors manage their economies even more effec- 47For an excellent discussion of the role of creditors and debtors in the debt strategy, see de Larosiere (1986). 49For additional expositions of these adaptations, see Richard 48In effect, growth and efficiency have always been ultimate Erb's "Current Developments in the Debt Crisis" in Stoll (1990) aims in the adjustment effort, in general, and in those under- and Guillermo Ortiz's "The IMF and the Debt Strategy," in taken to overcome debt problems, in particular; but these as- Gwin, Feinberg, and contributors (1989), an article that also pects were enhanced with the Baker initiative. For a discussion contains an extensive discussion of the most recent arrangement of the issues of adjustment, growth, and debt, see International with Mexico, which includes many of the adaptations discussed Monetary Fund and World Bank (1987) and Selowsky and Van in the text. Since then, other countries have also completed der Tak (1986). Brady-type arrangements with creditors.

©International Monetary Fund. Not for Redistribution Broad Issues

tively than could adapting the debt strategy alone. debtors contending that the adjustment effort has For this reason, increasing attention has been paid been derailed by the failure of financingt o conform by the IMF to industrial country policy and to its to the programmed path; creditors arguing that fi- impact on the economies of individual members or nancing cannot proceed precisely because the ad- groups of members, including debtor countries and justment effort has faltered. The complications the developing world at large.50 caused by these different perceptions have often been compounded by the linkage typically made between the disbursement of financial flows and Practical Difficulties policy performance in the debtor country. Yet this The task of bringing together a group of separate linkage has been a necessary feature of the ap- interests is rarely simple, and cohesion can prove proach, given that in its absence external financing the most elusive of aims. In the process of imple- could hardly be expected to resume. menting the debt strategy, examples of such elu- siveness have often cropped up. During the nego- tiation of financial arrangements with debtor Broad Issues countries, pressures have developed as each party These practical difficulties point to an important has sought to protect what it perceives as its imme- lesson concerning the areas on which the various diate interest. Frequently, but perhaps not sur- parties involved in the debt problem should focus. prisingly, those frustrations have been directed at While it is undeniable that each party has unique the IMF, since the institution has provided the fo- interests, the effectiveness of the whole strategy cal instrument that makes the operation possible can critically hinge on the ability and willingness of (that is, the financial arrangements). everyone to focus on the common aspects of those To a large extent, the pressures have reflected a diverse interests. For debtors, adjustment programs possibly excessive amount of attention given to the that contemplate financing on terms that are not apparent substitutability between adjustment and compatible with the economy's productive capacity financing. This has led debtors, on one side, to and its prospects for balance of payments recovery stress the importance of financing, or the contribu- will contribute neither to adjustment nor to growth. tion of creditors, and has led creditors, on the other Conversely, for creditors, financing that constrains side, to underscore the necessity of adjustment, or debtors excessively will obstruct the adjustment the contribution of debtors. There is a certain logic effort and ultimately impair the value of their past in these positions: for debtors, financing would per- loans. Clearly, financing that supports efficient admit them to stretch out the adjustment effort; for justment provides the best means for its own pro- creditors, a determined adjustment effort would tection. Apart from this practical lesson, however, justify their provision of financing. From a funda- several other fundamental issues from the in- mental standpoint, however, adjustment and fi- debtedness decade transcend the problems of debt nancing complement one another, and this is the and point to the importance of the existence and aspect of the relationship on which the IMF— observance of certain rules for the efficient opera- which represents both creditors and debtors—has tion of markets. based its approach to the issues of indebtedness. In principle, the issues posed by these divergent perceptions would be settled once the expectations Moral Hazard of debtors and creditors, and consequently their Behind creditors' concern with the strength of understandings regarding adjustment and financ- adjustment efforts and their reluctance to entertain ing, have been aligned; yet, the pressures do not debt relief is the risk of moral hazard.51 Most fre- vanish at that stage. Once agreement has been se- quently, concern about the moral-hazard risks re- cured, it becomes necessary to ensure that the flects the possibility that unless new financing flows various components of the financial package not are clearly associated with a serious adjustment only materialize but do so at the appropriate time. effort on the part of the debtor, a clear danger will Otherwise, the adjustment path carefully mapped arise that such external support, rather than en- out by the debtor can be thrown off track. In other couraging the pursuit of corrective policies, will words, such deviations tend to distort the carefully only contribute to the continued pursuit of inap- crafted balance of interests built into the original propriate economic management. agreement, thereby giving rise to a vicious circle: 51For an ample discussion of these issues, see Cohen (1989), 50Such policy interactions are examined in the IMF's World who, besides moral hazard, lists the following related concerns Economic Outlook as well as in individual consultations of the over debt relief: contagion, loss of creditworthiness, weakening institution with major industrial countries. of discipline, and legal and political issues.

©International Monetary Fund. Not for Redistribution IN THE INTERNATIONAL DEBT CRISIS

The risk of moral hazard is perceived most moral-hazard risks. If debtors and creditors had strongly in the context of debt forgiveness or debt perceived that inefficient decisions on their part reduction,52 because consideration of these options would have no cost and would be treated like effi- tacitly acknowledges that debts cannot be repaid, cient ones, they would inevitably have become in- an acknowledgement that can undermine the different to the risks inherent in their transactions. lending-borrowing process. Because of this risk, it Fortunately, a measure of hedge against moral haz- is generally agreed that debt reduction should be ard has been provided by the exceptional character infrequent; if possible, it should be a one-time of debt relief and has been supported by the event so as to avoid the recurrence of debt willingness of debtors and creditors to accept that if problems. excess borrowing can be seen as the counterpart of This moral-hazard risk is the fundamental ra- excess lending, debt reduction is consistent with a tionale behind the insistence that the adoption of market-determined outcome. Indeed, when the adequate policies be a prerequisite to the extension market distributes losses and gains—as is typically of external assistance in the form of new funds, the case in the context of national economies—the debt relief, or debt reduction. Fundamentally, it is allocation is perceived to be based on objective cri- in the interest of both creditors and debtors to en- teria (market rules) rather than discretion. sure that external resources support, rather than hinder, efficient adjustment efforts. Only on that basis can international capital flows be expected to Public Versus Private Risk resume and persist. Another important issue when dealing with A risk of moral hazard can also arise with respect countries' indebtedness problems concerns the to creditors. While concerns over debtors focus on firmness of the separation between private and the insufficiency of their adjustment effort (or its public risks. An immediate example is the exten- counterpart, unduly severe adjustment), the con- sion of government guarantees in connection with cern with regard to creditors revolves around the private borrowing-lending transactions. As is the insufficiency of their financing (or its counter- case with all types of insurance, these guarantees part, excessive or inappropriate financing). An ap- blur the frontier between private and public risk proach that ensures full servicing of outstanding and can be expected to affect the behavior of eco- debt at any cost, that is, even when the debtor is in nomic agents. irreparable difficulties, would tend to dampen cred- The perception that the line between these two itors' incentive to maintain efficiency in their kinds of risks can be softened is likely to give rise to lending. pressures that may be difficult to resist. For exam- These two moral-hazard risks are intercon- ple, in circumstances of debt difficulties, debtor nected: total elimination of moral hazard for governments typically face pressure to guarantee debtors would ensure the emergence of moral haz- or even to assume private debts. And the pressure ard for creditors and vice versa. As was the case comes from both sides of the original transaction: with the mix of adjustment and financing, here from the private domestic debtor, who would like again the issue is one of balance. And the signals to share the burden of the liability with other tax- for assessing balance are best sought in the market, payers (and thus pass it on); and from the private with such market criteria going beyond traditional foreign creditor, who perceives a reduction in the indicators of macroeconomic performance to en- risks associated with the asset.54 Thus, from the compass the efficiency of the lending-borrowing standpoint of both the private debtor and the pri- process. Thus, the market separates efficient and vate creditor, there is an advantage in having the productive lending and borrowing decisions from government guarantee or assume the debt. To the those that are inefficient and unproductive; on this extent that those pressures are allowed to prevail— basis, "good" loans, or assets, are distinguished thereby reducing or eliminating the separation be- from "bad" loans, or liabilities. tween private and public risks—dangers of moral However, the initial urgency of the debt crisis hazard similar to those already discussed will arise. meant that the first approach treated all outstand- Therefore, for the same reasons that the debt strat- ing debts equally,53 thereby raising the specter of egy should seek to replicate market outcomes, practices or actions that can easily convert private risks into public ones should be avoided. 52A hurdle to which debt reduction gives rise is the difficulty of reconciling it with demands for continued new lending. 53This is by no means necessary and, as noted earlier, strong 54See, in this context, Jeffrey Sachs's "The Debt Overhang of arguments can be and have been made to the effect that the Developing Countries" and, in particular, George L. Perry's resolution of debt problems would be best left to the market; "Comment" on Sachs in Calvo and others (1989) for further see Friedman and others (1984). discussion of these points.

©International Monetary Fund. Not for Redistribution Final Observations

Role of Government better to the principle of separation between the two sectors than the international economy does. This discussion of risks leads directly into the 55 On the international level, not only is there no au- fundamental question of the role of government. thority comparable to a national government but An important share of the literature in economic the rules of behavior are less well defined (and ob- theory and policy has been based on a clear distinc- served) than in the domestic setting and the conse- tion between the public sector and the private sec- quent risks of ambiguity and moral hazard are tor. Blurring or softening that distinction has im- larger. portant policy implications because it affects the In the specific context of the debt strategy, the pattern of economic behavior. need for a balanced distribution of the burden A clear example of the dangers of ambiguity is among debtors and creditors illustrates both the the argument that economic imbalances that origi- importance of rules and the difficulties that can nate from private sector behavior are not matters arise in their absence. Consider the general princi- for public policy because they are essentially self- ple of the "sanctity of contracts," which is generally correcting. There are at least two levels on which agreed to be of enormous relevance for reducing this argument needs to be closely examined. One is uncertainty and for forming expectations. In the the extent to which it can be clearly demonstrated domestic domain, the principle prevails and its ob- that an imbalance originated exclusively in the pri- servance is protected by well-established pro- vate sector, which is not always easy to do; an ex- cedures that deal with situations when the terms of ample is the case where a private sector imbalance a contract become difficult or impossible to meet, has been caused by inappropriate government pol- for example, bankruptcy law and procedures.56 icies. The second is the extent to which government The absence of an equivalent law or of similar con- and private sector domains remain separate in ventions at the international level renders the reso- practice, that is, the government's ability to resist lution of external indebtedness problems and other intervening when pressure from private imbalances international conflicts all the more difficult. Such builds in the economy at large. an absence again increases the appeal of letting ob- The more permeable the line between the gov- jective market forces handle the debt problems, ernment and private sectors, the higher is the risk though examples abound, both nationally and in- of moral hazard. Here again, the importance of ei- ternationally, of the reluctance to entertain the ther keeping the separation intact or openly facing market option, particularly when the problems are the consequences of blurring the boundary cannot thought to be systemic. be overstressed. A government that is in balance It is indeed paradoxical that governments that and that invariably sticks to the separation between often act together to develop a debt strategy and public and private affairs can argue plausibly that other cooperative actions are so unwilling to estab- private imbalances will correct themselves. A gov- lish a clear code of conduct to steer the actual im- ernment less credible on this issue must be ready to plementation of their national economic policies correct even privately originated imbalances. and their cooperative initiatives.57 It may well be time to ask whether the case-by-case approach Importance of Rules should be buttressed by well-defined rules. Without them, the piecemeal approach can set precedents The common thread linking all the issues dis- that are difficult to reconcile with each other or cussed in this section is the importance of a clear that perpetuate the application of the lowest com- code of conduct—a transparent set of rules govern- mon denominator to the quality of economic pol- ing economic behavior—for minimizing the nu- icies or to the responsibility of economic agents. merous risks of moral hazard. In addition, the code of conduct should provide for a clean separation between government and the private sector, thus Final Observations distinguishing public risks from private ones; such identification is relevant in both the domestic and Broadly speaking, in its various phases— the international economic spheres. At present, adjustment with austerity, adjustment with growth, however, the domestic economic domain conforms 56See Jeffrey Sachs's "The Debt Overhang of Developing Countries" in Calvo and others (1989) for an extensive discus- 55This is a subject that straddles many areas and disciplines sion of these issues. and can only be cursorily discussed here. Consensus on the role 57A similar point was made in the Group of Thirty (1988) of government is critical for domestic economic management report on international macroeconomic policy coordination, and for international economic policymaking; it is also one of where it is noted that the debt crisis in the developing world led the central issues now confronting the reforming economies of to "an impressive display of economic cooperation among a Central and Eastern Europe and the former Soviet Union. wide range of countries" (p. 19).

©International Monetary Fund. Not for Redistribution Ill THE INTERNATIONAL DEBT CRISIS

and adjustment with debt reduction58—the debt In the process, however, care should be taken to strategy has effectively reduced the debt crisis from keep attention focused on the fundamental chal- its original level of a systemic threat to that of a lenge of re-establishing normal capital flows, with difficult and pressing, but relatively contained, normalcy entailing the resumption of an appropri- problem. The strategy has been less effective in ate level of capital movements as well as the restor- reaching a definitive solution to the debt-servicing ation of an appropriate composition or structure to difficulties of individual countries, largely because those movements, particularly in the form of for- of the complexity of initiating a growth process and eign private direct investment and equity flows. the reluctance of capital flows to resume. Indeed, Another significant concern for the years ahead the strategy has yet to succeed in its avowed objec- will be for countries to pursue policies that ensure tive of restoring normalcy to international capital that international capital flows—both in level and markets, if such normalcy includes access to those structure—spontaneously conform to a market- markets by debtor countries.59 determined pattern of economic incentives. After more than a decade's worth of experience This section has also raised a number of thorny in dealing with debt difficulties in a variety of coun- issues that may affect the future of the debt strat- tries, what are the general lessons to be learned? egy. In its implementation, it will be important to One urgent lesson from the past two decades is that minimize the moral-hazard risks that can material- the solutions devised for current difficulties should ize either from the policies of debtors or from those not be allowed to become problems later on. This of creditors. Short of solutions that rely fully on means approaching imbalances in the national and market forces, this objective will be greatly helped international domains with a view to their durable by the establishment of an agreed set of rules, solution. To this end, sound and sustainable, not which can be applied to individual countries on a necessarily expedient, initiatives are required. case-by-case basis, that is, with discretion. At each stage of the debt strategy, difficulties led The set of rules should include a clear separation to successive adaptations. At first, slower-than- between public and private risks, but when this is expected balance of payments and economic recov- not possible the rules should be complemented by ery in debtor countries severely constrained their clear guidelines on how to handle such a situation. ability to generate resources; hence, the emphasis of Such rules will strengthen the credibility of govern- the strategy moved toward reform and growth- mental policies. It must be noted that this requires oriented policies. The difficulty in restoring lending addressing the question of the role of government and capital flows, in turn, led to the introduction of a on at least two levels: an abstract one, which sepa- variety of financing modalities and menus; later, it rates the functions and responsibilities of govern- contributed to the international support for volun- ment from those of the rest of the economy, and a tary debt and debt-service reduction. At each point, practical one, which ensures that the government there was scope for dissent; and dissent did surface will not bail out sectors in the economy from the on each occasion concerning the proper mix and consequences of their own decisions. sequence of reform, such as whether the debt strat- From this standpoint, the critical importance of a egy had attained a balanced blend of adjustment and commonly agreed code of conduct can hardly be financing and which element should come first.Simi - overrated. Such a code contributes a measure of lar dilemmas surfaced at later stages as perceptions objectivity to cooperative strategies, which, in deal- evolved regarding the appropriateness of an adjusting with economic problems, inevitably must rely ment effort, the adequacy of a financing package, on an element of judgement. In addition, it helps the proper rate of growth, and the relevant scope for establish uniformity and comparability of treat- a debt-reduction package, to name just a few. ment among countries, both debtors and creditors. It also contains the incidence of policy impasses 58These various phases represent a progressive "softening" of (such as those that arise between creditors and the constraints facing adjusting countries or conversely a pro- debtors when each group points to the shortcom- gressive "hardening" of those constraints confronting parties in- ings of the other as justification for their own involved in external financing. Again, the phases can be seen as steps in the search for a balanced distribution of efforts among activity) by indicating clearly where the primary countries. In this context, models that stress the importance of responsibilities for action lie. Finally, the existence rules are preferable to those that focus on bargaining', see for of a broad set of common norms is the only opera- further discussion Kenen (1989, 1990b) and Section II of this paper. tional basis on which to exercise the flexibility re- 59A discussion of the outlook for the debt strategy in the quired to deal with diverse countries in different current decade can be found in Fischer and Husain (1990). situations.

©International Monetary Fund. Not for Redistribution IV Adjustment and Reform: Differences Between East and West?

