Structural Adjustment Loans - Literature review Example

Running Head: STRUCTURAL ADJUSTMENT LOANS Structural Adjustment Loans [Name Of Student] [Name Of Institution] STRUCTURAL ADJUSTMENT LOANS ABSTRACT The term capital surge, or capital inflows - the two are often used interchangeably in the literature - is applied variously to situations involving gradually increasing net inflows, a sharp acceleration in inflows, or a switch from a net outflow to a substantial inflow. The faster rate of inflow typically lasts for some years before petering out. The greater inflow of funds can be due to a larger capital account surplus, or to a current account surplus or to both. This paper reviews the development of international financial support for the countries in transition. It includes an overview of the events that set the stage for this international support. In this paper information is provided on the flow of private capital into the less developed countries. This is followed by a discussion of official bilateral and multilateral financing and also deals with special financing, which has become a major component of international assistance. The paper ends with some observations on the current adequacy of the finance available and how have they affected less developed nations, women, and the poorest groups in less developed countries. INTRODUCTION The possible benefits of capital inflows to the importing country are well known and do not require extensive discussion here. Often accompanied by business skills and technology, capital inflows can boost investment and economic growth, beyond the constraints of domestic resources. In the case of the transition economies, external resources are essential to help finance their large economic restructuring needs and to raise income levels. Second, foreign monetary flows tend to lower internal interest rates, thus stimulating domestic investment and reducing the cost of servicing the domestic debt. Third, foreign exchange reserves are likely to rise, indirectly conferring a broad range of benefits (Carlos, 2007). Due to the cessation of new loans at the turn of the decade, the official reserves of virtually all transition economies were depleted and rebuilding them became a priority of economic policy. Fourth, the very fact of being able to attract inflows is positively assessed by the international community and helps to boost credit ratings (and vice versa- creditworthiness helps to attract capital flows). Fifth, sustained inflows may make it possible to liberalize capital Controls, not only on inflows, but also on certain outflows (e.g. allowing FDI abroad can foster export growth). Overall, liberalizing capital imports has been shown to boost investor confidence and seems to result in further inflows. Sixth, in nascent or previously protected local financial markets, capital imports can increase competition and improve internal resource allocation. Finally, under a flexible exchange rate system a flow-induced appreciation of the currency will cut the burden of servicing the country's foreign debt (Carlos, 2007). The potential benefits which capital exporting countries derive from investing in emerging markets include the possibility of obtaining higher yielding assets than may be available at home and portfolio diversification. Overall, the world economy could benefit from better resource allocation, but it cannot be taken for granted that this will simply occur as a result of worldwide liberalization of current and capital accounts. STRUCTURAL ADJUSTMENT LOANS The ultimate goals of stabilization and structural adjustment programmes -- supported by external assistance -- are to put the transition countries on the path to economic growth. Re-establishment of creditworthiness (for those currently lacking access to financial markets) and the attraction of significant capital inflows are essential elements of the longer-term strategy. Re-entry into credit markets, however, will not be easy for some countries. In Bulgaria, for example, a very high debt burden and modest medium-term export prospects have set the stage for debt reduction talks with creditors (Cull, 2005). Poland has already negotiated such an agreement. By contrast, the longer-run debt-servicing capacity of some of the ex-Soviet republics, particularly Russia, should be better. However, time and large foreign investments in the natural resource industries are required to revitalize the production and export of fuels. DISCUSSION A strong capital surge can also trigger a host of adverse macroeconomic repercussions in the importing country and increase certain risks. There are at least three broad areas of concern that may require policy responses: (Lizano, 2001) Capital surges can boost inflationary pressures, cause the real exchange rate to appreciate, reduce international competitiveness and worsen the current account balance. Countries reforming their trade systems typically carry out substantial devaluations of the exchange rate to promote export growth and structural adjustment. However, this measure can be at least partially offset by an inflow-induced appreciation of the real exchange rate, delaying the expected supply responses, prematurely increasing import competition and, perhaps, weakening the credibility of reform. Any resulting reductions in domestic interest rates may reduce local savings and offset the impact of structural policies aiming to raise savings (Carlos, 2007). The second set of issues relates to the capacity of the economy to efficiently absorb foreign capital, with implications for the sustainability of a given current account deficit. If the inflows boost domestic investment, especially in export oriented industries, any additional external debt has a better chance of being fully serviced. However, "excessive" inflow-fuelled consumption can provoke serious adjustment problems at a later