Lecture 4

Prof. Dr. Durmuş Özdemir Department of Economics

Yaşar University

.

Neoliberalism, World Bank and the

IMF Policy

• Beginning in the late 1960’s a new

economics opposed to Keynesianism,

Structuralism and Development

economics.

• Neoliberalism came from 3 linked sources;

– Monetarists

– The new classical liberalism of economists

– Conservative political and economic ideas

glorifying Laissez-faire and rugged

individualism.

Sources of Neoliberalism:

Monetarists

• M. Friedman

• The Chicago School,

• Institute of Economic Affairs (UK)

• They argued that macroeconomic

problems like inflation and indebtedness

derived from excessive government

spending driving up the quantity of money

circulation in a society.

Sources of Neoliberalism: The new

classical liberalism of economists

• i.e. Friedrich von Hayek

• Socialist ideas (like Keynesian planning)

would lead to disaster and that classical

Smithian and Ricardian economics

principles should be relied on instead.

Conservative political and economic ideas

glorifying Laissez-faire and rugged

individualism• Authors such as Ayn Rana, American heritage

foundation and similar right-wing organizations.

• These ideas began to be taken seriously again in a context of economic crises.

• The Bretton Woods agreement broke down in 1970.

• Oil price rise; 1973-1974 and again 1979; several waves of inflation occured.

• So many economists said Keynesian economics finished, that planning had been found lacking.

Conservative.....Laissez-faire.. (Cont.)

• Neoliberal economic policies put into effect by the conservative Reagan and Thatcher governments in the early 1980’s.

• Many had already been tested in Chile where General Pinochet was heavily advised by Chicago school economists.

• The counter revolution extended with Deepak Lal (Economist, Univ. California), LA.

Deepak Lal..

• Perverted standard economic principles, efficiency of price mechanism or Free trade, in the belief that developing countries were special cases rather than examples of universal behaviour.

• Argued; Fundemantals of growth in developed countries applied equally to the developing countries. (Position of Macroeconomics)

• Development economics had misinterpreted welfare economics, in particular the ‘second best theorem’, to produce situations worse than laissez-faire would yield.

Lal.. (Cont.)

• In a necessarily imperfect world, imperfect market mechanisms would do better in practice than imperfect planning mechanisms.

• Lal argued against income redistribution from rich to poor people.

• On standard, classical economic grounds, Lal was against all economic controls or government interventions and trade controls in a return to nearly free trade regimes.

• Lal’s ideas were complemented by the work of Bela Balassa on commercial policy in developing countries.

Balassa

• Free trade did not mean the total absence of government intervention, nor complete acceptance of the pattern of production dictated by freely operating world market forces.

• Permissible government interventions such as state protection of infant industries, and indeed choice of policy was key to understanding develomental success.

• Argued for stage theory and development start in third world countries as a response to the needs of the primary sector (i.e. Processing raw materials, providing simple inputs etc.)

Balassa’s development stages

• Stage 1: An ‘easy’ stage of import substitution entailed the local manufacture of previously imported non durable goods.

• This industry small scale require unskilled labour

• But provided rapid growth as tariff on imports enabled local production to gain increasing shares of the market.

• Local consumption and growth raised.

Balassa, Stage 2• Import substitution or exporting.

• Replacement of imports of intermediate goods (i.e. Petrochemicals, steel), producer durables (machinery), and consumer durables (automobiles) by domestic production. (After W.War II Latin America, Turkey, some south Asia, East European countries).

• Problems, such as the small size of the market (when industries are characterised by considerable economies of scale) led to the need for considerable state protection; in fact, in several underdeveloped countries the cost of protection amounted to 6 or 7% of the GDP.

• Balassa found that economic growth was distorted in environments protected from outside competition, that agriculture suffered, and that countries following this strategy lagged behind.

Balassa, Stage 3

• Policy reforms like reduction in import protection and subsidization of exports a main advantage of exporting being that it enabled economies of scale.

• Export oriented policies, were adopted by Japan in the mid 1950’s; Korea, Singapore and Taiwan in the ealy 1960’s; and the Latin American countries in the mid-to late 1960’s.