"Nothing so needs reforming as other people's cess, fraught with pitfalls and calling for a large habits." dose of determination in the reforming societies. MARK TWAIN As for the rest of Europe and the world, the fundamental aim must be to actively assist the reforms so everal years ago, few, if any, observers would that these countries can be integrated into the Shave predicted in either scope or pace the his- world economic system with a minimum of disrup- toric events now under way in Central and Eastern tion. Interesting in this context are the divergent Europe and in the republics of the former Soviet trends under way in the two European hemi- Union. Yet these events are changing the shape of spheres. In Western Europe, the economics of inte- the European continent and the world at large. As gration are proceeding ahead of the politics of inte- a result, a unique opportunity now exists to build gration; indeed, political circumspection may be an orderly international system of a truly universal the thorniest obstacle to economic unification. In character, free of the tensions that have so divided Central and Eastern Europe (and in the republics the international community since the Second of the former Soviet Union), the politics of reform World War. This section presents some ideas for are moving faster than the economics of reform; in achieving that goal. fact, harsh economic realities may prove a barrier The tasks ahead for the region are daunting and to the political evolution of these countries. For will affect all facets of human society. Within the both sides of the continent, the uneven pace of eco- economic domain, the challenges that confront the nomic and political change may well turn out to be Central and Eastern European nations—and the the toughest hurdle to overcome. major economies of the rest of the world if they are Desirable though internal economic reform and to help the reforming countries—are unprece- external economic integration are, their complexity dented. Meeting the challenges and completing the is a matter of primary concern. A strong argument tasks will require not only persistence in Central can be made that the transition to a market econ- and Eastern Europe, as well as in the former Soviet omy will prove harder to achieve than its antithesis republics, but vision in the rest of the world to pre- had been, the process of collectivization. In other words, it is probably easier to destroy a market vent the numerous risks in reform from obscuring 61 the immeasurable returns to be derived from a har- than to build one. There is, of course, a good deal monious international environment. of accumulated knowledge both about the work- The countries to Europe's east have decided to ings of centrally planned systems and about the op- convert their systems of economic organization eration of market-based regimes, but it is of limited from central planning into market-based regimes.60 use because the former is rapidly becoming ob- This endeavor, initially perceived with a good deal solete and the latter has yet to become applicable. of optimism, is increasingly seen as an arduous pro- As such, the transition between the two regimes

60The scope of the reforms is much broader, encompassing 61This seems to be the case if only because processes like actions to establish democracy and pluralism in Central and nationalization are easier to accomplish than those of restitution Eastern European societies. Viewed from this perspective, the or privatization. The fact that gradualism hardly characterized transition toward a market economy is only one aspect of a the process of collectivization also supports this point; the shock widespread process of transformation. For a lucid discussion of approach was typical of the introduction of central planning. It the economic opening in the region, see Williamson (1991a). should also be pointed out that the intrinsically complex reforms Remarkable events have also been taking place in the republics under way in Central and Eastern Europe have been rendered that composed the former Soviet Union. They are abandoning even more difficult by events in the Middle East and by the dis- central planning as a principle of economic organization, and mantling of the trading and payments arrangements under the many of the points made in this paper also apply to them. For a Council for Mutual Economic Assistance (CMEA) at the end of recent discussion of events in the Soviet Union from an eco- 1990. For a timely analysis of transitional arrangements for the nomic standpoint, see Havrylyshyn and Williamson (1991). CMEA countries, see Kenen (1991); also see Schrenk (1990).

©International Monetary Fund. Not for Redistribution IV ADJUSTMENT AND REFORM

resembles a voyage on uncharted waters and has reform within the central planning regime was fea- often been described that way. sible. Accordingly, partial efforts were made to im- Nonetheless, care should be taken to avoid exag- prove elements of central planning without seeking gerating the depth and width of those waters. What to change the regime as a whole; those efforts in- is needed, and what this section aims to provide, is cluded improving the operations of the state enter- a discussion of the real and apparent differences prises, providing for a measure of decentralization between East and West in the specific context of in decision making, and allowing more room for the process of economic adjustment and reform. In private activities.62 Current reform efforts, on the this effort to distinguish true from imaginary obsta- contrary, do not seek to improve selected parts of cles, some selected background issues and a few the centrally planned system but have abandoned it basic elements of an effective strategy for adjust- instead. The objective now is a wholesale change in ment and reform are identified. This is followed by regime, a radical reform in the principles of eco- a discussion of the design and implementation of nomic organization. economic policies in a number of Central and East- ern European countries. Next, essential differences are separated from differences in degree in the ex- Elements of an Effective Strategy periences in Central and Eastern Europe and the West. The section concludes with some general The complicated rhythm that has developed be- thoughts on how best to assist the reform efforts. tween rapid political evolution and the slower pace Underlying the whole section is the issue of rules of economic reform underscores some of the most and discretion, the balance between which can be difficult challenges facing the Central and Eastern of particular importance in the area of reform. European countries, as well as the former Soviet republics. The first factor fuels expectations of a speedy change. The second factor suggests the im- General Setting possibility of fulfilling those expectations, especially when a complete transformation of the The events of the past few years in Central and economy is intended and required. Eastern Europe and the dismemberment of the So- viet Union (with the subsequent emergence of the Commonwealth of Independent States) provide a Basic Principles good illustration of the interaction between politi- It is no longer a novelty to say that the transition cal and economic factors over time. A fundamental from a command economy to a market-based sys- force behind the rapid political change in the re- tem not only will be protracted but will also be gion has clearly been the below-par economic per- complex; there are neither categorical answers nor formance under central planning, the evidence of unambiguous blueprints to guide the reform. In the which became more and more obvious as improved abstract, however, an argument can be made that a communications technology and closer world eco- few strategic principles can help reform, at least in nomic interdependence rendered the Iron Curtain the macroeconomic policy sphere: simplicity; re- increasingly porous. In turn, the rapid pace of polit- liance on policy rules; and unequivocal signals that ical transformation has raised expectations and cre- the changes in economic policy are irrevocable. En- ated a demand for equally speedy economic acting these principles may help build the cohesion reform. and resilience in the social and political fabric that There are several common themes that can be are needed for radical transformation. gleaned from the experience of the various coun- Simplicity in the design of a policy strategy, for tries in Central and Eastern Europe and in the for- instance, eases not only its implementation but also mer U.S.S.R. The first and most dramatic one is the its acceptance. Reliance on policy rules helps con- widespread recognition that central planning has tain inertia and reflexive behavior in the economy not worked well as a principle for efficient eco- based on past experience. (A strategy providing for nomic organization. Though countries have spo- policy discretion, in contrast, would tend to per- radically acknowledged this failure, it is only now that the inadequacy of central planning is generally 62There is an ample literature dealing with these partial re- accepted, as demonstrated by the concrete actions form efforts. See, for example, Kornai (1990a, 1990b); in the taken across the region to dismantle it. latter article, Kornai discusses at length the issue of transforma- In contrast with most past reform efforts, there is tion without reform and the weaknesses of "third form," or also broad recognition that attempts to improve hybrid, solutions. Also see the collection of papers on Hungary and Poland in Commission of the European Communities the system without discarding the fundamental (1990a), as well as Hinds (1990), Institute for International Fi- tenets of a command economy will fail. Earlier at- nance (1990), Prust and IMF Staff Team (1990), and Wolf tempts at change were based on the premise that (1990a, 1990b).

©International Monetary Fund. Not for Redistribution Stabilization and Adjustment Under the Reform Process petuate such inertia and reinforce the obstacles to these economies; on this reasoning, a rapid pace is change.) A strong and credible announcement of more a matter of necessity than of choice. Given the new policies elicits and encourages the attitudi- these considerations, rapid policy decision and im- nal changes needed for reform to succeed. plementation seem the best course, particularly Two characteristics of centrally planned econo- with respect to those areas where measures are mies, more specifically two of their weaknesses, are likely to take a long time to yield results. This said, the prevalence of aggregate and sectoral shortages however, the challenge confronting the policy- and relative price distortions. This pair of features maker is to select a path fast enough to provide motivates two often mentioned aspects of the strat- clear signals, and thus elicit positive responses in egy of transition toward the market: the introduc- the economy, but not so rapid as to prove coun- tion of domestic financial discipline—to eliminate terproductive or unfeasible. aggregate shortages or excess demand; and domes- Much has been written about the appropriate se- tic price liberalization together with the opening of quence of reform, with views also differing widely the economy—to ease sectoral shortages, introduce on this issue though some agreement can be dis- a rational relative price structure, and free compet- cerned. In the abstract, coherent arguments can be itive forces. But for these policy initiatives to yield made for phasing in reform measures, if only be- results, action must be taken from the outset to cause there is a limit to how much can be done at establish the rules of the game that steer economic 63 one time. But a strong case can also be made for a behavior in the new environment. These rules comprehensive approach to reform, that is, for si- provide the necessary conditions for the operation multaneous rather than sequential action.64 It has of a market economy and include the establish- been observed that partial actions rarely add up to ment of clear ownership and property rights, the a complete result,65 whereas simultaneous action dismembering of the state's role in the economy, may foster synergy by averting the potentially ad- and the development of legal, fiscal, and social se- verse effects of piecemeal measures and by helping curity institutions that provide the framework for a to consolidate support for the reform process. Here constructive and sustained interaction of the gov- again, this view must be tempered by the inherent ernment with the private economy. difficulty in reform implementation as the checklist for effective reform is nothing less than staggering: Pace and Sequence of Reform fiscal discipline, monetary stabilization, price liberalization, opening the economy to international Given that actions will be required to influence trade and capital flows, state-enterprise restructur- most, if not all, aspects of economic behavior, the ing, privatization, and so on. Each step seems nec- questions of their pace and sequence inevitably essary, yet neither a single one nor a subset of them arise. These questions apply generally to the imple- appears sufficient in itself for effective reform. This mentation of all economic policy and have been leaves the policymaker with the difficult choice of raised frequently in connection with adjustment where, if anywhere, to draw the line on how far and reform efforts in other types of economies. It is actions need to go to ensure reform. not surprising, therefore, that they have received attention in the context of reform in command economies. Stabilization and Adjustment Under With respect to the pace of reform, views continue to differ about the relative merits of a fast the Reform Process ("shock") or a slow ("gradual") approach to the reform effort. The balance of opinion and, most It may be possible to clarify the pace and se- importantly, the revealed preference in the coun- quence of reform by distinguishing among three tries undertaking economic reforms, has been for stages of policymaking: policy decisions, policy rapid action. Two different but not mutually exclu- actions, and policy results. The time profiles of sive reasons account for this preference. One is the these three categories do not coincide, yet they do conviction that speedy policy implementation will increase the effectiveness of the reform process. 64For further elaboration of the strategy discussed in this sec- Another is the recognition that fast action is made tion see Guitian (1991c). The scope of reform and policy pri- somewhat inevitable by the lack of resources in orities as well as the sequence of actions have been discussed recently by Dornbusch (1991) and Williamson (1991c); also see Richard Portes's "Introduction" in Commission of the Euro- 63The importance of transparent rules of the game can hardly pean Communities (1990a), Genberg (1991), Fischer and Gelb be overemphasized in circumstances where behavioral changes (1991), and Calvo and Frenkel (1991). are to be effected. For a discussion of this subject in the general 65For a lucid and forceful set of arguments in favor of simul- context of international economic relations, see Dam (1982). taneous policy action, see Kornai (1990c).

©International Monetary Fund. Not for Redistribution IV ADJUSTMENT AND REFORM

represent conceptually separate phases in what is These imbalances, which are the counterparts of essentially a continuous process.66 past and present shortages in the economy, have Speed and simultaneity apply particularly to the monetary and fiscal aspects, and policy actions in policy decisions that need to be taken in a variety both domains are needed to redress them. of areas: legal, institutional, social, and economic. Some of those decisions must be translated into Stock Imbalances immediate policy actions, while others require follow-up later in the reform process. Thus, al- The stock imbalance in centrally planned econo- though policy decisions are best taken together at mies typically surfaces in the form of a liquidity the outset of reform, their conversion into concrete overhang—an excess supply of money or, more policy actions does not need to be simultaneous. broadly, of bank liabilities. In addition, another far The speed and timing of policy results are the most less mentioned stock imbalance that affects bank difficult to control. Some results can develop very assets and is closely connected with accumulated rapidly, while others take hold slowly. The fact that public sector deficits is the portion of essentially unrecoverable assets in bank portfolios, which typ- policy actions take time to yield results is not 67 unique to the centrally planned economies in tran- ically are claims on nonviable state enterprises. sition, however; it applies to all types of economies. The correction of these two stock imbalances in- General experience indicates that the attainment volves monetary and fiscal measures. In the mone- of results, both in timing and in degree, depends tary sphere, some of the liquidity overhang will critically on the appropriateness and timeliness of likely be corrected through a rise in the price level the required policy actions. Indeed, given the inter- associated with the adjustment of relative prices. But its full elimination may require additional ac- action between expectations in the economy and 68 the credibility of policies, it can be argued that option, such as a monetary reform or its equivalent. portune, determined, and credible policy actions In the fiscal domain, the asset portfolio of banks will elicit synergetic reactions, thereby hastening must be strengthened. This will call for the genera- results. tion of public sector resources to rehabilitate and capitalize the banks, thus influencing the design of fiscal policy. Stabilization and Adjustment It was pointed out earlier that two of the characteristic features of centrally planned economies are Flow Imbalances the presence of shortages and relative price distor- Flow imbalances reflect current aggregate short- tions. The elimination of the chronic shortages can ages in the economy; their elimination also de- be seen as one of the major aims of the macroeco- pends upon fiscal and monetary action. From the nomics of reform, which revolve around the intro- standpoint of monetary management, the solution duction and maintenance of domestic financial dis- means aligning the stock of money and the demand cipline in the reforming economy. But for financial for money. As experience in market economies in- discipline to yield the desired results, it must be dicates, balancing money supply and money de- accompanied by the elimination of relative price mand is no mean endeavor. This is an area where distortions because an economically sound relative the basic principles outlined in the earlier section price structure is essential for effective macro- on an effective strategy can help, particularly in the economic management. Price reform also provides context of centrally planned economies, where esti- the link with the microeconomics of reform, by mating money demand is likely to be especially contributing to an efficient allocation of resources hazardous. The simplest rule for monetary man- and easing sectoral shortages. agement in these cases is the adoption of a cur- The establishment of domestic financial disci- rency board principle. This principle provides for pline requires the correction of aggregate stock domestic monetary expansion only to the extent (accumulated) and flow (current) imbalances. that it corresponds to the accumulation of foreign

66Evidence on these issues can already be found in the rela- 67Issues connected with financial reform in centrally planned tively short period since reform in Central and Eastern Europe economies have been recently discussed by Brainard (1991), took off. For example, a shock approach was taken in Poland Blejer and Sagari (1991), Sundararajan (1990), and Calvo and toward stabilization and liberalization and in Yugoslavia toward Frenkel (1991). An excellent discussion of financial imbalances stabilization. In Hungary, where the initial domestic imbalance in east Germany can be found in Lipschitz and McDonald was more limited, a more gradual approach was pursued; see (1990). Lipton and Sachs (1990a), Coricelli and Rocha (1991), Kornai 68A timely and useful analysis of historical experience with (1990a, 1990c), Commission of the European Communities issues of liquidity overhang and monetary reform can be found (1990a), and "Stabilization Efforts in Poland and Yugoslavia— in Dornbusch and Wolf (1990); also see Calvo and Frenkel Early Lessons" in World Bank (1991). (1991).

