MACROECONOMIC ADJUSTMENT IN DEVELOPING COUNTRIES

The short-run adjustment problem in developing countries involvesboth the improvement of the current account and the reductionof inflation. In both cases, the usual reason for adjustmentis shown to be the fiscal deficit. The article distinguishesprimary adjustment costs, which are inevitable, from secondarycosts, which result, for example, from failure to devalue orfrom real wage rigidity. The article then analyzes the effectsof expenditure reduction and currency devaluation on varioussectors of the economy. Reducing inflation involves both aninflation tax replacement and a price adjustment problem, and"heterodox" policies designed to deal with the latter are discussed.If the fiscal deficit cannot be reduced, the article argues,improving the current account may be at the cost of increasinginflation and likewise reducing inflation may be at the costof worsening the current account.      

FISCAL DEFICITS AND MACROECONOMIC PERFORMANCE IN DEVELOPING COUNTRIES

Although fiscal adjustment was urged on developing countriesduring the 1980s to lead them out of economic malaise, considerableuncertainty remains about the relations between fiscal policyand macroeconomic performance. To illustrate how financial markets,private spending, and the external sector react to fiscal policies,the behavior of holdings of money and public debt, private consumptionand investment, the trade balance, and the real exchange rateis modeled for a sample of ten developing countries. The studiesfind strong evidence that over the medium term, money financingof the deficit leads to higher inflation, while debt financingleads to higher real interest rates or increased repressionof financial markets, with the fiscal gains coming at increasinglyunfavorable terms. Consumers respond differently to conventionaltaxes, unconventional taxes (through inflation or interest andcredit controls), and debt financing, in ways that make fiscaladjustment the most effective means of increasing national saving.Private investment—but not private consumption—issensitive to the real interest rate, which rises under domesticborrowing to finance the deficit. Contrary to the popular presumption,in some countries private investment increases when public investmentdecreases. There is strong evidence that fiscal deficits spillover into external deficits, leading to appreciation of thereal exchange rate. Fiscal deficits and growth are self-reinforcing:good fiscal management preserves access to foreign lending andavoids the crowding out of private investment, while growthstabilizes the budget and improves the fiscal position. Thevirtuous circle of growth and good fiscal management is oneof the strongest arguments for a policy of low and stable fiscaldeficits.      

MACROECONOMIC ADJUSTMENT IN DEVELOPING COUNTRIES: A POLICY PERSPECTIVE

A comprehensive macroeconomic adjustment program is expectedto have the following objectives: a sustainable current accountposition, a stable and high rate of economic growth that wouldallow for a steady rise in per capita consumption, a reducedrate of inflation, and a manageable level of foreign debt. Thepackage designed to meet these objectives would typically includepolicy measures that simultatenously restrain aggregate demandand increase the availability of resources. These policies maybe grouped as follows: demand-management policies, structuralpolicies, exchange rate policies, and external financing policies.This article describes how these policies can be expected toachieve the goal of macroeconomic adjustment. The focus is primarilyon the theoretical and empirical links between policy instrumentsand ultimate objectives. An examination of these links is necessarybefore issues of the appropriate mix of demand-management, structural,exchange rate, and external policies, and the sequencing ofthese policies in a program, can be properly addressed.      

INTERPRETING RECENT RESEARCH ON SCHOOLING IN DEVELOPING COUNTRIES

Policymakers in developing countries have long been troubledby the undesirable, but apparently unavoidable, choice betweenproviding broad access to education and developing high-qualityschools. Recent evidence, however, suggests that this is a badway to think about human capital development. Grade repetitionand high dropout rates lead to a significant waste of resourcesin many school systems. Students in quality schools, however,respond in ways that reduce such inefficiencies, perhaps evensufficiently to recoup immediately investments in quality. Promoting high-quality schools, however, is more difficult thanmany have thought, in part because research demonstrates thatthe traditional approach to providing quality—simply providingmore inputs—is frequently ineffective. Existing inefficienciesare likely to be alleviated only by the introduction of substantiallystronger performance incentives in schools and by more extensiveexperimentation and evaluation of educational programs and schoolorganizations. Incentives, decentralized decisionmaking, andevaluation are alien terms to education, in both industrialand developing countries, but they hold the key to improvementthat has eluded policymakers pursuing traditional practices.      

