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.      

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.      

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.      

CHANGES IN POVERTY AND INEQUALITY IN DEVELOPING COUNTRIES

This paper presents new data on poverty, inequality, and growthin those developing countries of the world for which the requisitestatistics are available. Eco-nomic growth is found generallybut not always to reduce poverty. Growth, however, is foundto have very little to do with income inequality. Thus the "economiclaws" linking the rate of growth and the distribution of benefitsreceive only very tenuous empirical support here.      

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.      

INCOMPLETE MARKETS AND COMMODITY-LINKED FINANCE IN DEVELOPING COUNTRIES

This article provides a framework for appraising new financialinstruments and evaluating the extent to which they can helpalleviate problems of incomplete credit markets and contingentclaims markets in developing countries. Although the issuesinvolved apply to any new financial instrument, we give particularattention to commodity-linked securities because many developingcountries specialize in producing a handful of primary commoditiesand are therefore exposed to substantial commodity price risks.The article looks at the supply of, demand for, and pricingof commodity-linked securities and discusses some issues thataffect their use by developing countries: their special legalstatus as sovereign debt; their feasibility (since to becometruly effective they will require liquid secondary markets);and the construction of an optimal portfolio of external debtobligations. It also discusses the potential for new financialinstruments—particularly commodity-linked securities—asa tool for risk management in developing countries.      

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.      

PRODUCER TURNOVER AND PRODUCTIVITY GROWTH IN DEVELOPING COUNTRIES

The reallocation of resources, either across sectors or acrossproducers within a sector, can serve as a potential source ofproductivity growth. New research findings exploit comprehensivemicroeconomic data on the manufacturing sectors of Chile, Colombia,and Morocco to document resource shifts as producers enter,expand, contract, and exit operation. The micro-level adjustmentis substantial; between 25 and 30 percent of the total numberof manufacturing jobs turn over each year. In the short run,the productivity effects of this turnover are modest becausethe new plants that come on line are only slightly more productivethan the ones they replace—and both are typically small.In the longer term, however, the turnover generates more substantialincreases in productivity because the new firms that surviverecord substantial productivity gains in their early years.Moreover, firms that exit are typically on a downward productivityspiral and would probably have dragged down sectoral efficiencyfarther if they had continued in operation.      

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.      

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.      

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.      

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.      

USING RANDOMIZED CONTROL DESIGNS IN EVALUATING SOCIAL SECTOR PROGRAMS IN DEVELOPING COUNTRIES

Seven case studies—from Bolivia, Colombia, Indonesia,Mexico, Nicaragua, Taiwan (China), and Turkey—demonstratethe feasibility of conducting rigorous impact evaluations indeveloping countries using randomized control designs. Thisexperience, covering a wide variety of settings and social programs,offers lessons for task managers and policymakers interestedin evaluating social sector investments. The main conclusions are: first, policymakers interested inassessing the effectiveness of a project ought to consider arandomized control design because such evaluations not onlyare feasible but also yield the most robust results. Second,the acute resource constraints common in developing countriesthat often make program rationing unavoidable also present opportunitiesfor adopting randomized control designs. Policymakers and programmanagers need to be alert to the opportunities for buildingrandomized control designs into development programs right fromthe start of the project cycle because they, more than academicresearchers or evaluation experts, are in the best positionto ensure that opportunities for rigorous evaluations are exploited.      

THE RELEVANCE FOR DEVELOPING COUNTRIES OF RECENT DEVELOPMENTS IN MACROECONOMIC THEORY

This article reviews recent developments in macroeconomic theoryand considers their relevance for developing countries. Particularemphasis is given to the rational expectations revolution. Thearticle asks whether government policies are systematic andsuggests the need to study the expectations on which governmentsbase their decisions. Also discussed are the neo-Ricardian theorem,the implications of real wage rigidity and of supply side modelswith sectoral income effects, and recent models involving largegroup interaction.      

FINANCING INFRASTRUCTURE IN DEVELOPING COUNTRIES: LESSONS FROM THE RAILWAY AGE

In recent years suggestions for reforming the provision andfinancing of infrastructure services in developing countrieshave focused on private participation. This alternative to publicfinancing is seen as a way both to minimize the inefficienciesof public administration and to avoid the need for externalborrowing. In fact, for much of the nineteenth century, infrastructureprojects were privately financed and built. This approach, however,did not obviate the need for government intervention and foreigncapital. Because of the difficulties of assessing projects,investors were reluctant to commit their funds, and governmentsturned to subsidies and loan guarantees to encourage investment.Often, however, government intervention only replaced one setof problems with another. Investors with government-guaranteedloans had no incentive to monitor the firm's performance—alimitation that led to the diversion of funds and frustratedthe public interest. This article draws out the implicationsof this experience for policymakers in developing countriestoday.      

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.      

ORGANIZED LABOR, POLITICS, AND LABOR MARKET FLEXIBILITY IN DEVELOPING COUNTRIES

Organized labor is usually viewed as an obstacle to labor marketadjustment. But unions' responses to adjustment programs infact range from militant opposition to acquiescence or evenexplicit cooperation. Three sets of variables shape these responses:the strength and characteristics of the union movement itself;economic cycles; and political institutions and their ties tounions. •Strength of the labor movement: In industrial democracies,an aggressive stance on wages tends to be associated with moderatelystrong unions. Small or weak unions are less militant, as mightbe expected; more surprisingly, large and powerful unions alsotend to be more moderate, primarily because of their greaterparticipation in consultation and decisionmaking at the nationallevel. The experience in developing countries is somewhat different:only a few of these have strong labor movements, and among these,militancy is common. The large share of wage labor in the publicsector complicates comparisons with industrial nations, sincegovernments as employers clearly behave differently from privateemployers, particularly in hard times. •Economic cycles: Depression almost invariably reducesmilitancy in developing as well as industrial nations. •Political institutions: The nature of the political regime—democraticor authoritarian—is only roughly associated with how governmentshandle labor relations, and correspondingly with the optionsavailable to unions. More important in shaping unions' behaviorare the nature of the political party system and how unionsare connected with parties. The conditions needed to gain workers'cooperation are analogous to those which encourage businessto invest: political stability, a voice in policy that affectstheir interests, and arising from these, the confidence thatcurrent sacrifices will ultimately yield a fair share of futurebenefits.