©International Monetary Fund. Not for Redistribution Stabilization and Adjustment Under the Reform Process exchange reserves. As such, it represents a clear anchor may also be necessary when inflation is not rule, and a sharp departure from the accommodat- a particular problem, to prevent wage costs from ing monetary management typical of a centrally constraining domestic output and reducing ex- planned economy; if held to, this principle makes a ports.69 It hardly needs noting that the use of an- strong statement and can affect expectations. chors is equivalent to the setting of rules. Beyond its clarity and simplicity, the attractiveness of the currency board approach lies in its presump- tion that any domestic monetary expansion will be Complexities in Policy Design and demand driven, as it can only occur through volun- Implementation tary sales of foreign exchange. A dilemma often arises when an exchange rate Of course, less stringent monetary rules can be anchor is used to bring about price stability in an devised that permit monetary growth to reflect fac- inflationary setting: domestic financial discipline tors other than the accumulation of net interna- and wage moderation do not immediately arrest tional reserves. For example, it would be possible inflation, so that prices continue to increase for to allow an increase in the money stock to reflect some time (albeit, at declining rates) while the the purchase of domestic assets, in other words, to nominal exchange rate remains unchanged. During reflect domestic credit expansion. The lesser strin- this period, the exchange rate anchor reduces the gency of this rule, however, will compromise cred- upward pressure on the price level but at the pos- ibility because the rule is less clear with regard to sible expense of impairing competitiveness. Thus, the nature of the monetary expansion—that is, even when domestic financial and wage restraints whether it is demand or supply determined—and are in place, there are risks for the viability of the less simple since it embodies two sources of mone- exchange rate anchor. The risks obviously increase tary expansion instead of just one. when discipline on the financial or wage front From the standpoint of fiscal management, the falters. typical (and possibly minimum) aim is a balanced In principle, when confronting this dilemma it budget in the government or the public sector at would be useful to ascertain the relative priorities large. As pointed out earlier, however, in the pres- attached to the price stability and balance of pay- ence of weak bank portfolios, fiscal management ments objectives. When controlling inflation is para- must allow for bank capitalization, which means mount, the role of the exchange rate anchor may be generating budget surpluses large enough to ser- so necessary as to justify the consequent risks to vice the government paper issued to the banks in competitiveness: the potential and actual impair- lieu of their unrecoverable assets. This considera- ment of competitiveness would provide the incen- tion can clearly complicate fiscal policy. tive needed to maintain domestic financial and wage discipline. If such discipline is not restored promptly, Question of Anchors however, and inflation does not fall sufficiently fast, the damage to competitiveness may be so severe as Domestic financial policy rules such as those de- to bring the balance of payments constraint to the scribed above typically must be supported by nomi- fore, thus rendering the credibility of the exchange nal anchors, particularly when price stability is a rate suspect and its role as anchor unsustainable. goal. An anchor that has been increasingly used is the exchange rate, which exhibits a specific advan- 69 I am indebted to Peter Kenen for having brought this wage- tage in the case of command economies. Because cost argument to my attention. Bruno (1990) provides an exten- these economies traditionally suffer from distorted sive examination of nominal anchors in open economies, includ- relative prices, an exchange rate anchor imme- ing the possible need for many of them. On the issue of system diately translates the world relative price structure overdetermination, Bruno acknowledges the "prima facie contradiction in an argument that calls for the fixing of more than into domestic currency terms. Accordingly, using one nominal variable at a time," but he points out that it "rests the exchange rate as an anchor rapidly exposes the on the assumption of full certainty" and goes on to argue that in extent of domestic price distortions needing conditions of uncertainty the issue "must be redefined in an correction. expectational sense. Given the potential benefits of success and the high risks of failure of a sharp disinflation, tying one's boat For the anchor and the price liberalization to be to several anchors rather than one would seem to be a prudent effective, however, not only is domestic financial policy as is the portfolio diversification of risk in the optimal discipline required but income moderation— menu of risky assets" (p. 26). Kenen's point concerning the specifically wage moderation—must also prevail, supply effects of wage costs is important in this context. After all, though Bruno's reasoning is appealing, "more" instruments particularly when inflation is present. Actually, in need not be equivalent to a "less uncertain" environment. Actu- such circumstances a wage anchor may be needed ally, it can be argued that uncertainty calls less for additional to provide supplementary support to the exchange tools and more for a relatively predictable use of those that are rate, at least in the initial period of reform. A wage available.

©International Monetary Fund. Not for Redistribution IV ADJUSTMENT AND REFORM

When priority is given instead to balance of pay- measurement of the overhang and the price change ments objectives, protecting competitiveness is the can render a given rate of monetary expansion ei- predominant concern, and the risks attached to the ther too tight or too expansionary.71 With regard to exchange rate anchor are not worth running. A policy implementation, monetary management in policy that envisages the exchange rate as an in- reforming economies is complicated by the rudi- strument for achieving balance of payments goals mentary state, or even lack, of financial markets rather than price stability is required. Such a policy and by general structural weaknesses in the finan- must be supported by financial and income moder- cial system. Some of these problems derive from ation just as the anchor strategy was. Without such vulnerable bank balance sheets, lack of competi- moderation, adjustments in the exchange rate, tion and segmentation in credit markets, and inade- though temporarily able to protect competitiveness quate accounting practices. and the balance of payments, will also contribute to Fiscal policy implementation is also fraught with domestic price increases. In this way, inflation can difficulties. The risks arise not only from the large reach critical levels.70 uncertainty that surrounds reforming economies in In practice, however, the nature of an economic transition but also from deep-seated resistance to imbalance often dictates its own solution. When a essential aspects of fiscal adjustment and reform. country has no access to international capital mar- The issue of curtailing subsidies acquires particular importance here, as does the subject of state- kets and its international reserve availability is lim- 72 ited, exchange rate policy must be geared to bal- enterprise restructuring. In any type of economic ance of payments objectives. In situations charac- system, subsidies are difficult to eliminate and hard terized by relatively strong international reserve budget constraints are difficult to establish, but this positions and by concern for inflation, an exchange is particularly so in centrally planned economies rate anchor for price stability is the appropriate where subsidies and soft budget constraints have course of action. This strategy also often requires long been central features. In addition, the disrup- international financial support to supplement inter- tions caused by the reform process will need to be mitigated by public social expenditure, such as the national reserve use and enhance its credibility. provision of income support to those becoming un- Difficulties in policy design and implementation employed, a factor that threatens to upset any fiscal also arise in the closely related area of monetary balance that is achieved, let alone a fiscal surplus.73 management. Where the exchange rate anchor is Incomes policy is another area where close vig- used, a most relevant but difficult design issue is ilance is warranted. Typically, nominal wage guide- the level at which the anchor should be set, because lines are an important component of macro- an appropriate level can be decisive for the resolu- economic management. Such guidelines can bring tion of the price stability versus competitiveness demand developments in line with supply and, dilemma. Another complex issue is the estimation where the exchange rate performs as an anchor, of the monetary overhang. The uncertainty sur- can protect competitiveness. Incomes policy also rounding the size of the upward adjustment in controls costs; as such, it can help focus enterprise prices induced by price and trade liberalization attention on the importance of restraining costs as makes the calculation particularly problematic. a means of diminishing the resurgence of soft bud- These difficulties compound the process of design- get constraints. ing a path for monetary expansion. Errors in the

70 Structural Reform Here again, evidence can be found in the experiences of Hungary, Poland, and Yugoslavia. The predominant aim in the At this stage, the microeconomics of reform and case of Hungary was strengthening the balance of payments position, and nominal adjustments in the exchange rate were the institutional aspects of reform become relevant. correspondingly effected to ensure competitiveness. In the cases Although for expository purposes these issues are of Poland and Yugoslavia, on the other hand, inflation was the paramount concern, and the exchange rate was therefore an- 71For further discussion of these issues in the case of Poland, chored at a fixed level vis-a-vis the U.S. dollar in the former see Calvo and Coricelli (1991), Concern" and Rocha (1991), and country and vis-a-vis the deutsche mark in the latter. Examples Lipton and Sachs (1990a). Also see Calvo and Frenkel (1991) of the difficulties involved in either policy, but also of their for an extensive examination of the demand, supply, and port- potential effectiveness, are well illustrated by these countries' folio effects of credit policies. experiences: Hungary witnessed an increase in inflation and 72For a more extensive discussion of fiscal issues in the pro- Yugoslavia, confronting a severe balance of payments con- cess of transition to market-based regimes, see Holzmann straint, had to adjust the exchange rate. In Poland, on the other (1991), Tanzi (1991a, 1991b), and Kopits (1991). hand, price performance has improved as has the external posi- 73Yugoslavia provides a good illustration of some of the prob- tion, so the exchange rate anchor has not yet exhibited strains. lems discussed in the text; see World Bank (1991). A brief ex- See "Stabilization Efforts in Poland and Yugoslavia—Early amination of the social aspects of the transition in reforming Lessons" in World Bank (1991). economies can be found in Schweitzer (1990).

©International Monetary Fund. Not for Redistribution Stabilization and Adjustment Under the Reform Process

often separated from macroeconomic manage- scarce resources to salvaging it or to build an al- ment, in practice all these dimensions of the reform together new capital stock. It can be persuasively process must be intimately linked for an effective argued that the best strategy would be to address at transition to a market system. the outset those sectors where decisions to start anew may be required, since these choices are the most difficult to make. Ability and determination Design and Implementation to undertake hard measures may prove the best The microeconomics of reform include the liber- route for establishing the credibility of reform and alization of domestic prices, the opening of the eliciting the required behavioral changes. economy to international trade in goods, services, and capital, and the dismantling of exchange con- Institution-Building Efforts trols.74 Though, in principle, reforms like these would appear straightforward, they actually in- Both the macroeconomics and the micro- volve numerous difficult choices and to carry their economics of reform depend closely on the prompt effects through must have support from other areas buildup of market-supporting institutions and of reform. An important example of the interaction rules—that is, on the development of an institutional infrastructure to buttress the functioning of a among various reform measures is the fact that lib- 76 eralization must be accompanied by the develop- market system. Such an infrastructure includes a ment of competitive market structures if it is to legal system to guide the conduct of economic yield results. More specifically, the process of liber- transactions and to help enforce market- alization and opening up of the economy affects determined accountability; an accounting and au- state enterprises, some of which are likely to prove diting system to aid economic decision making and nonviable in the new environment; an immediate to bolster such accountability; a fiscal system to fos- corollary is the desirability of closing those enter- ter an efficiency that is in line with social prefer- prises; this, in turn, requires the establishment of ences; a social insurance system to contain the bankruptcy laws and procedures. hardships of market solutions and to provide inter- As experience gathers in the process of reform, generational transfers; and sectoral reforms to cor- restructuring may not be sufficient—wholesale re- rect problems in the labor market, the state- construction of many industries may be needed to enterprise sector, the external sector, and the bank- set economic activity and growth on a sound and ing system, as well as in the pricing regime. Perhaps sustained path.75 In effect, what is at stake is the the most fundamental priority in this broad area of viability of a capital stock built up over several de- institutional reform is the establishment of clear cades on the basis of persistently distorted relative ownership and property rights. Without clarifica- prices. A significant part of such a capital stock is tion of these rights, many of the necessary ingre- unlikely to prove capable of competing in a market dients of reform, such as investment, new attitudes environment, and the question is whether to devote toward work and production, and an improved def- inition of the role for government and the process

74 of privatization, are unlikely to materialize. A clear The paper does not discuss the scope of external liberaliza- system of ownership, therefore, is an urgent imper- tion: whether it should be complete (with regard to both the current and capital accounts) or partial (current account first ative and the means must be found to ensure its and capital flows later on). This same issue arises in reforming feasibility; without it, other aspects of reform—for centrally planned economies in connection with currency con- which the establishment of ownership rights is a vertibility, the scope of which can also be complete or partial. necessary condition—cannot be launched.77 My preference is for complete convertibility but views on this issue are yet to arrive at a consensus. For an extensive discussion of the subject of convertibility in these economies in transi- Balance in the Policy Mix tion, see Jacques J. Polak "Convertibility: An Indispensible Ele- ment in the Transition Process in Eastern Europe" and John The need for a balanced mix of policies surfaces Williamson's own essay "The Economic Opening of Eastern in most, if not all, areas of reform: macroeconomic, Europe" in Williamson (1991b); issues of capital flows are examined in Guitian (1991b) and International Monetary Fund microeconomic, structural, and institutional. (1991). 75 In addition to the issues discussed in the text, the micro- 76General and insightful discussion of the importance of the economics of reform also encompass a variety of sectoral ques- institutional aspects of reform will be found in Dornbusch tions not addressed in this paper; they concern distribution sys- (1991) and Williamson (1991c). tems, energy, environment, housing, agriculture, and 77An insightful discussion of the dilemmas posed by the inter- manufacturing. As for the need for full-scale revamping of sec- connection and different time horizons of privatization and re- tors in the economy, Gros (1991) notes that in east Germany the structuring can be found in Blanchard and others (1991). For a "disastrous state of the environment, obsolete industry and out- specific country example, see Lipton and Sachs (1990b) who dated public infrastructure require that almost the entire stock have examined the issue of privatization in Eastern Europe, of private and public capital be rebuilt" (p. 8). particularly with respect to Poland.

©International Monetary Fund. Not for Redistribution IV ADJUSTMENT AND REFORM

With regard to macroeconomic management, of reform must be successfully orchestrated: from balance is essential on at least two levels: the mix the din of transition, a symphony must arise.78 must ensure domestic financial policies that are consistent with the nominal anchors, if these are part of the policy package, or with income guide- Differences Between Economic lines and exchange rate management, if these are Systems—How Significant for Reform? part of the strategy. Balance must also prevail among fiscal, monetary, and incomes policies them- Differences between centrally planned and selves so as to avoid burdening any one policy with market-based economies abound. Accordingly, the shortcomings of another. A typical example of there are risks in seeking to transfer the experience an unbalanced policy mix is one where monetary of market economies to command economies.79 policy carries the full burden of inflation control, Yet, it would also be inadvisable to presume that that is, it does not receive the support of the other little of relevance can be derived from the stabiliza- two policy areas. In general, experience has shown tion, adjustment, and growth experiences of de- that without reinforcement, strict implementation veloped and developing market economies. of monetary policy is unlikely to keep inflation down for long without impairing other aspects of economic performance. In essence, a balanced do- Essential Differences mestic macroeconomic policy mix merely reflects the need to attain and maintain an appropriate The primary difference between the starting level and composition of aggregate demand, with point of Central and Eastern European economies, the composition of demand balanced in three key as well as that of the former Soviet republics, and dimensions: its public and private components— their final destination is the absence of market- hence, the importance of fiscal policy; its consump- supporting institutions and rules. The creation of tion and investment components—hence, the im- those institutions and the establishment of those portance of monetary policy (generally, interest rules is the hardest challenge these countries must rate policy); and its domestic and foreign meet. This task is made no easier by the lack of components—hence, the importance of competi- guidance. Most economic literature on adjustment tiveness, or consistency between exchange rate and growth in market-based economies assumes and incomes policy and the domestic financial the existence of a market-supporting institutional stance. infrastructure; little has been written about what to do in its absence. Balance is also required on the microeconomic front to ensure that supply responses develop in As discussed in the previous section, a market the economy. Domestic price liberalization without infrastructure comprises a legal and regulatory steps to open the economy to foreign competition framework, an accounting and auditing system, a and improve the distribution system will not lead to fiscal regime, and a social insurance framework. efficient resource allocation. In such circumstances, But a critical element underpinning this market- little can be expected in the way of additional supporting institutional setting has yet to be output. mentioned—the existence and observance of a code of conduct, a set of rules of the game which is Besides balance at the macroeconomic and the typically absent in centrally planned economies. microeconomic levels, a successful transition to- Such a code of conduct includes the willingness to ward the market also requires an appropriate blend make individual economic decisions, to assume between these two areas of reform and the actions risks, and to accept responsibility for the con- taken to restructure the economy and build up its sequences of those decisions. institutions. Only in the presence of such an admittedly complex balance can the interplay of demand Only through overcoming these basic differences (the macroeconomic aspect) and supply (the mi- will the transition to a market system work, and the croeconomic element) in a sound market (the structural and institutional dimensions) yield opti- 78The 1990 WIDER report on Reform in Eastern Europe mal results. (Blanchard and others, 1991) goes into the intricacies of weav- ing together the major building blocks of reform: stabilization, In sum, it is clear that fundamental issues are liberalization, privatization, and restructuring. involved in the search for balance in the global pol- 79The need for caution in the extrapolation of developed icy mix—the role of government, state-enterprise market-economy experiences to regimes based on central plan- reform, and privatization. Transparency in all these ning is the main subject of Marer (1991). In the context of this paper, which argues that real differences between East and domains can go a long way toward promoting the West should not be exaggerated, Marer's message is that neither change in economic behavior needed for the pro- should apparent differences be overstressed. Once again, an is- cess of transition to succeed. In this way, all aspects sue of balance is at stake.

©International Monetary Fund. Not for Redistribution Final Remarks

establishment of an institutional framework and a agement and system reform poses equivalent ana- corresponding code of conduct are time-consuming lytical challenges in both types of economies. endeavors. Nevertheless, it is only in the context of these systemic changes that attitudes and behavior in reforming societies will adapt to the change in the economic setting. Final Remarks It is abundantly clear that the tasks confronting the Central and Eastern European countries and Differences in Degree the former Soviet republics in their voyage toward Other seeming differences between market and market environments are daunting. But the bene- centrally planned economies are more numerous fits that they and the world economy can derive and straddle most economic policy spheres; they from a successful transition are innumerable. It ap- are more apparent than real. In terms of strategy, pears imperative, therefore, that efforts are made the pace and sequence of adjustment and reform, in all quarters to maximize the effectiveness of the as well as the lags in the effect of economic policies, reform efforts under way. are such issues, in that they are general and ana- As far as the reforming countries are concerned, lytically equivalent in the two types of systems. an urgent order of business is to eliminate Their presence or absence does not depend on the promptly the essential differences discussed above. system. Even such central questions as the role of Establishment of market-supporting institutions government are common to market- and should be an absolute priority. Parallel with this, it command-type regimes. These differences, then, is important to learn from the experiences of the are a matter of degree, not of the systems' basic developed and developing market economies natures. about those issues where only differences in degree On the macroeconomic front, it is clear that the have been identified. In the process, critical ques- complexity of coping with fiscal issues, such as soft tions, such as the role of government, must be ad- budget constraints, subsidies, budget deficits, and dressed, and priority must be given to the most state-enterprise management, does not belong ex- pressing issues, such as the establishment of clear clusively to centrally planned economies. The same ownership and property rights. Activity on these is true of monetary issues, such as the liquidity fronts will help induce the supply responses that overhang (a specific instance of an excess supply of can ease the reform path. liquid assets), and the difficulty of forecasting the To reach the final destination, however, requires demand for money. On the exchange rate front, persistence in policy implementation, even in the too, the dilemma between price stability and com- face of adversity, if the proper signals are to be petitiveness, or the difficulty of determining the ap- given and credibility is to be ensured. It is also propriate level for an exchange rate anchor, applies important to exhibit transparency in the strategy, both to market and planned economies. the instruments, and the objectives of reform in In the microeconomic and structural domains, order to gather the necessary consensus. Building similarities abound as well. Relative price distor- such a consensus means prompt recognition that tions are not typical of centrally planned econo- the original overoptimistic expectations on the mies alone. Issues connected with state-enterprise speed of the reform process and its ability to yield reform and control are also widespread. The prob- rapid results have been somewhat unrealistic. But lem of vulnerable banking and financial institu- these are areas where support from the rest of the tions, which confronts a number of reforming econ- world economy can help. omies, has arisen too among market-based systems. The role of the market economies in easing the Differences of degree also characterize the pol- process of reform in Central and Eastern Europe icy mix. Indeed, the need for balance between and beyond can be critical on a variety of fronts. monetary and fiscal policy (and for consistency Given the importance of setting up market- among them, incomes policy and exchange rate supporting rules of the game in the region, a first management) has been long recognized in the responsibility of market economies is themselves to context of market-based economies. In turn, the abide by those rules, implying openness of markets, importance of keeping progress in the macro- respect for budget constraints, and support for the economic and the microeconomic areas commen- integration of national economies into the world surate is no new revelation; it has been repeatedly system. Policy advice, both in the area of building underscored in the context of the linkages among an institutional infrastructure and in the area of adjustment, development, and growth. The need macroeconomic and structural management, can for proper balance between macroeconomic man- also smooth the reform process.