SHELTER STRATEGIES FOR THE URBAN POOR IN DEVELOPING COUNTRIES

Rapid growth in many developing-country cities is strainingthe capacity of their shelter delivery systems. Governmentshave chosen a variety of implicit and explicit policies to amelioratethese strains. However, these policies are not always consistentwith their objectives, often because of a lack of knowledgeof how housing markets actually work and how policies affectand are constrained by market behavior. This paper reviews recentresearch on housing market behavior in developing countries,including the demand for housing and the pattern of housinginvestment across countries, the financing of housing by low-incomehouseholds, and the willingness to pay for secure tenure. Commonhousing policies are then examined, including public housing,sites and services projects, and slum clearance versus upgrading.Rent controls, measures to improve the supply of finance andinfrastructure, and building codes and standards are also discussed.      

OPTIONS FOR DISMANTLING TRADE RESTRICTIONS IN DEVELOPING COUNTRIES

Although many countries have adopted freer trade regimes orare in the process of reforming quantitative restrictions, suchreforms are not without shortterm costs. Sudden removal of quantitativerestrictions can release a surge of demand for imports thatcan deplete foreign exchange reserves and force rapid adjustmentby domestic industries. Five methods to more gradually liberalizequantitative restrictions are discussed: raising quota ceilingsuntil they are non-binding; eliminating quotas product by product;converting quotas to equivalent tariffs and then reducing them;auctioning quota licenses; and converting quotas to tariff quotas,and then liberalizing these. The various instruments are evaluatedaccording to their implications for the adjustment period, forgovernment revenue, for the balance of payments, and for theextent to which they are likely to produce political disruptions.      

THE IMPACT OF EC-92 ON TRADE IN DEVELOPING COUNTRIES

How is the attempt of the European Community (EC) to createa single market going to affect the developing countries? Thisarticle argues that the net direct effects of EC-92 may be rathersmall: the trade creation and trade diversion effects broughtabout by the program may cancel each other out, with few repercussionsfor the developing countries as a group. The expected changesin trade flows arising from relatively small changes in nominalprices and aggregate incomes, the changes in market structure,the removal of internal barriers, and a predicted 5 percentincrease in EC output may be important to European policymakers,but they are rather remote from the developing countries. The threat of EC-92 to the developing countries lies elsewhere:from diversion of investment from those countries to the ECand from the resurrection of protectionism by the EC, especiallyin the form of nontariff barriers, toward the outside world.      

RECENT DEVELOPMENTS IN THE HIGH YIELD MARKET

After a period of virtually uninterrupted growth stretching from 1994 through the first half of 1998, the high yield market suffered a sudden, jarring setback that led to the widest credit spreads seen since 1991. With the global spread of the Asian flu in August, spreads became so wide that the market for new issues virtually ceased. The most frequently used word to describe conditions in the high yield market during this period was carnage.
Then, in response to the Federal Reserve's series of rate cuts beginning in late September, the market staged a modest recovery that carried through the end of the year. Since then, the market has experienced several periods of alternating strength and weak ness, and new issuance has moderated relative to the record levels of a year ago. This article examines last year's volatile new issue environment and analyzes recent developments that can be expected to influence financing opportunities for corporate issuers in the near future.     

THE RELATIVE EFFICIENCY OF PRIVATE AND PUBLIC SCHOOLS IN DEVELOPING COUNTRIES

Aside from revenue mobilization, one of the arguments for allowingthe private sector to assume a larger role in the provisionof education is that it would increase efficiency, as administratorsbecome more responsive to the needs of students and their parents.But what is the evidence? Based on case studies that compareprivate and public secondary education in Colombia, the DominicanRepublic, the Philippines, Tanzania, and Thailand, private schoolstudents generally outperform public school students on standardizedmath and language tests. This finding holds even after holdingconstant for the fact that, on average, private school studentsin these countries come from more advantaged backgrounds thantheir public. school counterparts. In addition, preliminaryevidence shows that the unit costs of private schools are lowerthan those of public schools. Although these results cannot,in themselves, be used as arguments for massive privatization,they indicate that governments should reconsider policies thatrestrain private sector participation in education. Furtherresearch is needed to determine whether some teaching and administrativepractices in private schools are applicable to public schools.      