• Korea, Sngapore and Taiwan, all of which implemented ‘free trade regimes’ (exporters could choose to use local or imported inputs in their manufacturing), increased industrial exports rapidly in the early 1960’s.

Balassa... (Cont.)

• In the late 1960’s and early 1970’s various incentives for exporting in these countries led to further growth in manufacturing employment and higher incomes.

• Countries in Latin America (i.e. Brasil) that reformed their system of incentives also experienced (somewhat lower) rates of increase in exports and employment.

• Butr countries retained inward looking strategies (e.g. India, Chile, Uruguay) remained at the bottom of the industrial growth chart.

For Balassa..

• Evidence was coclusive; ‘Countries applying

outward oriented development strategies had a

superior performance in terms of exports,

economic growth, and employment whereas

countries which continued inward orientation

encountered increasing economic difficulties’.

• So, Choice of economic policy was the

differentiating factor, and export led

industrialization was the promise of the future for

the underdeveloped world.

Balassa... (Cont.)

• Balassa (1981) argued that East Asian countries with high educational levels would replace japan in exporting skill-intensive production, and that countries at lower stages of industrial development would export product requiring unskilled labour.

• This would widen the circle of industrial development to eventually include all.

• The basic idea that now emerged was that the new industrial countries (NIC’s) were models for the rest of the developing world to follow.

• This view was given credence by the apparent success of the NIC’s in the 1970’s and 1980’s.

Balassa... (Cont.)

• The developed countries had economic growth rates averaging 4.8% a year in the period 1964-1973 and 2.1% a year in the period 1973-1983; the NIC’s (Brasil, Mexico, Hong-Kong, Singapore, Taiwan) collectively had growth rates of 8.4% and 5.3%, respectively, in the same periods, with the East Asian countries sustaining growth rates on the order of 10% a year often for a decade or more (OECD 1988).

• In the mid 1980’s a new wave of industrialization in Indonesia, Malaysia, Thailand and (later) China seemed to confirm the Balassa theory of an ever widening circle of industry led growth.

Balassa... (Cont.)• In the view of many,this brought to an end the North-South

division of labour involving exchanges between primary commodities and industrial goods.

• Neoliberal development theorists argued that the success of the NIC’s confirmed their views that sound development policies could be based on conventional neoclassical economic principles.

• ‘Growth and development in the NIC’s are viewed as natural, inherent properties of open capitalist economies in which market forces are allowed to operate with little state interference’

• Putting this differently, compared to comparative advantage theory ‘Developing countries to providing cheap labour products to the global system.

• The notion of a ladder leading to increase sophisticated products made by better paid workers suggested a more acceptable development theory.

Policy consensus

• By the end of the 1980’s a system of recommendations based on neoliberal ideas became standard in conventional international economic policy circles.

• In a book on the debt crises in Latin America, John Williamsom, a senior fellow at the Institute of International Economics in Washingtonn DC. Outlined the policy consensus reached by the IMF, the World Bank, and the US executive branch.

• The ‘Washington Consensus’ dismissed the conclusion reached in the development literature and relied instead on classical economic theories to reach a list of policy recommendations.

Washington Consensus• 1) Fiscal discipline: Government budget deficits

should be no more than 2% of GDP.

• 2) Public expenditure priorities: expenditures should be redirected from politically sensitive areas toward neglected areas like primary health care, education, and infrastructure.

• 3) Tax reform: incentives should be sharpened and security improved.

• 4) Financial liberalization: Interest rates should be market determined as far as possible.

• 5) Exchange rates: Rates should be sufficiently competitive to induce rapid growth in non traditional exports.

Washington Consensus (Cont.)• 6) Trade liberalization: quantitative restrictions

on imports should be replaced with tariffs in the range of 10% over a period of 3-10 years.

• 7) FDI: barriers to the entry of foreign firms competing on equal terms with domestic companies should be abolished.

• 8) Privatization: State enterprises should be returned to private ownership.

• 9) Deregulation: governments should abolish regulations restricting competition.