©International Monetary Fund. Not for Redistribution IV ADJUSTMENT AND REFORM

Thus, on one level assistance consists of preach- help, not hinder or delay, the reform process. ing by example and drawing lessons from past mis- Though important and delicate, this is not a new takes. On another level, it consists of making re- problem, and it is amenable to reasonable solu- sources available to support the adjustment effort tions, even in areas where conditionality has not required for reform. In making resources available, been extended in the past.81 the amount and terms of assistance must be com- A trade-off between concessionality and condi- patible with the adjustment effort and the pros- tionality can also be a means to resolving potential pects of the reforming economies. Moreover, its conflicts between political and purely economic ob- disbursement must be clearly linked to perfor- jectives. It can also be argued that it may give rise mance under the reform process. These two consid- to an important measure of synergy. Generous fi- erations are related in a particularly complex way nancial support can help shield reform efforts by in that they exhibit elements of both sub- establishing protective mechanisms—such as policy stitutability and complementarity. On one side, it safeguards to correct slippages or adapt to unex- can be argued that if policy conditionality (the link- pected deviations and still yield results; financial age of resource availability to performance in pol- safeguards to cover unanticipated needs or shocks icy implementation) is well defined and linked to a that do not require policy adjustment (for example, substantial adjustment effort, the provision of am- transitory and reversible events); and social safe- ple amounts of resources on favorable terms or on guards to soften the burdens of change and thus terms that do not produce undue risks is appropri- widen the acceptance of reform. ate. But then, if performance is strong, the likeli- By way of conclusion, the trade-off approach hood is that less, rather than more, financing on also conforms to comparative advantages de- soft terms will be required. veloped in the international economy over nearly Given the importance of fostering reform efforts, five decades. On the side of international institu- generous support is a fair reward for determina- tions, the IMF can provide the broad framework of tion, breadth, and depth in policy implementation. conditionality, as well as develop appropriate new In other words, an appropriate trade-off may be criteria to measure policy performance in areas not established between the degree of concessionality normally covered by the traditional scope of condi- and the degree of conditionality attached to exter- tionality. Though it would continue to provide its nal assistance. Such a trade-off seems particularly own assistance, the institution would focus on the well suited to the reforming economies of Central monitoring, follow-up, and adaptation of policy im- and Eastern Europe and the former U.S.S.R., plementation. The financial terms of access to IMF where the emphasis must be on setting conditions resources would be dictated by the cooperative na- for the prompt establishment of a market-based ture of the institution, which requires that its assis- system. Given the externalities that can be ex- tance revolves among members in accordance with pected from a successful transition in the region, their balance of payments needs and adjustment the terms of repayment, though admittedly impor- efforts. As necessary, IMF conditionality could be tant, should not be the only consideration. The supplemented by work undertaken elsewhere, such effectiveness of the effort to create a market will as by the OECD in the structural area and the depend more on the determination, persistence, World Bank in the project and sectoral domains.82 and strength of policy implementation than on the Other multilateral institutions (including the re- particular timing of policy results, on which repay- cently established European Bank for Reconstruc- ment is contingent. Policy implementation is at the tion and Development), together with official very center of conditionality, so it is conceivable sources of bilateral flows, would provide the bulk that by stressing it more than the financial terms of external assistance the likelihood of the reforms 81This expansion is what may give rise to complex questions succeeding may be improved. A cautionary note in the sense that to be effective, conditionality may have to must be sounded, however: this approach, like extend beyond its traditional macroeconomic sphere and pure many others of a similar nature, carries a risk of efficiency criteria. Admittedly delicate issues are involved here, moral hazard.80 To minimize this risk, it is critical but they are not insoluble. 82The argument in this paragraph deals only with the econo- to design and measure policy conditionality in a mies in Central and Eastern Europe and addresses basically the manner sufficiently clear and precise that the re- question of how to foster reform. The effectiveness of reform lated access to concessional assistance and aid will requires completion; so the trade-off between conditionality and financial terms of assistance is, in this sense, a singular event. But the general argument for such a trade-off can be 80Such issues of moral hazard are part and parcel of the ex- extended beyond the issue of reform to areas like development. ercise of conditionality, so the risk mentioned is not new, In this context, the idea would be to keep the terms of assistance though it may give rise to relatively complex questions. A spe- commensurate with the economy's capacity to develop and ex- cific example of an area where moral-hazard risks clearly arise is amine the possibility of a trade-off when the latter falls short of the international debt strategy as discussed in Section III. the former.

©International Monetary Fund. Not for Redistribution Final Remarks of the assistance on terms tailored to an economy's In sum, the reform process typically entails a dy- capacity to adapt its production patterns and struc- namic balance between rules and discretion. In the ture to market signals, thus laying the ground for a early stages, when institutions are lacking and mar- resumption of sustained activity and growth. kets are budding, reliance on rules is the best strat- Whenever it is clear that the prospective capacity egy. At those times, discretion must be limited not to recover falls short of what would be required to only because the means for its exercise are lacking service external assistance on market terms, the but also because of the need to provide clear sig- trade-off between conditionality and conces- nals. As institutions develop and markets take sionality would provide a logical means on which to hold, however, the balance is likely to allow for a continue aiding reforms without wasting scarce more even distribution between the observance of resources. rules and the exercise of discretion.

©International Monetary Fund. Not for Redistribution V The Route Toward One European Economy: Need for More than One Track?

"Democracy . . . is a charming form of the outer edge of a long process of growing interna- government, full of variety and disorder, and tional economic interdependence that has been un- dispensing a sort of equality to equals and der way—albeit, with recurrent intervals of pro- unequals alike." gression and retrogression—for more than four 83 PLATO decades. Progress in Europe owes much to the establish- "If we cannot end now our differences, at least ment of an international code of conduct governing financial, exchange, and trade relationships in the we can make the world safe for diversity." 84 JOHN F. KENNEDY wake of the Second World War. But Europe has also contributed much to the design, development, vents in Europe have been moving so fast that and implementation of that code. And as this paper it is proving hard to keep up with them. They will make clear, Europe continues to contribute to areE, moreover, unfolding on all sides of the conti- the international order on a wide range of issues. nent. Remarkable progress has been made in West- To analyze this broad subject of integration, this ern Europe toward economic and monetary union, section first addresses the setting against which the a process that has gained great momentum and dy- notion of an integrated Europe that can accommo- namism in recent years. But even more date nations at various speeds or on several tracks remarkable—at least in the sense of being must be examined. Second, it examines the country unexpected—have been the events that began in differences that have given rise to the desirability Central and Eastern Europe approximately two or inevitability of potentially diverse approaches to and a half years ago, continued in the republics of an integrated Europe; the central focus of this dis- the former Soviet Union, and are still evolving, cussion is the "peripheral" economies, those that from some perspectives (politics) at a startling pace appear unlikely to achieve complete integration and from other standpoints (economics) at a some- within Europe on the current schedule. Third, the times frustratingly slow speed. These events are fundamental issues to be addressed when taking a lending an extra dimension to continental eco- differentiated approach to a common goal are pre- nomic integration by raising the possible need for sented. Next, the characteristics of the Single Mar- multiple tracks, or for "I'Europe a plusieurs ket are briefly discussed, particularly as seen from vitesses" (a Europe at several speeds), in the pro- its periphery, and the policy constraints that result cess of building an economically unified Europe. from participation in an integrated system are ad- The progress that has been made to bring down dressed. The events in Central and Eastern Europe national economic barriers in Western Europe and and Eurasia are then placed within the framework the reforms currently being undertaken in Central of European integration. Finally the section exam- and Eastern Europe are closely related. But what- ines Europe's ongoing contribution to the interna- ever the degree of closeness in their relationship, it tional economic order in the context of its integra- is clear that an important page of history is being tion. The paper concludes with a few remarks written: for the present and the foreseeable future, neither the western nor the eastern front is likely to 83For an extensive analysis of international economic interde- remain quiet. History should also note, however, pendence, see Cooper (1968, 1987). An examination of periods of increasing and decreasing interdependence is contained in that important though these developments are, Section II; also see Dam (1982). The related issue of economic they are part of an even broader evolution in the policy coordination has been studied recently by Dobson world economy. The efforts toward European (1991). integration—the goal being a Single European 84The development of the code of conduct was examined in depth in Horsefield (1969) and de Vries (1976, 1983). Also see Market by the end of this year—and those toward Dam (1982), Gilpin (1987), Guitian (1981), and Kenen (1986, European economic and monetary union represent 1987).

©International Monetary Fund. Not for Redistribution Meaning of Country Differences

pointing out the limitations of a differentiated ap- nomic front, the pace is evident in the effort to proach to economic integration, showing how the establish a Single Market by the end of 1992. need for policy coordination and convergence can As if these were not sufficiently ambitious goals, conflict with the need for national autonomy, es- more daunting challenges lie ahead for Europe: re- pecially when the structures of economic activity, forming the economies in Central and Eastern Eu- the stages of development, and the levels of na- rope, including republics from the former U.S.S.R., tional wealth differ across the countries. and accommodating those reforms in the continued evolution of European economic integration. The Setting outlook for Europe, therefore, depends on a diverse group of countries, indeed. And yet, rarely, if Efforts to create an enlarged market—a Com- ever, have better conditions prevailed for an effec- mon Market—in Europe go back more than three tive (voluntary) integration of the continent at decades. The Treaty of Rome that established the large. European Economic Community (EEC) and launched the Common Market was signed in 1957 and went into effect in 1958. A precursor to this Meaning of Country Differences important covenant had been an even earlier The whole question of an integration requiring agreement establishing the European Coal and separate tracks or speeds of implementation pre- Steel Community (the Treaty of Paris of 1951). sumes that national economic circumstances are The first stage of integration encompassed the sufficiently diverse to warrant such an approach. In Europe of the Six (Belgium, France, Germany, its simplest version, the question presupposes that Italy, Luxembourg, and the Netherlands), which two basic country groups exist: a "center," or a core sought to create a large, unencumbered, and tariff- of countries with enough similarities to assume a free market where production and economic trans- common approach and schedule for economic inte- actions would take place according to comparative gration; and a "periphery," a set of other countries advantage and where economies of scale could be with characteristics that suggest a different exploited across national frontiers. From the very approach—typically less ambitious and slower.87 start, issues arose similar to those currently under At first impression, the term periphery connotes discussion—issues concerning the implications of a region of limited influence with regard to the cen- diverse economic structures and uneven develop- ter. A related interpretation relates periphery to ment across the European countries for the feasi- the size of those economies, in the sense of their bility of a single approach to the unification pro- being small. Since the relatively large countries can cess. Though there were obvious differences be seen to determine the nature and direction of among the Europe of the Six, the question of coun- the international economic system, the small country differences acquired particular relevance with tries, with little, if any, systemic influence, would the potential enlargement of the EEC to include represent the periphery. In certain other contexts, the rest of the western European countries, par- center and periphery conform to the dichotomy ticularly those in the southern region of the 85 often made between North and South. But when it continent. comes to the economic domain, the term periphery Since that early period, Europe has nearly trans- relates more to size than to geographical location. formed itself. The scope of the European Com- A possible set of distinguishing criteria can be munity has expanded to encompass the Europe of developed that classifies economies according to Twelve (the original six members plus Denmark, the degree of flexibility they exhibit to external Greece, Ireland, Portugal, Spain, and the United shocks, or more broadly, to external influences. To Kingdom). And the pace of the integration has ac- one extent or another, all economies are open, but celerated, as made evident on the monetary front not all of them exhibit the same degree of re- by the establishment of the European Monetary silience. Another possible perspective would be to System and the ongoing plans for European Mone- distinguish by degrees of economic development, tary Unification, including those for the creation of 86 a European Central Bank. On the general eco- 87 The distinction between a "center" and a "periphery" is not unique to the European context; on the contrary, it is a well- 85This was most clearly the case with the eventual accession established classification long used in discussions of relation- to the Common Market of the southern European countries; see ships between developed and developing countries. The terms the chapter on "The Underdeveloped Countries of Emigration: acquired broad currency in the 1950s and early 1960s in the Portugal, Spain, Greece, and Turkey" in Kindleberger (1967). context of the structuralist-monetarist controversy in Latin 86See Giavazzi, Micossi, and Miller (1988); Giavazzi and America; see, for example, United Nations (1950) and Prebisch Giovannini (1989); De Cecco and Giovannini (1989); Giavazzi (1959). Also see Pinder (1983) and Clout (1986) for a discussion (1990); and Giovannini (1990). of these concepts in the context of the European Community.

though such a criterion may not be very useful for ripheral relative to Germany, the nominal center of particularly homogeneous groups of countries. The the system.88 And in the European Community, merit of such a perspective, however, is that it em- Spain—with an economic structure rapidly ap- phasizes that the issue of peripheral countries in an proaching that of larger European countries—may enlarged common market does not differ concep- be considered central relative to Greece or Portu- tually from that of developing countries in the gal. In this sense, there is as much a periphery in broader, interdependent world economy. the center as there is a center in the periphery. All these possible classifications are among the factors that motivate the debate over the pace of integration in Europe. In fact, the criteria often re- Fundamental Issues flect the fact that some of the Europe of Twelve joined the European process at a relatively late When a country contemplates participation in an stage and with relatively inflexible economic struc- enlarged common market, the basic considerations tures. Thus, it might have been considered unrea- revolve around how much scope such participation sonable to expect them to move on the same track would leave for national policy choices, in particu- or at the same speed as those that began with rela- lar, those relating to the pace of economic adjust- tively uniform situations and had already under- ment. Completion of the Single Market will entail taken many of the measures required for the abolition of all barriers to trade in goods and integration. services and to the movement of factors of pro- As a first approximation, a periphery typically duction; it also involves the complete removal of includes economies with some or all of the follow- physical, technical, fiscal, and other obstacles to ing features: high levels of protection from external economic transactions within the European Com- competition; relatively inefficient industries, munity. For countries with economies that exhibit characterized by small size and less advanced tech- characteristics typical of the periphery, participa- nology; overly regulated and inflexible financial tion in such an open market carries risks while it markets; and rigid labor markets with relatively also provides opportunities. low productivity. By these criteria, the Single Euro- pean Market will encompass peripheral areas or Convergence and Divergence regions. (The phrase "areas or regions" is warranted since not only countries, such as Greece and Unifying and broadening a market brings con- Portugal, can be considered peripheral; areas like vergence in a number of variables, such as prices the Italian Mezzogiorno also qualify.) and the regulatory and institutional environments As noted above, the distinction between central within which economic agents operate. This con- and peripheral economies is relevant not only in vergence does not mean, however, that complete the European context. A European integration at uniformity will be established among all the ac- various speeds recalls issues similar to those that tivities and variables in the market. On the con- arose in the international economy when it agreed trary, some divergence is also likely to result from that global economic integration could occur at dif- the integration process. For example, although ferent rates for different countries. A very clear freedom of trade and exchange among the various illustration of this principle is contained in the Arti- countries should lead to converging standards of cles of Agreement of the International Monetary living, they will also foster comparative advantage Fund. When nations join the institution and sub- and specialization in productive activities, thus scribe to the code of conduct contained in the Arti- leading to diverging patterns of production. Not cles, they make a commitment to eliminate ex- surprisingly, arguments based on these two con- change restrictions. But the Articles also allow for cepts tend to lead in opposite directions. According the temporary retention of such restrictions if an to one line of reasoning, the creation of an en- actual or potential balance of payments problem larged free market will foster regional equilibrium, would result from their removal. Countries that that is, convergence in welfare and income levels. avail themselves of such provisions are in effect Another strand of reasoning contends that forces will develop in such a market that will widen exist- allowed to reach conformity with the Articles of 89 Agreement at varying speeds and according to ing gaps among regions. their particular circumstances. It must be noted, however, that the difference 88For an excellent discussion of the related issue of asymme- tries in the European Monetary System, see Wyplosz (1989). between central and peripheral economies is a mat- 89 Basically, these two lines of reasoning argue that a common ter of degree, not of essence. For example, in the market area can give rise to a virtuous (convergence) or vicious European Monetary System, even an economy as (divergence) circle regarding regional welfare. See Pinder large and advanced as Italy may be considered pe- (1983) and his cited sources for further details.