STABILIZATION POLICIES IN DEVELOPING COUNTRIES

The article focuses on the design of stabilization measuresto correct excessive balance of payments deficits and moderatethe rate of inflation. It distinguishes three sources of balanceof payments difficulties—excessively expansionary aggregatedemand policies; domestic supply shocks stemming, for example,from increases in real wages in excess of productivity growth;and external terms of trade shocks. It also analyzes the effectsof devaluations. The second part of the article discusses policiesaimed at reducing the rate of inflation and summarizes the theoreticalliterature on the dynamics and the transitional costs of adjustmentto lower rates of inflation in closed economies. Evidence onthe adjustment costs of disinflationary policies is reviewed,and the discussion is extended to some recent analysis of adjustmentin open economies.      

COMMODITY EXPORT BOOMS IN DEVELOPING COUNTRIES

This article surveys the experiences of commodity-exportingcountries faced with resource discoveries and widely fluctuatingworld prices. Favorable developments of the commodity exportmarket often prove to be a mixed blessing, as poor boom managementleads to major internal and external economic imbalances. Manydeveloping countries overconsume during boom periods. More oftenthan not, the unsustainable increases in spending are initiatedby the public sector. When the boom ends, tardiness in decreasinggovernment spending and in increasing revenues from nonboomingsectors creates fiscal deficits and monetary control problems. In the 1970s many booming economies allowed regulated pricestructures, and particularly exchange rates, to deviate substantiallyfrom free market levels, discouraging efficient resource allocationand greatly compounding the problems of adjustment to subsequentdrops in export prices. Countries that managed booms well weretypically those that (a) did not allow fiscal variables, exchangerates, agricultural producer prices, and wages to get badlyout of line, (b) avoided indulging in wasteful and inefficientinvestment or investment that involved burdensome recurrentcosts, (c) limited increases in government spending to levelsconsistent with long–term trends in revenue collection,and (d) maintained prudent external borrowing and foreign exchangereserve policies.      

PARALLEL EXCHANGE RATES IN DEVELOPING COUNTRIES

Dual exchange rates and black markets for foreign exchange arecommon in developing countries, and a body of evidence is beginningto emerge on the effects that such parallel foreign exchangesystems have on macro-economic performance. This article presentsa simple typology of parallel systems, discusses their emergence,and looks at why countries prefer these arrangements to themain alternatives. The article examines the ability of parallelmarkets to insulate international reserves and domestic pricesfrom shocks to the balance of payments. Drawing on the findingsfrom eight detailed case studies, the authors discuss the determinationof the parallel premium in the short and long terms, the relationshipbetween the premium and illegal transactions, and the fiscaleffects of parallel rates. They compare the experiences of countriesthat have attempted to unify their foreign exchange marketsand discuss the implications for policy alternatives.      

EXCHANGE RATE MISALIGNMENT IN DEVELOPING COUNTRIES

This article analyzes the theory of equilibrium real exchangerates and defines misalignment as a deviation of the real exchangerate (RER) from its equilibrium level. The role of macroeconomicpolicies is then analyzed under three alternative nominal exchangerate regimes: predetermined nominal exchange rates, floatingnominal rates, and dual or black market nominal exchange rates.This discussion points out how inconsistent macroeconomic policiesoften lead to real exchange rate misalignment. Corrective measures,including nominal devaluations and several alternative approaches,are then evaluated.      

MARKET EFFICIENCY IN DEVELOPING COUNTRIES: A CASE STUDY OF THE NAIROBI STOCK EXCHANGE

This study extends evidence on the efficiency of stock markets in developing countries using data from the Nairobi Stock Exchange (NSE), and also addresses some methodological issues which have contributed to the sparseness of similar studies. Evidence is provided that small markets such as the NSE may provide empirical results consistent with weak-form efficiency. This evidence holds for the NSE irrespective of whether bid-, ask-, or market-price series are used in conducting the study.