OCCASIONAL PAPER 97 Rules and Discretion in International Economic Policy Manuel Guitian INTERNATIONAL MONETARY FUND Washington DC June 1992 ©International Monetary Fund. Not for Redistribution © 1992 International Monetary Fund 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 iv ©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 pa- pers 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 par- ticular, 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 environ- ment 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. V ©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 perspec- tive 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