Adjustment and Integration services and capital) that can affect integration must be identified. Closely related to this is the role The particular characteristics of the peripheral that market forces (for example, price adjustments countries will inevitably influence the nature and and quantitative resource flows) play in steering pace of their adjustment and integration into the the economy toward a large, open market. And Single Market. The extent of their influence will finally, but most important, the role of economic depend on a variety of factors: the level of initial policies in minimizing the costs of the required ad- protection, the degree of external financial im- justments must be specified. balance, and the depth of the distortions resulting Over the long run, the permanent benefits or from overregulated and segmented financial mar- costs of integration can be more properly evalu- kets, inefficient industries, and rigid labor markets. ated. Investigation into the scope of the net bene- While this proposition is general in character, in fits has been increasing—much of it under the the European context it is particularly interesting sponsorship of the Commission of the European because current European economic events are at Communities—and the findings indicate that the the forefront of a growing global interdependence benefits are significant (a subject that is discussed and represent a clear illustration of the potential later in the paper). But more broadly, the world benefits to be derived from an ambitious effort at economic experience over the past nearly 50 years integration. has illustrated vividly the benefits of integration Indeed, the leading frontier of international eco- and interdependence, both in Europe and in the nomic relations at this time is Europe. There has international economy.90 Of course, costs also been a great leap from the "Europessimism" (or arise, such as those from the limitations imposed on "Eurosclerosis") of only a few years ago to the national autonomy, but it is generally recognized "Europtimism" (or "Europhoria") recently. Still, that the benefits outweigh them, at least when mea- serious challenges will yet confront the European sured over extended periods of time. Community as the less flexible economies in the region adjust to a dynamic, growing, and closely interconnected European-wide market. Possible Responses A point that needs to be stressed when discuss- Problems Ahead ing economic integration and its consequences is that the problems confronting integrating econo- The integration of peripheral economies into the mies do not always arise from their actual or pro- European market cannot and should not be ex- spective participation in a common market. Often, pected to be smooth. These countries will have to they reflect distortions and imbalances already contend with financial shocks and with shocks to present in their economic systems. In those circum- the real economy, many of which will be perma- stances, the problems have to be confronted nent and will therefore require extensive adapta- whether or not integration is occurring. The only tions in economic regime and policy. Conse- difference would be the specific modality and pace quently, prompt and clear identification of the of the adjustment to be undertaken. All of this largest potential problems in the adjustment pro- seems clear from the parallel experiences of pe- cess is needed. ripheral economies in the European setting (where The problems to be addressed over the short to the final aim is integration in the Single Market) medium run include the consequences of opening and in the world economy at large (where full inte- the economy for the balance of payments—for gration is not being considered). both the current account and the capital account— An attractive angle for the design of policy re- and for the country's economy at large as it is ex- sponses to integration is to use the process to maxi- posed to external competition. This exposure af- mize comparative advantage, reduce existing dis- fects the patterns of demand and production, the tortions, and redress imbalances. Such a design financial and capital markets, and the labor market. would contribute to an appropriate allocation of Important conceptual and practical issues are in- resources, increase efficiency, and lower pressure volved here. They include the appropriate se- on global resources. The process of integration, quence for the opening of the economy, that is, in however, will not be painless, if only because it will what order current account transactions or capital force some sectors to contract, or lose relative flows are to be liberalized. They also involve an weight in the economy. It is true enough that other assessment of the risks and opportunities associ- sectors will expand, but the required reallocation of ated with integration, of their real or financial character. In addition, the structural aspects of the 90See, for example, Solomon (1982) and Frenkel and Mussa various markets in the economy (for goods and ser- (1984). For a discussion of this subject in a European setting, see vices, for factors of production, and for financial Guitian (1988b) and Gros and Thygesen (1988).

factors of production from contracting to expand- which requires the existence of a capital market ing sectors will not always be commensurate or capable of allocating resources efficiently and of smooth. buttressing the economy's dynamic sectors. In this A possible way to soften the bumps is to keep context, several actions will be required: the main- the economy growing while the adjustment takes tenance of adequate profitability (yet another rea- place. This will not always be easy because par- son for the establishment of wage-cost modera- ticipation in a common market typically constrains tion); efficient financial and credit markets to not only the available range of national policy tools channel available resources to those sectors with but also the ability to contain their effects domes- comparative advantage; an appropriate stance and tically. For example, those European countries par- mix in domestic economic policies to keep real in- ticipating in the exchange rate mechanism of the terest rates from diverging widely from their equi- European Monetary System cannot use the ex- librium levels; and openness to foreign investment change rate as an independent policy instrument.91 flows. And more broadly, participation in a common mar- All of these measures will help restructure the ket prohibits the use of tariffs and other trade bar- pattern of domestic production in favor of the rela- riers. This means that competition from other areas tively more competitive sectors, which given the within the common market can make deep inroads characteristics of the economies under review will into other participants' economies. For this reason, typically be labor intensive. In addition, foreign it becomes imperative that existing distortions not capital flows and technology imports will encour- prevent such competition from highlighting areas age the modernization of production, thus reducing of respective comparative advantage or from iden- the gaps among the economies in the common tifying activities that should be curtailed or aban- market. doned on efficiency grounds. Policy must be geared at improving resource allocation through flexibility in the labor and capital markets in order to mini- Evolution of the Periphery mize unemployment and idle productive capacity The peripheral nature of some of the economies during the change in production patterns called for in Europe is likely to persist for some time, and by market integration. with it, the perception that European integration Typically in the peripheral economies, the labor requires different tracks or speeds. Here again, the market is characterized by a lack of functional and similarity with other developing countries is clear; geographical mobility as well as by a rigid wage- nowhere has the process of economic transforma- setting process. Though wages are often low, they tion been an overnight affair. are not necessarily low in relation to productivity In the early stages of European integration, the levels; and unemployment is high. In these circum- periphery of the continent provided a pool of la- stances, a number of steps can ease the process bor from which the more advanced industrial of integration: wage-cost moderation to stimulate economies—the center—could draw; high "pe- demand for domestic labor and enhance labor ripheral" unemployment levels and high "central" competitiveness, thereby helping to attract foreign wage rates made this feasible. This phenomenon investment; the development of sufficient differen- was clear in the first decades of the European Com- tiation within the wage structure to encourage mon Market, when the Europe of the Six drew sub- functional as well as geographical labor mobility— stantial migrant labor from Spain, Portugal, and indeed, marginal wage equalization should be the Greece (and had been the case earlier with Italy result of such mobility not the cause that prevents and later with Turkey). it from taking place; and the establishment of incentives for the unemployed to search for jobs— As integration has proceeded, most of these pe- training policies, flexible work contracts, well- ripheral economies have become full partners in defined, temporary unemployment benefits, and the European experiment, and a trend has de- the like. veloped accordingly in which capital flows replace labor migration. Such a trend reflects not only the As important as a properly functioning labor progress made by the periphery itself (witness, for market is the attainment and maintenance of an example, the case of Spain) but also the potential appropriate rate of domestic capital formation, gains to capital-intensive (and high-saving) regions from investing in capital-scarce areas. Ultimately, 91 At present, the participants in all aspects of the European these developments build up capital in the periph- Monetary System (including the exchange rate mechanism) are ery, thus creating job opportunities and enhancing Belgium-Luxembourg, Denmark, France, Germany, Ireland, Italy, the Netherlands, Spain, and the United Kingdom. For a productivity and output. In this manner, foreign in- recent examination of developments and perspectives in the Eu- vestment flows can assume the role played earlier ropean Monetary System, see Ungerer and others (1990). by labor flows. The potential benefits for both the

center and the periphery are clear: access by the will require an important measure of vision on the periphery to the savings of the center and access by part of national governments. At a minimum, do- the center to high yields from investing in capital- mestic economic policies must be kept on a sound scarce peripheral areas; increased technology path to limit wasteful imbalances. And govern- transfers; access by all areas to a wider and more ments must be able to assess properly intertem- open market, which allows for efficient division of poral choices so as to ascertain when today's ad- labor and specialization; the prospect of rising justment cost is worth tomorrow's welfare gain. growth potential; and the related prospect of low unemployment. Peripheral Aspects Besides these general effects, a number of signifi- The Single Market: A Positive Sum cant steps are needed to support the completion of Game the Single Market. Many of them are intended to assist peripheral economies in their integration It is clear from the discussion so far that adjust- efforts, such as actions to reform the Community's ment in the periphery to the shocks of integration Structural Funds—with a prospective doubling of will not be costless. But it is also true that if the their resources—in order to promote regional de- process is handled well, the benefits will more than velopment and correct prevailing regional eco- compensate for these costs. nomic imbalances. Behind these steps there is a notion that the Structural Funds can be used to mitigate transitory Central Aspects problems associated with the adjustment. This is a The Single Market is expected to yield significant modality of lending intended to support needed net benefits to the European Community over the policy corrections and other efforts to reform. As medium term. Studies sponsored by the Commis- such, the structural assistance responds to a ra- sion of the European Communities provide quan- tionale similar to that underlying International titative estimates of the possible scale of welfare Monetary Fund conditionally or World Bank gains in the region and they amount to a significant structural adjustment lending. percentage of the European Community's gross In principle, the provision of assistance to coun- product. In addition, further welfare gains will re- tries or areas affected adversely by adjustment and sult from improved price performance and addi- reform processes is hardly a controversial proposi- tional employment growth in the region.92 tion. In practice, however, the idea can become Briefly, the economic effects of integration will more contentious for a variety of reasons, two of span a variety of areas. They will influence effi- which are discussed below. ciency and growth performance in the European setting by eliminating exchange rate variability, re- Recipient Identification ducing uncertainty, and lowering related transaction costs by improving the potential for economies Proper use of structural resources in the adjust- of scale and by improving price as well as public ment and reform process means identifying the finance performance. All these will come at the ex- countries or groups of countries that qualify for the pense of national policy autonomy, especially with assistance. Such identification can pose difficult regard to the exchange rate instrument. As a result, problems. It is not always easy to distinguish those wage and price flexibility in Europe is imperative that truly stand to lose from the reforms from those to reap the benefits of integration. that have a vested interest in the status quo, that is, There are grounds to contend, therefore, that all those that gain from the absence of reform. While participating economies stand to benefit from the conceptually the distinction is clear, in practice the process of market integration,93 but that collecting borderline often turns out to be blurred. To some those benefits will depend on complex factors and extent, this reflects the fact that external financial assistance can serve either to support reform 92 efforts or to perpetuate the pursuit of inappropri- See Commission of the European Communities (1988, 1989a, and 1990b) for a detailed examination of the benefits and ate policies, particularly when the linkage between costs of integration both for the European Community at large the disbursement of funds and progress in policy and for each country. implementation is not sufficiently precise, as is typ- 93As already noted, theories of regional imbalance do not ically the case. Thus the fundamental challenge of always reach this conclusion. For a survey of theoretical arguments of regional equilibrium and disequilibrium, besides conditional lending is to segregate borrowers or re- Pinder (1983), see Wilhelm Molle's "Regional Policy" in Coffey cipients willing and able to undertake corrective (1990) and Padoa-Schioppa (1987). policies from those unwilling or unable to do so.

Compensation and Inequality gressively decline and eventually disappear. This is Compensation for losses incurred in the process already the situation for those economies that par- of adjustment and reform is a natural enough con ticipate in the exchange rate mechanism of the Eu- cept. The European Community also aims at re ropean Monetary System. But it will also affect ducing inequalities across regions.94 This is also a countries outside the system, even more so as Eu- legitimate goal, though a separate one from com- rope moves toward monetary union. pensation for adjustment. The distinction between The implications of this exchange rate constraint these two objectives can hardly be overstressed be- are pervasive. This is because it renders national cause the combination of adjustment compensation economic policies endogenous—that is, it makes it with redistributional assistance may lead to ineffi- necessary for these policies to be consistent with cient use of structural resources. The possible con- the exchange rate constraint, or, in keeping with flict would pit effective economic adjustment, the fundamental theme of this paper, it requires which often calls for factor mobility (and typically national policies to conform to the exchange rate gives rise to some costs), against the search for rule. An immediate consequence is that challenges equality, which may involve halting such mobility. to a particular economy's competitiveness will have to be met by means other than exchange rate varia- Thus, the two types of assistance may act at coun- 95 ter purposes. tions. In concrete terms, when competitiveness is These are not novel problems and they arise in eroded, it must be restored through lower wages, domestic national settings frequently. What is clear costs, and prices, a true departure from the upward is that the effective use of the European Com- adjustment those variables usually exhibit. munity's Structural Funds will depend on the adoption of transparent criteria to separate between different types of lending, as well as between types of Monetary Policy recipients, in order to prevent one form of assis- The exchange rate constraint also eliminates the tance from frustrating the objectives of another. independence of monetary policy. It makes it impossible to pursue the single objective of price sta- Policy Constraints bility (except when it is compatible with the exchange rate constraint). In effect, endogeneity of As a general proposition, participation in an national monetary policies sets price stability in the open and growing market diminishes the effective- common area as the standard to be achieved. Thus, ness and insulation of domestic policy because any regional divergences can only cause resource market forces acquire a predominant role as guides flows because adjustments in the exchange rate are of economic behavior. It is also true, however, that precluded. And, more importantly, monetary pol- in a common market a relatively minor domestic icy will not be available as a source of government policy action (a small increase in interest rates, for revenue through the inflation tax. In effect, com- example) can have a significant effect on the larger mitment to virtually fixed exchange rates requires market (substantial capital flows). monetary policy coordination so as to bring about Though in apparent contradiction, these two convergence in price performance within the com- statements are consistent in that the capability of mon market. Any inflation differentials that arise national policy to influence the domestic economy can be maintained only temporarily through inter- is severely limited by participation in a common est rate flexibility. As far as the European integra- market. But precisely this inability to contain pol- tion effort is concerned, the close linkage among icy effects within a limited geographic segment of monetary policies will be even tighter now that a the market is what explains the dispersion and po- substantial liberalization of capital movements tentially large effect that any one country's policy across national borders has been completed among actions can have on the market at large. 96 Apart from these "environmental" market- the major European economies. determined constraints, a few specific limitations also bind concrete policy areas. 95 Section IV of this paper contains an extensive discussion of the potential dilemma between protecting competitiveness and ensuring price stability in the context of an exchange rate con- Exchange Rate Policy straint. An excellent discussion of the role of exchange rates in As the process of integration advances, the scope balance of payments theories can be found in Mundell (1991). 96This liberalization represents a quantum jump over the for independent exchange rate policy will pro- Bretton Woods par-value regime, with which the European Monetary System is often compared. The Bretton Woods re- 94These issues were taken up forcefully by Spain during the gime envisaged the need for, and therefore allowed for, controls December 9-10, 1991 summit meeting of the European Com- on capital movements, a provision that was included in the Arti- munity countries in Maastricht, the Netherlands. cles of Agreement of the International Monetary Fund. See

All these constraints have operated in a setting importance of competitiveness for the mix of for- of broad, fundamental changes in financial mar- eign and domestic demand components. Finally, kets, and consequently one of increased competi- the relevance of the public financesfo r the distribution among financial intermediaries. Those changes tion of demand between the private and public sec- have resulted (at least for a transitory period) in tors is obvious. less predictable monetary behavior than in the Taking these considerations into account, it is past. Thus, while an exchange rate anchor may clear that coordination of fiscal policy is another have helped to sidetrack some of the difficulties constraint imposed by participation in a common confronting domestic monetary management, the market. As far as Europe is concerned, patterns of latter has not become totally immune to them. domestic fiscal policies are likely to require a measure of consensus on public sector debt management, public sector deficit control, expenditure re- Fiscal Policy form, the structure and harmonization of taxation, A topic of particular importance for peripheral and the government contribution to capital countries is fiscal policy, given the relative impor- growth.98 tance of the government in their economies. At first glance, it could be argued that fiscal policy independence is less threatened by participation in Final Balance a common market than is the independence of Opportunities to increase welfare will undoubt- monetary policy. But the force of this argument edly open up for the periphery as a result of its may prove more difficult to substantiate upon participation in an enlarged common market. But closer inspection. exploiting them will mean taking adequate mea- In principle, consistency with a nominal ex- sures: to increase the flexibility of the structure and change rate anchor only requires that aggregate de- production patterns of the economy, as well as of mand be kept on a path commensurate with aggre- the reactions of market agents to price signals; to gate supply. And barring the difficulties noted accept that domestic policymaking is subject to earlier, the level of demand can be controlled by constraints, particularly when policies are geared monetary policy. If so, fiscal policy should not be exclusively to internal aims; and to acknowledge strictly bound by the fixed nominal exchange rate, that policy effectiveness to attain marketwide ob- and over the short term this line of reasoning is jectives (if coordination of policy positions exists basically accurate. among participating countries) is likely to increase As the time horizon lengthens, however, other significantly. As far as participation is concerned, target variables come into play.97 Attainment of the key question for peripheral countries is growth potential in a setting of price and exchange whether they have any other choice. Arguably, rate stability calls for a more multifaceted equi- these economies cannot insulate themselves from librium than that of simple aggregate demand- the common market's influences, in which case supply balance. Not only must supply potential be membership emerges as the only practical option. maintained, but both the level and composition of demand must be sustainable. Maintaining supply potential will require relative A Periphery Beyond the Periphery cost-price flexibility, efficiency in resource alloca- The events under way in Central and Eastern tion, and responsiveness to market signals. De- Europe and the former Soviet Union add—at least, mand management, in turn, will have to keep ag- potentially—a dimension to the discussion of pe- gregate spending in line with the available ripheral countries and to the question of approach- resources and the composition of demand on a rea- ing European integration on different tracks or at sonably balanced path between consumption and different speeds. In other words, those events raise investment components, domestic and foreign additional grounds on which to argue the impor- sources, and private and public sector shares. tance of diversifying the tracks available to com- The importance of the interest rate for the plete the integration. The characteristics of the consumption-investment choice is obvious, as is the economies in this region conform closely to those typical of the periphery: they are inward-looking Folkerts-Landau and Mathieson (1989) for an extensive discus- and protected systems dominated by the govern- sion of European financial integration. The issue of an aggre- ment or public sector and exhibit narrow or nonex- gate demand for money in the European Monetary System has istent markets and extensive distortions. Thus, the been examined by Kremers and Lane (1990). 97For further elaboration of the issues of fiscal policy coordination, see Guitian (1988a, 1988b) and Tanzi and Ter-Minassian 98Further informative analysis of those issues may be found in (1987). Commission of European Communities (1989b).