date, particularly if it undermines the confidence of international investors. At the microeconomic level, the efficient absorption of external funds may be hindered by a weak banking system, substandard banking practices and poor supervision. The application of non-commercial criteria to bank lending (say, for political reasons) may result in loans to loss-making enterprises (which are unlikely to be repaid) and a misallocation of resources. Large inflows also raise the spectre of financial destabilization because they aggravate a variety of risks (e.g. those pertaining to interest rates, maturity, currency, etc.), (Dervis, 2002) the management of which may already challenge the capabilities of banks in systems undergoing reform. The third set of issues concerns the consequences of a rapid tapering off or reversal of inflows. The risk involved is that policy makers will assume that capital inflows will continue to sustain a given or a widening current account deficit. In the absence of large foreign exchange reserves, a failure of the expected capital inflows to materialize will precipitate costly adjustments usually involving a fall in domestic economic activity. Commercial banks are particularly vulnerable to capital reversals if there are large mismatches in the maturity structure of their assets and foreign liabilities (Cull, 2005). For these reasons it is not unusual for a negative capital shock to precipitate a domestic banking crisis. Several major developments have shaped the financial relations of the east with the international financial community during the past three years. In the wake of the east European revolutions in 1989, international banks reassessed their lending to the eastern area. Banks' private lending had been increasing rapidly, but the new, uncertain political situation, the initiation of major economic reforms and the emergence of payments difficulties in Bulgaria and the former USSR prompted private creditors to reduce their exposure vis-a-vis all the eastern countries. In consequence of the persistence of political uncertainty in the region (and armed conflict in certain areas), and generally poor economic results, private creditors and other investors have generally remained cautious (Carlos, 2007). Although this is understandable from their own viewpoint, this policy has tended to aggravate' the financial weakness of the transition countries and make them virtually dependent on official lenders. As the reforms got under way it was widely recognized that the transition economies would require large-scale assistance from the international community. Resources would be essential not only to support the implementation of reforms and restructuring but also to help these countries adjust to a series of strong external shocks: the contraction of trade in the former CMEA area, in particular the collapse of the important Soviet market; significant losses in the terms of trade due to the introduction of world market prices (especially for fuels) and convertible currency settlements for trade among the former CMEA countries; and the interruption of trade during the Persian Gulf crisis and the rise in world oil prices. Moreover, all east European countries needed to rebuild their foreign currency reserves, in part to support the introduction of unified exchange rates and more liberal payments regimes (Cull, 2005). Eastern Europe's adjustment to external disturbances has been made more difficult by the demise of the former Yugoslavia which had been a major trading partner. While Czechoslovakia and Hungary retained some access to flows of private finance, official sources were counted on to provide the bulk of eastern Europe's immediate credit needs. Those countries which were not already members of the Bretton Woods organizations in 1990 submitted their candidatures. Membership of the IMF and World Bank, and eventual implementation of economic reforms and stabilization programmes, were expected to enable them to tap the considerable resources of these institutions and trigger the release of other types of assistance as well (Stephen, 2005). Even with the prospective funding from these institutions, it was determined in late 1990 that additional resources would be required to close the financing gaps then projected for 1991for all east European countries. This need led the Group of Twenty-Four (G-24) western nations to arrange exceptional complementary financing, originally targeted at $4 billion, for Bulgaria, Czechoslovakia, Hungary and Romania (Carlos, 2007). From its very inception this aid was viewed as temporary, to be phased out as soon as the financial positions of the recipient countries strengthened. Similarly, the one-year IMF oil facility attached to the new standby credits was intended as a response to unusual circumstances. The availability of credits to eastern Europe through these exceptional multilateral facilities peaked in 1991. Since then new commitments from the international agencies reflect traditional lending, i.e., standby credits, project and structural adjustment loans, etc. Substantial financial support in the form of debt relief and arrears has benefited Albania, Bulgaria and Poland (Cull, 2005). THE CONSEQUENCES OF THE BRETTON WOODS IDEOLOGY IN THE CARIBBEAN By all standards, the structural adjustment/NIEs experience a la Bretton Woods, was a failure in the Caribbean. Admittedly, it is still relatively early to draw final conclusions, but several trends have emerged which give rise to serious concern. There is a rapid and most serious deterioration in the standards of primary and secondary education. Recent sociological data collected by researchers at the University of the West Indies clearly indicate that neo-liberal structural adjustment programs in Jamaica have created significant socio-demographic changes in the structure of the middle classes. One of the