• 10) Property rights: the legal system should secure property rights without excessive costs.

Washington Consensus (Cont.)

• As founder Williamson put it;

‘The economic policies that Washington

urges on the rest of the world may be

summarized as prudent (İhtiyatlı) macro

economic policies, outward orientation,

and free market capitalism’.

Washington Consensus (Cont.)

• The consensus was subsequently widely interpreted by critiques as the essence of a neoliberal development policy package.

• Development policy came to consist in withdrawing government intervention in favour of the rationalization of an economy through disciplining by the market and by self interested individuals efficiently choosing between alternatives in the allocation of resources.

• In the external sector, neoliberalism entailed the devaluation of currencies, convertible monetary system, and the removal of restrictions on trade and capital movements.

Washington Consensus (Cont..)• In the international sectors, markets were to be

deregulated (including deunionizing) while price subsidies on food were to be reduced and then eliminated.

• Government spending was reduced, and private consumption restricted (by higher prices) so that incomes flowed into private investment, stimulating growth.

• This alternative theory of development was applied to some Latin American countries in the early 1970’s, from which it spread to Africa, by the mid 1990’s likewise, neoliberalism became the West’s model for reshaping Eastern Europe in the Postcommunist 1990’s.. A good example was Poland’s ‘return to Europe’.

Washington Consensus..

Implemented

• Jeffrey Sachs (1991), a Harward Univ. Economist and an advisor to Solidarity, the Polish workers movement, and subsequently to the post communist Polish government, saw structural change occuring through the generalized reintroduction of market forces.

• 3 types of policies were introduced in Poland.

Polish Neoliberal Policy

implementations

• 1) Economic Liberalization: the broader rubric for legal and administrative changes needed to create institutions of private property and market competition.

• 2) Macroeconomic stabilization, including measures to limit budget deficits, reduce growth of the money supply, and create a convertible currency with stable prices

• 3) Privatization, transfering ownership of state property to the private sector.

Polish Neoliberal Policy

implementations (2)• Furthermore, Sachs also advocated a social

safety net, to prevent reforms from injuring the most vulnarable sectors of society, and public investment program, mainly for infrastructure as a complement to economic restructuring.

• He thought that measures like these could be introduced virtually overnight (light switching the driving side in Britain from left to right) in a process that became known as ‘shock therapy’.

• The key to economic reform (Sachs) said was that several years had to pass in a value of tears before the fruits were borne, the time depending on the boldness and consistency of the reforms if theer was wavering, it was easy to get lost in the valley.

Sachs summary of neoliberal

approach to development

• ‘Liberal’ in the classical sense of lack of

state control and reliance on markets and

the price mechanism.

• ‘Liberal’ in the contemporary sense of

concern for victims but

• ‘Neo’ in the sense that suffering was

accepted as an inevitable consequence of

reform and efficiency.

World Bank and IMF

• The IMF designed to help countries avoid

balance of payments problems by giving

short term loans.

• The World Bank ( Or International Bank for

Reconstruction and Development)

guaranteed private bank loans for more

long term investment in productive

activities.

World Bank History(1)

• 1950’s Eugene Black (president -1949-1962): The bank mainly loaned capital for the construction of Infrastructure (roads, rail roads, dams etc.)

• In the belief: development basically meant economic growth and this, in turn depend on investment.

• In the mid 1960’s: Gerge Woods (president 1963-1968); emphasis shifted to education and Third World agriculture.

World Bank History (2)• 1968-1981 President Robert McNamara: The bank

increased rapidly in size and charged quickly in orientation. (Mc Namara had been president of Ford Motor company and was US secretary of Defence during the Vietnam War)

• His speech in 1972: ‘’40% of the people in the south, or third world lived in absolute poverty, which he defined as conditions so deprived as to prevent realization of the potential of a person’s genes.

• The immediate priority was enabling decent living conditions (food, clothing, housing services), that is, a basic needs approach to development assistance, in which resources were given directly rather than trickling down to the poor.

World Bank History (3)

• The ultimate goal, Mc Namara (1981) said, was to raise the productivity of the poor, enabling them to be brought in to the economic system.