very nature of the widespread reforms that must be cific Rim was the future gained currency. Now, the completed in the area will dictate that diversity pendulum may be swinging back, with the Pacific prevail in the possible approaches to integration." Rim facing competition from a Europe that prom- Nonetheless, it may be argued that to link the pro- ises strong growth and contributions to the interna- cess of reform unfolding in Central and Eastern tional order on the scale to which the system had Europe and beyond with the process of integration once been accustomed but had had to give up. in Western Europe is premature. A response to this argument has been that both sides of the continent have "the same last name," that all European Europe's Continued Contribution to countries share some common ground.100 In addition, the vertiginous speed of change in Central and the International Order Eastern Europe may not stop with market reforms. The transition to market regimes is probably only a For some time now, Europe has been searching precursor to further engagement in the European for a balanced blend of national and international Community. considerations as the basis for economic relation- The prospects ahead also give rise to risks and ships on the continent. With regard to the real opportunities in the relationship between the "old economy, the Europe of the Six sought to lower periphery" and the "new periphery." The risks de- barriers to internal trade by establishing a Com- rive from two main facts: there will now be addi- mon Market. The Europe of Twelve is pushing to- tional claims on available resources in the system, ward the creation of a Single Market in which as the rate of resource absorption in Central and goods, services, and factors of production can move Eastern Europe outpaces that region's rate of pro- freely. On the monetary front, Europe sought a duction; and the economies of Central and Eastern measure of exchange rate stability soon after the Europe will offer competition to the rest of Europe collapse of the Bretton Woods par-value system on account of their supplies of relatively cheap and through the adoption of the "snake arrangements." skilled labor. The opportunities follow from the po- Later, the European Monetary System was estab- tentially higher demand for the output of the econ- lished, based on a fixed (but adjustable) exchange omies already in the common market, thus increas- rate mechanism which has helped integrate the ing their exports to the "new periphery" and participating economies and has laid the ground for contributing to its integration. On balance, then, monetary unification. European policymakers face a rather unexpected If revealed preference is a guide, Europe has but generally positive challenge—a "new frontier" been betting for a long time that an international on the "old continent," which is dramatically order fundamentally based on rules is the one most changing the shape of relationships. conducive to harmony and cohesion among coun- The contrast is also vivid when viewed from a tries. By favoring rules, European countries have broader historical perspective. Though fast reced- expressed the willingness and, more importantly, ing in memory, the specter of the American Chal- the ability to set explicit constraints on their lenge, which was raised in the late 1960s, contrib- national autonomy. Within its preference for rules, uted to the Europessimism of the 1970s and early Europe also seems to be searching for a reason- 101 able degree of discretion in the actual operation of 1980s. Later, the notion was that economic pro- the continental order. By seeking a measure of gress had bypassed and surpassed not only Europe discretion, the Community recognizes national but also the Atlantic, and the prospect that the Pa- considerations to the extent required to foster

99 cohesiveness. For a discussion of reform issues in Central and Eastern But there is a question as to how well rules will Europe, see Blanchard and others (1991), Dornbusch (1991), Guitian (1991c), and Calvo and Frenkel (1991). Some lessons serve a periphery that has little say in either their can be drawn from the experience of other countries that also design or their implementation. My impression is faced the challenge of developing a market. For a discussion of that rule-based systems particularly benefit pe- the Turkish experience, see Guitian (1991a). For a discussion of ripheral countries because they limit the freedom the impact of Eastern Europe on European integration, see Centre for Economic Policy Research (1990). of the center and thus enhance economic certainty 100See Silva and Sjogren (1990), where the importance of the and predictability. Another important question is impetus toward Europe 1992 is examined and the point is made whether Europe will be able to integrate its central that as "we stand in awe of the domino decline of communist and eastern regions without slowing the momen- governments, we should not overlook the fact that Western and tum present on the western front. The task imposes Eastern Europe share the same last name" (p. 15). 101See Servan-Schreiber (1968), where the issue of a tech- difficult, but not impossible, challenges. Keeping nological gap between the United States and Europe is raised the process on track in both spheres will mean and a call for a concerted European response is made. looking beyond short-term obstacles and focusing

©International Monetary Fund. Not for Redistribution Final Remarks on long-term benefits. The bias toward rules should recent illustration in the area of monetary integra- also convey to Central and Eastern Europe a mea- tion is provided by the differences that prevail sure of certainty and order, thus fostering the pro- among the countries participating in the European cess of reform. Thus, a key contribution by Europe Monetary System: one group has virtually achieved to the broad international order is the need for convergence in economic performance, in particu- balance between rules and discretion. lar with respect to inflation (France, the Nether- It must be stressed that closely integrated sys- lands, Germany), and another group has yet to at- tems disseminate the costs and benefits from one tain convergence on inflation and on other fronts country's economic policies to the other partici- (Italy, Spain, the United Kingdom). pants. In the process, incentives can arise to "ex- Perhaps the central issue here is the appropriate port" costs induced by domestic policy and "imbalance between two positions that have charac- port" benefits from other nations' policies. If so, terized many discussions of European monetary in- this prospect can only be a source of permanent tegration. One position stresses the importance tension in interdependent regimes. The challenge is (even the necessity) of having achieved con- to recognize from the outset how futile a deliberate vergence before undertaking commitments that se- attitude of exporting internal costs and importing riously reduce the independence of national policy external benefits would be since it only dooms the (an example is the United Kingdom's former posi- system itself. To avoid such an attitude, nations tion that joining the European Monetary System must realize that there are no sustained free rides would be completed only when conditions al- within any system, regardless of the room given for lowed). The counter position maintains that under- national autonomy. Taking the European Mone- taking at the outset commitments that constrain tary System as an example, some members saw an domestic policy independence constitutes the imported benefit in the introduction of price disci- surest way of attaining convergence. This latter pline. But the benefit was purchased at a price—the reasoning underscores the point that waiting for risk of losing competitiveness. the "right time" may be the best way to ensure that In a nutshell, integration in a broad market is a such a time never materializes. positive sum game, no participant needs to lose. However, it does pose important distributional On the broader objective of European economic problems; to resolve these in a constructive fashion integration, a variety of tracks or speeds has actu- requires vision or its equivalent, "enlightened self- ally been in effect: different time schedules have interest."102 been allowed for reducing and eventually eliminating trade and financial barriers within the Com- munity; and the structural funds have been made available to support adjustment efforts and help Final Remarks create uniform economic conditions among member countries. Differentiation in the approach to There are good grounds to argue that European economic integration will probably be even more integration will require a variety of tracks and necessary with the prospect of an enlargement of speeds to accommodate the diversity of initial eco- the economic union of the Europe of Twelve. This nomic situations. The argument can be coherently prospect, remote until recently, has now acquired made with respect to the present membership of real potential with the reforming economies of European Community, which encompasses a rela- Central and Eastern Europe, including former re- tively new periphery with characteristics quite dif- publics of the U.S.S.R. The transition of these ferent from those of the core members, but it ac- countries from central planning to market-based quires even more strength with the prospect of the regimes will be disruptive, not smooth, and it will Community expanding beyond the Europe of be drawn out. Accordingly, specific means to assist Twelve to encompass the reforming economies of their reforms and support their efforts at integra- the central and the eastern regions of the continent. tion with the rest of Europe will be required. The concept of a journey toward a unified Eu- Valid though the arguments for differentiation rope that occurs at different speeds is not new. A are, they should not be carried too far; there is a flip side to the case for diversified approaches. As a 102In December of 1991, the countries in the Europe of general proposition, the ultimate aims of a unified Twelve met in Maastricht, the Netherlands, and made a number Europe will mean the elimination of fundamental of decisions leading to their monetary, economic, and eventual differentiation among its member countries. Con- political integration. The "after-Maastricht" prospects include national parliamentary debates for ratification of the Maastricht cepts, like the principle of universality, that eschew Treaty and the introduction of a common European currency country groupings or those, like the principle of uni- before the end of the century. formity of treatment, that reject preferential status

are probably crucial for the long-term cohesiveness transparent, and, to the extent possible, objective; of the system.103 and, in principle, their availability should extend to Advocacy of such fundamental principles need all members. not preclude the existence of transitory arrange- In sum, it seems clear that diverse tracks toward ments that recognize the diverse capacity of coun- European economic integration are virtually un- tries to withstand exogenous shocks. These ar- avoidable. Perhaps less evident, though certainly rangements typically allow for a gradual approach not less important, is that such tracks can lead to a to the requirements of integration or assist with the common setting that de-emphasizes particular costs of integration. But to ensure compatibility country differences. In essence, the success of di- with principles such as universality and uniformity versified approaches will best be measured by their of treatment, the transitional arrangements must ability to become redundant, to self-destruct. In exhibit certain characteristics. They must be short- other words, the tracks must all flow along a com- lived; the criteria for their use must be simple, mon route on which the same rules apply to all. And as with traffic, a common path and common 103There is a potential conflict between the principle of uni- set of rules do not preclude differences among trav- versality (all-encompassing participation) and the principle of elers; economies, as drivers, can and will differ. It is uniformity of treatment. For an insightful discussion of this in- the rule of law that cannot and should not waver. teresting subject, see Gold (1979).

uch has been written about economic policy, those external funds served to enlarge the scope for the international system, and national auton- national autonomy. But the use of foreign re- omyM. In particular, a plethora of views has been sources, for a variety of reasons, did not conform to expressed on how best to ensure consistency be- the norm of efficiency and therefore the added tween aspirations of national sovereignty and the scope proved to be only temporary. Undue use of restraints imposed by an international environ- that scope (on the part of both debtors and credi- ment. Two influential sets of views on how to attain tors) led to a crisis that although resolved from a such consistency involve the distinction between systemic perspective remains unsolved in many arrangements based on rules and those based on countries, as made evident by persistent debt- discretion. Regimes biased toward discretion stress servicing difficulties. Yet, the conflict between the the advantages of a global system characterized by freedoms and the constraints brought about by in- independent (perhaps insulated) agents, thereby terdependence need not always arise. A necessary leaving a wide berth for autonomous national eco- condition to enjoy the freedoms (in the debt con- nomic policy and, with it, for the individual pursuit text, these are the added possibilities of spending) of national welfare. Systems that stress the impor- is to recognize the constraints (the need to spend tance of rules emphasize the benefits of a global productively so as to be in a position to repay the environment of interconnected parts, which by debt) and act accordingly. The importance of clear constraining national economic policy expands the rules applied with an appropriate measure of judge- common economic space and, with it, the pursuit of ment is evident. individual as well as collective welfare. With regard to the challenges facing those coun- The futility of attempts to move too far in the tries currently in the process of adopting market- direction of either rules or discretion is illustrated based regimes and integrating themselves into the in the seesaw or pendulum pattern that has charac- world economy, many differences between East terized international economic arrangements in the and West are more apparent than real. In addition, past. Unless observed with a measure of discretion, much can be gained in the process of reform by rules carry with them the seeds of their own de- acknowledging the importance of keeping the pace struction. Correspondingly, unless a measure of re- of economic and political change commensurate, so spect for rules prevails, discretion can only lead to that expectations in each domain remain realistic disorder and eventual chaos. As the examination of and mutually consistent. In this context, simple and a whole century of economic policy experience transparent rules can be critical for their imple- makes evident, the appropriate measure of discre- mentation and acceptance as well as for the aban- tion and the proper degree of observance of rules donment of past behavioral patterns. A clean break are neither historical constants nor solely depen- with past attitudes will prove a necessary condition dent on economic factors. Indeed, a persuasive for reform measures to take effect and conse- case can be made that one of the strongest influ- quently for supply responses to materialize. ences over the seesaw pattern between rules and Nowhere have the challenges posed by rules discretion is the degree of consistency between po- been made clearer than in the economic integra- litical and economic forces in the system. tion effort of the European Community over the The need to acknowledge how interdependence past three and a half decades. The members of the can both expand and constrain the scope of na- Community have adopted an increasingly binding tional policy is clearly illustrated by the interna- set of rules and are now in the final stages of creat- tional debt crisis. External debt accumulation al- ing a single European market which, by its very lowed for actions and outcomes in debtor existence, will serve as a powerful constraint on economies that would not have been possible with- national economic policies. Accord on the need for out foreign borrowing. In that sense, access to rules and for limits on national autonomy is far

more important for economic integration than the cessive inclination to discretionary behavior, or the much vaunted dichotomy of a Europe "a une ou a undue bending of rules, will tend to eliminate that plusieurs vitesses." After all, national economies margin of discretion, if only because it will lead to have been known to survive even when composed disorder. And discretion in a disorderly setting can of regions at different levels of development, in- hardly be considered freedom. In many respects, come, and wealth. the interplay between rules and discretion repli- In conclusion, the dilemma between strict obser- cates that between principle and pragmatism: a vance of rules and reasoned exercise of discretion total lack of pragmatism surely leads to the aban- is more apparent than real. Rigid adherence to donment of principles, and the absence of princi- rules in circumstances that call for the use of some ples converts pragmatism into chaos. As Goethe discretion is inimical to the very existence of the once said about the importance of accepting limita- rules themselves. The longevity of norms of be- tions on freedom, "In limitations he first shows havior often depends on the ability to bend them himself the master, and the law can only bring us when conditions warrant. On the other hand, ex- freedom."

Blanchard, Olivier, and others, Reform in Eastern Eu- Centre for Economic Policy Research, Monitoring Euro- rope (Cambridge, Massachusetts: MIT Press, 1991). pean Integration: The Impact of Eastern Europe Blejer, Mario I., and Silvia B. Sagari, "Hungary: Finan- (London: Centre for Economic Policy Research, cial Sector Reform in a Socialist Economy," PRE 1990). Working Paper Series WPS 595 (Washington: World Cline, William R., International Debt: Systemic Risk and Bank, February 1991). Policy Response (Washington: Institute for Interna- tional Economics, 1984). Bloomfield, Arthur I., Monetary Policy Under the Inter- Clout, Hugh D., Regional Variations in the European national Gold Standard: 1880-1914 (New York: Community (Cambridge: Cambridge University Federal Reserve Bank of New York, 1959). Press, 1986). Brainard, Lawrence J., "Reform in Eastern Europe: Coffey, Peter, ed., Main Economic Policy Areas of the Creating a Capital Market," Federal Reserve Bank EEC: Towards 1992 (Boston: Kluwer Academic of Kansas City Economic Review, Vol. 76 (January/ Publishers, 1990). February 1991), pp. 49-58. Cohen, Benjamin J., Developing-Country Debt: A Middle Bruno, Michael, "High Inflation and the Nominal An- Way, Essays in International Finance, No. 173 chors of an Open Economy," NBER Working Paper (Princeton, New Jersey: International Finance Sec- 3518 (Cambridge, Massachusetts: National Bureau tion, Princeton University, 1989). of Economic Research, November 1990). Commission of the European Communities, "The Eco- Bryant, Ralph C, "The World Economy and Polity in nomics of 1992," European Economy, No. 35 the 1980s" (unpublished; Washington: The Brook- (March 1988). ings Institution, December 1984). (1989a), "The Effects of the Internal-Market Sensitive Sectors," European Economy, No. 42 , "Intergovernmental Coordination of Eco- (November 1989). nomic Policies: An Interim Stocktaking," in Interna- (1989b), "Public Finances and Fiscal Policy in tional Monetary Cooperation: Essays in Honor of the Community," European Economy, No. 42 Henry C. Wallich, Essays in International Finance, (November 1989). No. 169 (Princeton, New Jersey: International Fi- (1990a), "Economic Transformation in Hun- nance Section, Princeton University, 1987). gary and Poland," European Economy, No. 43 Bryant, Ralph C, and others, eds., Macroeconomics in (March 1990). an Interdependent World (Washington: The Brook- (1990b), "One Market, One Money: An Eval- ings Institution, Centre for Economic Policy Re- uation of the Potential Benefits and Costs of Form- search, and International Monetary Fund, 1989). ing an Economic and Monetary Union," European Calvo, Guillermo, and Fabrizio Coricelli, "Stagflationary Economy, No. 44 (October 1990). Effects of Stabilization Programs in Reforming So- Cooper, Richard N., The Economics of Interdependence: cialist Countries: Enterprise-Side vs. Household- Economic Policy in the Atlantic Community (New Side Factors" (unpublished; International Monetary York: McGraw-Hill, for Council on Foreign Rela- Fund, February 1991). tions, 1968). Calvo, Guillermo A., and Jacob A. Frenkel, "From Cen- , The International Monetary System: Essays in trally Planned to Market Economy: The Road from World Economics (Cambridge, Massachusetts: MIT CPE to PCPE," Staff Papers, International Mone- Press, 1987). tary Fund, Vol. 38 (June 1991), pp. 268-99. _, "What Future for the International Monetary System?" in The Evolution of the International Mon- Calvo, Guillermo A., and others, eds., Debt, Stabilization etary System: How Can Efficiency and Stability Be and Development: Essays in Memory of Carlos Attained? ed. by Yoshio Suzuki, Junichi Miyake, and Diaz-Alejandro (New York: Basil Blackwell, 1989). Mitsuake Okabe (Tokyo: University of Tokyo Press, Camps, Miriam (with the collaboration of Catherine 1990). Gwin), Collective Management: The Reform of Corden, W. Max, "Fiscal Policies, Current Accounts and Global Economic Organizations (New York: Real Exchange Rates: In Search of a Logic of Inter- McGraw-Hill, for Council on Foreign Relations, national Policy Coordination," Weltwirtschaftliches 1981). Archiv, Vol. 122, No. 3 (1986), pp. 423-38.