most disturbing aspects of these changes is that the `new' middle classes not only have significantly less formal education than their predecessors, but also no longer regard education as a precondition for status improvement and personal achievement (Dervis, 2002). As I point out elsewhere: Considering that 1) the dynamics of international industrialization are increasingly propelled by knowledge-and technology-intensive production and 21 the middle classes are often considered to be the anchor of national political and economic stability, the relative hostility of the `new' middle classes towards education is ... the probably most frightening consequence of `structural adjustment'. This aspect renders any positive comparison with the experience of East Asia and its emphasis on the promotion of education virtually impossible. Today high-tech and knowledge-intensive industries are the most dynamic economic sector's in the world economy and, as the software industry in India shows, they ought to be considered as viable options for developing countries. (Carlos, 2007) This, and the rapid expansion of the informal economy caused by the Bretton Woods programs, begs the question whether the two most significant negative consequences of the neo-liberal version of the Asian `model'--implicit in the structural adjustment package--are not the persistent marginalisation of small `developing' nations in the international division of labour and their weakened impact as potential providers of high-end, high-tech commodities in the world markets. Indeed, as other authors have also observed, it perpetuates their position as producers and exporters of raw materials and low-tech, low labour cost commodities which yield the lowest profit margins in the global economy. As Griffith points out correctly, the standard neo-classical prescription to devalue their currency finds structural limits in the fact that the region does not: produce many products which can benefit from a devaluation. A devaluation has only negligible impact on commodity exports because they are traded in regulated markets of the developed countries which are reluctant to buy these unlimited amounts of manufactures and primary products unless they desperately need them. Diminishing imports by devaluation has in the Caribbean context proven to be a purely theoretical notion. However, for the majority of the people living in the structural adjustment scenario, the economic consequences are much more immediate (Lizano, 2001). These consequences are not always quantifiable in precise terms. However, their cumulative impact has severe social consequences for those classes which have to carry the brunt of the burden of the adjustment process which are usually the lower classes. The World Bank's economists and decision makers are fully aware: of its negative economic and social consequences, but interpret them as an inevitable part of a painful, but ultimately healthy, economic restructuring exercise. To achieve the goal of setting free additional resources for the purpose of sustaining the debt repayment schedules as far as possible, structural adjustment radically cuts into public spending budgets without discriminating whether these cuts are socially desirable or contributing towards increasing, or even just maintaining, current levels of productivity. The net transfers can reach extraordinary proportions at a time when the restructuring of the economy would suggest even greater capital requirements. The state's reduced ability to provide employment and essential social services to the population has dire consequences for many of the lower classes. A few examples may indicate the extent of this radical social change. Although other Caribbean countries have undergone similar structural adjustment under IMF/World Bank guidance, Jamaica remains probably the most drastic example of its discriminative social consequences (Dervis, 2002). At the statistical level Jamaica's economic situation in the late 1980s improved only marginally compared to the late 1970s, the heyday of `democratic socialism'. Due to rapidly increasing migration, the growth of an informal economy and new computation methods, the figures for unemployment conceal an actual increase of unemployment in the late 1980s. As the figures show, the performance of the Jamaican economy in the late 1980s is by no means as impressive as the net capital inflows--most of it by structural adjustment loans--might suggest. In fact, the unprecedented numbers of Jamaicans seeking to migrate would indicate the massive social disenchantment induced by the adjustment exercise. It also needs to be kept in mind that a lot of the income generated in the 1980s was a direct result of preferential markets (for example, CBI, Lome (Carlos, 2007)) which in future: are likely to erode much more. In addition to reduced economic performance and public spending, individual spending power sharply decreased between 1977 and 1989 (Cull, 2005). Thus, the share of workers in urban areas earning less than the minimum required family income increased from 45.1 per cent in 1977 to 62.8 per cent, while the figures for the rural areas show a decrease from 72 per cent to 79.6 per cent over the same period (Christopher, 2005). In the East Asian NIEs income and living standards tended to increase, thereby positively contributing to productivity and the general performance of the economy. In contrast, all Caribbean economies under structural adjustment suffered a deterioration of their social services and infrastructure throughout the 1980s. In Dominica, for example, the number of beds in the country's main hospital was reduced by over a fifth between 1978 and 1987 and constant shortages of essential supplies are a direct consequence of strict new budget controls (Carlos, 2007). According to one physician `a child who comes in for a circumcision is