Coricelli, Fabrizio, and Roberto de Rezende Rocha, Marston (Cambridge: Centre for Economic Policy "Stabilization Programs in Eastern Europe: A Com- Research, National Bureau of Economic Research, parative Analysis of the Polish and Yugoslav Pro- and Cambridge University Press, 1985), pp. 139-78. grams of 1990," in The Transition to a Market Econ- (1989a), "Hegemonic Stability Theories of the omy, ed. by Paul Marer and Salvatore Zecchini International Monetary System," in Can Nations (Paris: Organization for Economic Cooperation and Agree? Issues in International Economic Coopera- Development, 1991). tion, ed. by Richard N. Cooper and others (Wash- Cuddington, John T., Capital Flight: Estimates, Issues, ington: The Brookings Institution, 1989), pp. 255-98. and Explanations, Studies in International Finance, (1989b), "The Comparative Performance of No. 58 (Princeton, New Jersey: Internatinal Finance Fixed and Flexible Exchange Rate Regimes: Inter- Section, Princeton University, 1986). war Evidence," NBER Working Paper 3097 Dam, Kenneth W., The Rules of the Game: Reform and (Cambridge, Massachusetts: National Bureau of Evolution in the International Monetary System Economic Research, September 1989). (Chicago: University of Chicago Press, 1982). (1989c), Elusive Stability: Essays in the History De Cecco, Marcello, and Alberto Giovannini, eds., A of International Finance, 1919-1939 (Cambridge: European Central Bank? Perspectives on Monetary Cambridge University Press, 1989). Unification after Ten Years of the EMS (Cambridge: _, "International Monetary Instability Between Cambridge University Press, 1989). the Wars: Structural Flaws or Misguided Policies?" de Larosiere, J., "The Debt Situation," remarks before in The Evolution of the International Monetary Sys- the Bankers' Association for Foreign Trade, Phoe- tem: How Can Efficiency and Stability Be Attained? nix, Arizona, May 16, 1986; reprinted in IMF Survey, ed. by Yoshio Suzuki, Junichi Miyake, and Mitsuake June 2, 1986. Okabe (Tokyo: University of Tokyo Press, 1990). , "Progress on the International Debt Strategy," El-Erian, Mohamed A., "Mexico's Commercial Bank Fi- Finance and Development, Vol. 24 (March 1987). nancing Package," Finance and Development, Vol. de Vries, Margaret Garritsen, The International Mone- 27 (September 1990). tary Fund, 1966-1971: The System Under Stress Feldstein, Martin S. (1988a), "Distinguished Lecture on (Washington: International Monetary Fund, 1976). Economics in Government: Thinking About Inter- , The International Monetary Fund, 1972-1978: national Economic Coordination," Journal of Eco- Cooperation on Trial (Washington: International nomic Perspectives, Vol. 2 (Spring 1988), pp. 3-13. Monetary Fund, 1983). , ed. (1988b), International Economic Coopera- Dobson, Wendy, Economic Policy Coordination: Re- tion (Chicago: University of Chicago Press, for Na- quiem or Prologue? Policy Analyses in International tional Bureau of Economic Research, 1988). Economics 30 (Washington: Institute for Interna- Feldstein, Martin S., and others, Restoring Growth in the tional Economics, April 1991). Debt-Laden Third World, Triangle Papers, No. 33 Dooley, Michael P., and C. Maxwell Watson, "Rein- (New York: The Trilateral Commission, 1987). vigorating the Debt Strategy," Finance and Develop- Fischer, Stanley, "International Macroeconomic Policy ment, Vol. 26 (September 1989). Coordination," in International Economic Coopera- Dornbusch, Rudiger, "Our LDC Debt," in The United tion, ed. by Martin S. Feldstein (Chicago: University States in the World Economy, NBER Summary Re- of Chicago Press, for National Bureau of Economic port, ed. by Martin Feldstein (Cambridge, Mas- Research, 1988). sachusetts: National Bureau of Economic Research, Fischer, Stanley, and Alan Gelb, "Issues in Socialist 1987). Economy Reform," in The Transition to a Market , "Background Paper," in The Road to Eco- Economy, ed. by Paul Marer and Salvatore Zecchini nomic Recovery (New York: Priority Press Publica- (Paris: Organization for Economic Cooperation and tions, for Twentieth Century Fund, 1989). Development, 1991). _, "Strategies and Priorities for Reform," in The Fischer, Stanley, and Ishrat Husain, "Managing the Debt Transition to a Market Economy, ed. by Paul Marer Crisis in the 1990s," Finance and Development, Vol. and Salvatore Zecchini (Paris: Organization for 27 (June 1990). Economic Cooperation and Development, 1991). Folkerts-Landau, David, and Donald J. Mathieson, The Dornbusch, Rudiger, J. H. Makin, and D. Zlowe, eds., European Monetary System in the Context of the In- Alternative Solutions to Developing Country Debt tegration of European Financial Markets, Occasional Problems (Washington: American Enterprise In- Paper No. 66 (Washington: International Monetary stitute for Public Policy Research, 1989). Fund, 1989). Dornbusch, Rudiger, and Holger Wolf, "Monetary Over- Frankel, Jeffrey A., Obstacles to International Macro- hang and Reforms in the 1940s," NBER Working economic Policy Coordination, Studies in Interna- Paper 3456 (Cambridge, Massachusetts: National tional Finance, No. 64 (Princeton, New Jersey: Inter- Bureau of Economic Research, October 1990). national Finance Section, Princeton University, Eatwell, J., M. Milgate, and P. Newman, eds., The New 1988). Palgrave: Game Theory (New York: Norton, 1989). Frenkel, Jacob A., Morris Goldstein, and Paul R. Mas- Eichengreen, Barry J., "International Policy Coordina- son, "International Dimensions of Monetary Policy: tion in Historical Perspective: A View from the In- Coordination Versus Autonomy," in Monetary Pol- terwar Years," in International Economic Policy Co icy Issues in the 1990s, proceedings of a symposium ordination, ed. by Willem H. Buiter and Richard C. sponsored by the Federal Reserve Bank of Kansas

City, Jackson Hole, Wyoming, August 30- Group of Thirty, International Macroeconomic Policy September 1, 1989 (Kansas City, Missouri: Federal Coordination (New York and London: Group of Reserve Bank of Kansas City, 1989). Thirty, 1988). _, "The Rationale for, and Effects of, Interna- Guitian, Manuel, "Credit Versus Money as an Instru- tional Economic Policy Coordination," in Interna- ment of Control," Staff Papers, International Mone- tional Policy Coordination and Exchange Rate Fluc- tary Fund, Vol. 20 (November 1973). tuations, ed. by William H. Branson, Jacob A. , "The Effects of Changes in the Exchange Rate Frenkel, and Morris Goldstein (Chicago: University on Output, Prices and the Balance of Payments," of Chicago Press, for National Bureau of Economic Journal of International Economics, Vol. 6 (Febru- Research, 1990). ary 1976), pp. 65-74. Frenkel, Jacob A., Michael P. Dooley, and Peter Wick- , Fund Conditionally: Evolution of Principles ham, eds., Analytical Issues in Debt (Washington: and Practices, IMF Pamphlet Series No. 38 (Wash- International Monetary Fund, 1989). ington: International Monetary Fund, 1981). Frenkel, Jacob A., and Michael L. Mussa, The World (1987a), "External Debt Management and the Economic System: Performance and Prospects International Monetary Fund," in Issues in North (Dover, Massachusetts: Auburn House Publishing, American Trade and Finance, ed. by R. Tremblay 1984). (Minneapolis: North American Economics and Fi- Friedman, Milton, Essays in Positive Economics (Chi- nance Association, January 1987). cago: University of Chicago Press, 1953). (1987b), "Adjustment and Economic Growth: , A Program for Monetary Stability (New York: Their Fundamental Complementarity," in Growth- Fordham University Press, 1959). Oriented Adjustment Programs, ed. by Vittorio Friedman, Milton, and others, Politics and Tyranny: Corbo, Morris Goldstein, and Mohsin Khan (Wash- Lessons in the Pursuit of Freedom, (San Francisco: ington: International Monetary Fund and World Pacific Institute for Public Policy Research, 1984). Bank, 1987). Genberg, Hans, "On the Sequencing of Reforms in East- (1988a), "Comment on Grober," in Economic ern Europe," IMF Working Paper 91/13 (Washing- Policy Coordination, ed. by Wilfried Guth (Wash- ton: International Monetary Fund, February 1991). ington: International Monetary Fund; Hamburg: Giavazzi, Francesco, "The EMS Experience," in The HWWA—Institut fur Wirtschaftsforschung, 1988). Evolution of the International Monetary System: (1988b), "The European Monetary System: A How Can Efficiency and Stability Be Attained? ed. Balance Between Rules and Discretion," in Policy by Yoshio Suzuki, Junichi Miyake, and Mitsuake Coordination in the European Monetary System, Oc- Okabe (Tokyo: University of Tokyo Press, 1990). casional Paper No. 61 (Washington: International Giavazzi, Francesco, and Alberto Giovannini, Limiting Monetary Fund, 1988). Exchange Rate Flexibility: The European Monetary (1989a), "Fiscal Adjustment, Debt Manage- System (Cambridge, Massachusetts: MIT Press, 1989). ment, and Conditionally," in Fiscal Policy, Eco- Giavazzi, Francesco, Stefano Micossi, and Marcus Miller, nomic Adjustment, and Financial Markets, ed. by eds., The European Monetary System (Cambridge: Mario Monti (Washington: International Monetary Cambridge University Press, 1988). Fund; Milan: Centro di Economia Monetaria e Giovannini, Alberto, "European Monetary Reform: Finanziaria, 1989). Progress and Prospects," Brookings Papers on Eco- (1989b), "Adjustment in the 1980s, the Role of nomic Activity: 2 (Washington: The Brookings In- International Organizations and the Outlook for the stitution, 1990), pp. 217-74.- 1990s," remarks to World Bank Symposium on Ad- Gilpin, Robert, The Political Economy of International justment Lending, Washington, April 7, 1989 Relations (Princeton, New Jersey: Princeton Univer- (1991a), "The Relevance of Turkey's Experi- sity Press, 1987). ence in Developing a Market Economy for Central Gold, Joseph, Legal and Institutional Aspects of the Inter- and Eastern Europe: An IMF Perspective," paper national Monetary System: Selected Essays, ed. by presented to an International Symposium on Tur- Jane B. Evensen and Jai Keun Oh (Washington: In- key's Experience in Developing a Market Economy ternational Monetary Fund, 1979). and Its Relevance for the Reforming Countries of Grober, Gunter, "Empirical Evidence of Effects of Pol- Central and Eastern Europe, Antalya, Turkey, April icy Coordination Among Major Industrial Countries 1-3, 1991. Since Rambouillet Summit of 1975," in Economic (1991b), "Economic Integration and Capital Policy Coordination, ed. by Wilfried Guth (Wash- Flows," paper presented to an International Sym- ington: International Monetary Fund; Hamburg: posium on Turkey's Experience in Developing a HWWA—Institut fur Wirtschaftsforschung, 1988). Market Economy and Its Relevance for the Reform- Gros, Daniel, "The New Germany: An Emerging Deficit ing Countries of Central and Eastern Europe, An- Economy," International Economic Insights (March/ talya, Turkey, April 1-3, 1991. April 1991), pp. 8-11. (1991c), "The Role of International Organiza- Gros, Daniel, and Niels Thygesen, The EMS: Achieve-- tions: The International Monetary Fund," in The ments, Current Issues and Directions for the Future Transition to a Market Economy, ed. by Paul Marer CEPS Paper No. 35 (Brussels: Centre for European and Salvatore Zecchini (Paris: Organization for Policy Studies, 1988). Economic Cooperation and Development, 1991).

Gwin, Catherine, Richard E. Feinberg, and contributors, (1990a), "Organizing Debt Relief: The Need The International Monetary Fund in a Multipolar for a New Institution," Journal of Economic Per- World: Pulling Together (New Brunswick, New spectives, Vol. 4 (Winter 1990), pp. 7-18. Jersey: Transaction Books, for the Overseas De- (1990b), "The Coordination of Macro- velopment Council, 1989). economic Policies," in International Policy Coordi- Hamada, Koichi, The Political Economy of International nation and Exchange Rate Fluctuations, ed. by Monetary Interdependence (Cambridge, Mas- William H. Branson, Jacob A. Frenkel, and Morris sachusetts: MIT Press, 1985). Goldstein (Chicago: University of Chicago Press, for Havrylyshyn, Oleh, and John Williamson, From Soviet National Bureau of Economic Research, 1990). disUnion to Eastern Economic Community? Policy _, "Transitional Arrangements for Trade and Analyses in International Economics 35 (Washing- Payments Among the CMEA Countries," Staff Pa- ton: Institute for International Economics, October pers, International Monetary Fund, Vol. 38 (June 1991). 1991), pp. 235-67. Hinds, Manuel, "Issues in the Introduction of Market Keohane, Robert O., After Hegemony: Cooperation and Forces in Eastern European Socialist Economies," Discord in the World Political Economy (Princeton, World Bank Report No. IDP-0057 (Washington: New Jersey: Princeton University Press, 1984). World Bank, April 1990). Khan, Mohsin, and Nadeem Ul Haque, "Foreign Bor- Holzmann, Robert, "Budgetary Subsidies in Centrally rowing and Capital Flight: A Formal Analysis," Staff Planned Economies in Transition," IMF Working Papers, International Monetary Fund, Vol. 32 (De- Paper 91/11 (Washington: International Monetary cember 1985). Fund, January 1991). , "Capital Flight from Developing Countries," Home, Jocelyn, and Paul R. Masson, "Scope and Limits Finance and Development, Vol. 24 (March 1987). of International Economic Cooperation and Policy Kindleberger, Charles P., Europe's Postwar Growth: The Coordination," Staff Papers, International Monetary Role of Labor Supply (Cambridge, Massachusetts: Fund, Vol. 35 (June 1988), pp. 259-98. Harvard University Press, 1967). Horsefield, J. Keith, The International Monetary Fund, , The World in Depression, 1929-1939 1945-1965: Twenty Years of International Monetary (Berkeley, California: University of California Press, Cooperation, Vol. I (Washington: International 1986). Monetary Fund, 1969). Kopits, George, "Fiscal Reform in European Economies Husain, Ishrat, and Ishac Diwan, eds., Dealing with the in Transition," in The Transition to a Market Econ- Debt Crisis (Washington: World Bank, 1989). omy, ed. by Paul Marer and Salvatore Zecchini Institute for International Finance, Building Free Market (Paris: Organization for Economic Cooperation and Economies in Central and Eastern Europe: Chal- Development, 1991). lenges and Realities (Washington: Institute for Inter- Kornai, Janos (1990a), Vision and Reality, Market and national Finance, 1990). State (New York: Routledge, 1990). International Monetary Fund, Research Department, (1990b), "The Affinity Between Ownership Determinants and Systemic Consequences of Interna- Forms and Coordination Mechanisms: The Com- tional Capital Flows, Occasional Paper No. 77 mon Experience of Reform in Socialist Countries," (Washington: International Monetary Fund, 1991). Journal of Economic Perspectives, Vol. 4 (Summer International Monetary Fund and World Bank, Adjust- 1990), pp. 131-47. ment and Growth, essays in Finance and Develop- (1990c), The Road to a Free Economy: Shifting ment (Washington: International Monetary Fund, from a Socialist System: The Example of Hungary 1987). (New York: W.W. Norton, 1990). Ize, Alain, and Guillermo Ortiz, "Fiscal Rigidities, Public Krasner, Stephen D., ed., International Regimes (Ithaca, Debt, and Capital Flight," Staff Papers, Interna- New York: Cornell University Press, 1983). tional Monetary Fund, Vol. 34 (June 1987). Kremers, Jeroen J. M., and Timothy D. Lane, "Eco- Kahler, Miles, ed., The Politics of International Debt nomic and Monetary Integration and the Aggregate (Ithaca, New York: Cornell University Press, 1986). Demand for Money in the EMS," Staff Papers, In- Kenen, Peter B., "Third World Debt: Sharing the Bur- ternational Monetary Fund, Vol. 37 (December den; A Bailout Plan for the Banks," New York 1990), pp. 777-805. Times, March 6, 1983, p. F3. League of Nations, with Ragnar Nurkse as primary con- , Financing, Adjustment, and the International tributor, International Currency Experience: Lessons Monetary Fund, Studies in International Economics of the Interwar Period (Geneva: League of Nations, (Washington: The Brookings Institution, 1986). 1944). , "What Role for IMF Surveillance?" World Lipschitz, Leslie, and Donogh McDonald, eds., German Development, Vol. 15 (December 1987), pp. 1445- Unification: Economic Issues, Occasional Paper No. 56. 75 (Washington: International Monetary Fund, , Managing Exchange Rates (London: Royal In- 1990). stitute of International Affairs, 1988). Lipton, David, and Jeffrey Sachs (1990a), "Creating a , Exchange Rates and Policy Coordination Market Economy in Eastern Europe: The Case of (Manchester: Manchester University Press, 1989). Poland," Brookings Papers in Economic Activity: 1

(Washington: The Brookings Institution, 1990), pp. Summits (Cambridge, Massachusetts: Harvard Uni- 75-133. versity Press, 1987). (1990b), "Privatization in Eastern Europe: The Regling, Klaus, "New Financing Approaches in the Debt Case of Poland," Brookings Papers on Economic Strategy," Finance and Development, Vol. 25 Activity: 2 (Washington: The Brookings Institution, (March 1988). 1990), pp. 293-341. Rotwein, Eugene, ed., David Hume—Writings on Eco- Marer, Paul, "Pitfalls in Transferring Market-Economy nomics (London: Nelson, 1955). Experiences to the European Economies in Transi- Sachs, Jeffrey D., Theoretical Issues in International Bor- tion," in The Transition to a Market Economy, ed. by rowing, Studies in International Finance, No. 54 Paul Marer and Salvatore Zecchini (Paris: Organiza- (Princeton, New Jersey: International Finance Sec- tion for Economic Cooperation and Development, tion, Princeton University, 1984). 1991). , New Approaches to the Latin American Debt McDonald, Donogh C, "Debt Capacity and Developing Crisis, Essays in International Finance, No. 174 Country Borrowing: A Survey of the Literature," (Princeton, New Jersey: International Finance Sec- Staff Papers, International Monetary Fund, Vol. 29 tion, Princeton University, 1989). (December 1982). Schrenk, Martin, "Whither Comecon?" Finance and De- Mehran, Hassanali, ed., External Debt Management velopment, Vol. 27 (September 1990). (Washington: International Monetary Fund, 1985). Schumpeter, Joseph A., History of Economic Analysis Mundell, Robert A., International Economics (New (New York: Oxford University Press, 1954). York: Macmillan, 1968). Schweitzer, Julian, "Transition in Eastern Europe: The , "Do Exchange Rates Work? Another View," Social Dimension," Finance and Development, Vol. IMF Working Paper 91/37 (Washington: Interna- 27 (December 1990), pp. 6-8. tional Monetary Fund, April 1991). Selowsky, Marcelo, and Herman G. Van der Tak, "The Nowzad, Bahram, "Lessons of the Debt Decade," Fi- Debt Problem and Growth," World Development, nance and Development, Vol. 27 (March 1990). Vol. 14 (September 1986), pp. 1104-24. Olson, Mancur, The Logic of Collective Action: Public Servan-Schreiber, Jean J., The American Challenge (New Goods and the Theory of Groups (Cambridge, Mas- York: Atheneum, 1968). sachusetts: Harvard University Press, 1971). Silva, Michael A., and Bertil Sjogren, Europe 1992 and , The Rise and Decline of Nations: Economic the New World Power Game (New York: Wiley, Growth, Stagflation and Social Rigidities (New 1990). Haven, Connecticut: Yale University Press, 1982). Simons, Henry C, Economic Policy for a Free Society Olson, Mancur, Jr., and Richard Zeckhauser, "An Eco- (Chicago: University of Chicago Press, 1948). nomic Theory of Alliances," Review of Economics Smith, Gordon W., and John T. Cuddington, eds., Inter- and Statistics, Vol. 48 (August 1966), pp. 266-79. national Debt and the Developing Countries (Wash- Oudiz, Gilles, and Jeffrey D. Sachs, "Macroeconomic ington: World Bank, 1985). Policy Coordination Among the Industrial Econo- Solomon, Robert, The International Monetary System, mies," Brookings Papers on Economic Activity: 1 1945-1981 (New York: Harper and Row, 1982). (Washington: The Brookings Institution, 1984), pp. (1990a), "An Overview of the International 1-75. Debt Crisis," in International Finance and Financial Padoa-Schioppa, Tommaso, Efficiency, Stability, and Eq- Policy, ed. by Hans R. Stoll (New York: Quorum uity: A Strategy for the Evolution of the Economic Books, 1990). System of the European Community (Oxford: Ox- (1990b), "The International Monetary System ford University Press, 1987). in Perspective," Brookings Discussion Papers in In- Pinder, David, Regional Economic Development and ternational Economics, No. 82 (Washington: The Policy: Theory and Practice in the European Com- Brookings Institution, September 1990). munity (London: Allen & Unwin, for University As- Stoll, Hans R., ed., International Finance and Financial sociation for Contemporary European Studies, Policy (New York: Quorum Books, 1990). 1983). Sundararajan, V., "Financial Sector Reform and Central Polak, Jacques J., Coordination of National Economic Banking in Centrally Planned Economies," IMF Policies, Group of Thirty Occasional Paper 7 (New Working Paper 90/120 (Washington: International York: Group of Thirty, 1981). Monetary Fund, December 1990). Prebisch, Raul, "Commercial Policy in the Under- Tanzi, Vito (1991a), "Tax Reform in Economies in Tran- developed Countries," American Economic Review, sition: A Brief Introduction to the Main Issues," Papers and Proceedings, Vol. 49 (May 1959), pp. IMF Working Paper 91/23 (Washington: Interna- 251-73. tional Monetary Fund, March 1991). Prust, Jim, and IMF Staff Team, The Czech and Slovak (1991b), "Mobilization of Savings in Eastern Federal Republic: An Economy in Transition, Occa- European Countries: The Role of the State," IMF sional Paper No. 72 (Washington: International Working Paper 91/4 (Washington: International Monetary Fund, 1990). Monetary Fund, January 1991). Putnam, Robert D., and Nicholas Bayne, Hanging To- Tanzi, Vito, and Teresa Ter-Minassian, "The European gether: Cooperation and Conflict in the Seven-Power Monetary System and Fiscal Policies," in Tax Coor-

dination in the European Community, ed. by Sijbren (1991a), "The Economic Opening of Eastern Cnossen (Boston: Kluwer Law and Taxation Pub- Europe," in Currency Convertibility in Eastern Eu- lishers, 1987). rope, ed. by John Williamson (Washington: Institute Taylor, John B., "International Coordination in the De- for International Economics, 1991). sign of Macroeconomic Policy Rules," European , ed. (1991b), Currency Convertibility in Eastern Economic Review, Vol. 28 (June/July 1985), pp. 53- Europe (Washington: Institute for International 81. Economics, 1991). Triffin, Robert, Gold and the Dollar Crisis: The Future of (1991c) "Current Issues in Transition Eco- Convertibility (New Haven, Connecticut: Yale Uni- nomics," in International Financial Policy: Essays in versity Press, 1960). Honor of Jacques J. Polak, ed. by Jacob A. Frenkel Ungerer, Horst, and others, The European Monetary and Morris Goldstein (Washington: International System: Developments and Perspectives, Occasional Monetary Fund and De Nederlandsche Bank, 1991). Paper No. 73 (Washington: International Monetary Wolf, Thomas A. (1990a), "Reform, Inflation, and Ad- Fund, 1990). justment in Planned Economies," Finance and De- United Nations, Economic Commission for Latin Amer- velopment, Vol. 27 (March 1990). ica, The Economic Development of Latin America (1990b), "Market-Oriented Reform of Foreign and its Principal Problems (Lake Success, New Trade in Planned Economies," IMF Working Paper York: United Nations Department of Economic Af- 90/28 (Washington: International Monetary Fund, fairs, 1950). April 1990). Weber, Max, The Theory of Social and Economic Orga- World Bank, Socialist Economies Unit, Transition: The nization, ed. by Talcott Parsons and trans, by Alex- Newsletter About Reforming Economies, Vol. 2 ander M. Henderson (New York: Free Press, 1964). (January 1991). Williamson, John, Voluntary Approaches to Debt Relief Wyplosz, Charles, "Asymmetry in the EMS: Intentional (Washington: Institute for International Economics, or Systemic?" European Economic Review, Vol. 33 1988). (March 1989), pp. 310-20.

Recent Occasional Papers of the International Monetary Fund 97. Rules and Discretion in International Economic Policy, by Manuel Guitian. 1992. 96. Policy Issues in the Evolving International Monetary System, by Morris Goldstein, Peter Isard, Paul R. Masson, and Mark P. Taylor. 1992. 95. The Fiscal Dimensions of Adjustment in Low-Income Countries, by Karim Nashashibi, Sanjeev Gupta, Claire Liuksila, Henri Lorie, and Walter Mahler. 1992. 94. Tax Harmonization in the European Community: Policy Issues and Analysis, edited by George Kopits. 1992. 93. Regional Trade Arrangements, by Augusto de la Torre and Margaret R. Kelly. 1992. 92. Stabilization and Structural Reform in the Czech and Slovak Federal Republic: First Stage, by Bijan B. Aghevli, Eduardo Borensztein, and Tessa van der Willigen. 1992. 91. Economic Policies for a New South Africa, edited by Desmond Lachman and Kenneth Bercuson with a staff team comprising Daudi Ballali, Robert Corker, Charalambos Christofides, and James Wein. 1992. 90. The Internationalization of Currencies: An Appraisal of the Japanese Yen, by George S. Tavlas and Yuzuru Ozeki. 1992. 89. The Romanian Economic Reform Program, by Dimitri G. Demekas and Mohsin S. Khan. 1991. 88. Value-Added Tax: Administrative and Policy Issues, edited by Alan A. Tait. 1991. 87. Financial Assistance from Arab Countries and Arab Regional Institutions, by Pierre van den Boogaerde. 1991. 86. Ghana: Adjustment and Growth, 1983-91, by Ishan Kapur, Michael T. Hadjimichael, Paul Hilbers, Jerald Schiff, and Philippe Szymczak. 1991. 85. Thailand: Adjusting to Success—Current Policy Issues, by David Robinson, Yangho Byeon, and Ranjit Teja with Wanda Tseng. 1991. 84. Financial Liberalization, Money Demand, and Monetary Policy in Asian Countries, by Wanda Tseng and Robert Corker. 1991. 83. Economic Reform in Hungary Since 1968, by Anthony R. Boote and Janos Somogyi. 1991. 82. Characteristics of a Successful Exchange Rate System, by Jacob A. Frenkel, Morris Goldstein, and Paul R. Masson. 1991. 81. Currency Convertibility and the Transformation of Centrally Planned Economies, by Joshua E. Greene and Peter Isard. 1991. 80. Domestic Public Debt of Externally Indebted Countries, by Pablo E. Guidotti and Manmohan S. Kumar. 1991. 79. The Mongolian People's Republic: Toward a Market Economy, by Elizabeth Milne, John Leimone, Franek Rozwadowski, and Padej Sukachevin. 1991. 78. Exchange Rate Policy in Developing Countries: Some Analytical Issues, by Bijan B. Aghevli, Mohsin S. Khan, and Peter J. Montiel. 1991. 77. Determinants and Systemic Consequences of International Capital Flows, by Morris Goldstein, Donald J. Mathieson, David Folkerts-Landau, Timothy Lane, J. Saul Lizondo, and Liliana Rojas-Suarez. 1991. 76. China: Economic Reform and Macroeconomic Management, by Mario Blejer, David Burton, Steven Dunaway, and Gyorgy Szapary. 1991. 75. German Unification: Economic Issues, edited by Leslie Lipschitz and Donogh McDonald. 1990. 74. The Impact of the European Community's Internal Market on the EFTA, by Richard K. Abrams, Peter K. Cornelius, Per L. Hedfors, and Gunnar Tersman. 1990.

73. The European Monetary System: Developments and Perspectives, by Horst Ungerer, Jouko J. Hauvonen, Augusto Lopez-Claros, and Thomas Mayer. 1990. 72. The Czech and Slovak Federal Republic: An Economy in Transition, by Jim Prust and an IMF Staff Team. 1990. 71. MULTIMOD Mark II: A Revised and Extended Model, by Paul Masson, Steven Symansky, and Guy Meredith. 1990. 70. The Conduct of Monetary Policy in the Major Industrial Countries: Instruments and Operating Pro- cedures, by Dallas S. Batten, Michael P. Blackwell, In-Su Kim, Simon E. Nocera, and Yuzuru Ozeki. 1990. 69. International Comparisons of Government Expenditure Revisited: The Developing Countries, 1975-86, by Peter S. Heller and Jack Diamond. 1990. 68. Debt Reduction and Economic Activity, by Michael P. Dooley, David Folkerts-Landau, Richard D. Haas, Steven A. Symansky, and Ralph W. Tryon. 1990. 67. The Role of National Saving in the World Economy: Recent Trends and Prospects, by Bijan B. Aghevli, James M. Boughton, Peter J. Montiel, Delano Villanueva, and Geoffrey Woglom. 1990. 66. The European Monetary System in the Context of the Integration of European Financial Markets, by David Folkerts-Landau and Donald J. Mathieson. 1989. 65. Managing Financial Risks in Indebted Developing Countries, by Donald J. Mathieson, David Folkerts- Landau, Timothy Lane, and Iqbal Zaidi. 1989. 64. The Federal Republic of Germany: Adjustment in a Surplus Country, by Leslie Lipschitz, Jeroen Kremers, Thomas Mayer, and Donogh McDonald. 1989. 63. Issues and Developments in International Trade Policy, by Margaret Kelly, Naheed Kirmani, Miranda Xafa, Clemens Boonekamp, and Peter Winglee. 1988. 62. The Common Agricultural Policy of the European Community: Principles and Consequences, by Julius Rosenblatt, Thomas Mayer, Kasper Bartholdy, Dimitrios Demekas, Sanjeev Gupta, and Leslie Lipschitz. 1988. 61. Policy Coordination in the European Monetary System. Part I: The European Monetary System: A Balance Between Rules and Discretion, by Manuel Guitian. Part II: Monetary Coordination Within the European Monetary System: Is There a Rule? by Massimo Russo and Giuseppe Tullio. 1988. 60. Policies for Developing Forward Foreign Exchange Markets, by Peter J. Quirk, Graham Hacche, Viktor Schoofs, and Lothar Weniger. 1988. 59. Measurement of Fiscal Impact: Methodological Issues, edited by Mario I. Blejer and Ke-Young Chu. 1988. 58. The Implications of Fund-Supported Adjustment Programs for Poverty: Experiences in Selected Countries, by Peter S. Heller, A. Lans Bovenberg, Thanos Catsambas, Ke-Young Chu, and Parthasarathi Shome. 1988. 57. The Search for Efficiency in the Adjustment Process: Spain in the 1980s, by Augusto Lopez-Claros. 1988. 56. Privatization and Public Enterprises, by Richard Hemming and Ali M. Mansoor. 1988. 55. Theoretical Aspects of the Design of Fund-Supported Adjustment Programs: A Study by the Research Department of the International Monetary Fund. 1987. 54. Protection and Liberalization: A Review of Analytical Issues, by W. Max Corden. 1987.

Note: For information on the title and availability of Occasional Papers not listed, please consult the IMF Publications Catalog or contact IMF Publication Services. Occasional Paper Nos. 5-26 are $5.00 a copy (academic rate: $3.00); Nos. 27-64 are $7.50 a copy (academic rate: $4.50); Nos. 65-86 are $10.00 a copy (academic rate: $7.50); and from No. 87 on, the price is $15.00 a copy (academic rate: $12.00).