very likely to leave with measles or another infectious disease, and come back sicker than before'. Another casualty is education. The number of students in primary schools declined by 23 per cent from 1978 to 1987, although the population grew by 9.9 per cent. For many successful students there are no places available in secondary schools (Sayek, 2005). The type of industrialization that structural adjustment policies have promoted has been a success only to a very limited degree. Indeed, workers fired due to the de-industrialization following the IMF/World Bank directives could not be absorbed by the few new industries-much of it speculative operations or the `free zone' enclave type--established in much of the Caribbean. Thus, in the case of Dominica, even the World Bank admits that the effects of structural adjustment on export oriented industry `have not been promising'. According to a senior official in Dominica's Ministry of Trade, consultants hired by USAID (Christopher, 2005): ... were here to attract US investors, but the kind of investments they promoted were the cut-and-sew type, that have limited and very short-term benefits to the economy. What we need are industries where there is more value added in Dominica. (Carlos, 2007) Very similar observations can be made with regard to the high-profiled Rockefeller Committee in Jamaica during the early 1980s. The list of academic accounts of structural adjustment is long and at this point there is little of substance that shall be added here. What has to be clearly understood, however, is that in the context of the ontology of Caribbean peoples, which looks back on four hundred years of proud resistance against colonization and persistent denial of their people hood, this kind of exogenously enforced `delayed gratification' is not acceptable and will not lead to higher productivity or development, but rather to greater withdrawal from a `system' which is perceived as hostile. The current IMF/World Bank/USAID inspired structural adjustment policies in the Caribbean will neither set entrepreneurial creativity free, nor unleash a wave of foreign investment in the most profitable industries, but rather create greater cynicism among the people about their countries' ability and willingness to care for their development. CONCLUSION Finally, structural adjustment has contributed to a serious erosion of civil society in many lesser developed countries. A new `free-for-all' and `quick-dollar' mentality has made not only drugs and violence endemic features of the region, but white collar crime hasalready been described as an even more serious problem. The progressive disintegration of civil rules and norms of interpersonal interaction combined with the withdrawal of critical resources is also putting new strains on the very fabric of the human rights situation and democracy in the region. The financial implication of this exercise and the threat that the debt pyramid might topple has led to a new phase of economic marginalization of the developing world. In this scenario, an abstract East Asian `model' of development was utilized for the legitimating of structural adjustment policy prescriptions for indebted developing states. Consequently, instead of developing, the number of `least developed countries' increased from 24 in 1972 to 41 in 1990. (Cull, 2005) This new peripheralisation stands under the contradictory omen of the breakdown of Soviet style `really existing socialism', which no longer requires massive aid schemes to `friendly' Third World regimes, on the one hand, and the fact that this breakdown has created a new `Third World' in the West's geographically and ethnically closer East European backyard (but also within many of their `domestic' economies) on the other hand. At the same time, international capital and the globalized bourgeoisie are enjoying their new freedom and are surfing on the top of increasing profit rates. This is not to argue that nothing the World Bank or the IMF suggested in the past made any (economic) sense. But it is important for the West to acknowledge the cultural foundations of economic development, which change the preconditions for economic growth dramatically from one country to the other, and factor them into its economic equations. In order to improve on the performance of the past, Western policy makers ought to give more room to each country to define its developmental objectives, the way it wants to achieve them and the time frame it requires for this process. Getting the basics right is therefore just a necessary precondition, but not in and by itself sufficient advice. REFERENCES Carlos, 2007. "IMF-Supported Adjustment Programs: Welfare Implications and the Catalytic Effect," Working Papers 07-22, Bank of Canada. Christopher, 2005. "Openness and inflation volatility: Cross-country evidence," Economics Papers 2005-W14, Economics Group, Nuffield College, University of Oxford. Cull, Robert & Effron, Laurie, 2005. "World Bank lending and financial sector development," Policy Research Working Paper Series 3656, The World Bank. Dervis, K., De Melo, J., & Robinson, S. (2002). General Equilibrium Models for Development Policy. Washington, DC: World Bank. GATT (1994). Uruguay Round of Multilateral Trade Negotiations: Morocco, Hong Kong, Tunisia, Bolivia, Costa Rica, Venezuela, El Salvador, Guatemala. Geneva: General Agreement on Tariffs Trade. Lizano Fait, E. (2001). Economic policy making: lessons from Costa Rica. Occasional Paper no. 21, International Center for Economic Growth. ICS Press, San Francisco. Sayek, 2005. "Aid and Foreign Direct Investment : International Evidence," Departmental Working Papers 0505, Bilkent University, Department of Economics. Stephen, 2005. "Foreign aid and market-liberalizing reform," The World Bank. Wilson, B. M. (1998). Costa Rica: Politics, Economics, and Democracy. Lynne Rienner. Read More