• The 1978 World Development Report (WDR) said that the development effort should be directed toard the twin objectives of rapid growth and reducing the numbers of people living in absolute poverty as quickly as possible.

• The idea was to use resources made possible by rapid economic growth to expand public services.

• For a while basic needs became the development approach of choice among international agencies.

World Bank History (4)

• So, 1968 the World Bank’s lending for

agriculture and rural development totalled 172,5

million $; by 1981 this risen to 3,8 billion $.

• President changed: A.W Clawson early 1980’s;

World Bank shifted emphasiz again.

• The first sign of charge came with a report on

development in sub-saharan Africa prepared by

the bank’s African strategy review Group

coordinated by Elliot Berg (1981)

A report on development in sub-

saharan Africa found;• The basic problems of region;

– Slow economic growth

– Sluggish agricultural performance

– Rapid rates of population increase

– BoP and fiscal crises

• Problems originates from the internal and external factors exacerbated by ‘domestic policy inadequacies’. These inadequacies:– 1)Trade and exchange rate policies over protected industry,

held back agriculture and observed administrative capacity.

– 2) There were too many administrative constraints and the public sector was over extended.

– 3) There was a bias against agriculture in price, tax, and exchange rate policies.

These areas has to be changed.

World Bank History (5)

• The bank found that the existing state controls over trade were effective, and indicated that private sector activity should be enlarged, that agricultural resources should be concentrated on small farmers and that human resources should be improved under an export-oriented development strategy.

• During the 1970’s the elites of many third world countries had borrowed as much as they could,ostensibly(görünüşte) to finance share of the funds ended up in swiss bank accounts.

• Third world and East European debt tripled (to a total of 626 billion $) between 1976 and 1982.

World Bank and IMF supervision• Mexico (1982) experienced its first debt crises: the

peso lost half its value in a week and the state was unable to meet payments on 20 billion $ in loans, along with Argentina, Brazil, and Turkey, many other countries.

• Mexico was forced into debt rescheduling (at lower interest rates, with payments over longer time periods) supervised by the IMF.

• This came at the expence of ‘structural adjustment’, a series of measures first put into place in the mid 1970’s but formalized in 1979 and 1980.

• By the mid 1980’s three quarters of latin American countries and two thirds of African countries were under some kind of IMF-World Bank supervision.

World Bank History (6)• Banks context gradually changing.

• The 1983World Bank Development Report (WBDR) argued that foreign trade enabled developing countries to specialize in production, exploit economies of scale, increase foreign exchange earnings.

• WBDR 1984 used ‘growth scenarios’ to argue that developing countries would improve their positions by changing their economic policies;– Avoiding overvalued exchange rates

– Reducing public spending commitments

– Having an ‘open trading and payments regime’ that encouraged optimal use of investment resources.

The case examples cited in the report were the ‘outward-oriented’ East Asian countries.

World Bank Development Reports

(Cont.)• WBDR 1985 was warning that a ‘retreat from

liberalization’ would slow economic growth.

• WBDR 1987 asks; what are the ultimate objectives of

Development? ;

– Faster growth of national income

– Alleviation of poverty

– Reduction of income inequalities

• The Bank stressed ‘efficient industrialization’ as the

key economic policy.

• The Bank devised a lending program that supported

policy reforms and structural changes across the

whole economy of a third World countries.

World bank’s theory base• The bank drew directly on Smith’s argument that

industrialization would be retarded by a low

ability to trade, and on Ricardo and Mill in

arguing that trade gave advantages that led to

productivity increases.

• Protection of industry in the past had led to

inefficient industries and poor quality, expensive

goods.

• So the idea was;

– Reduce trade barriers

– Switch the economies focus to exports

– Compete vigorously in world markets.

World Bank’s 3 policy reform

suggestions in the late 1980’s• 1) Trade reform

• 2) Specifically the adoption of an outward oriented trade strategy.

• 3) Macroeconomic policies to reduce– Government budget deficits

– Lower inflation

– Ensure competitive exchange rates and domestic competitive environment.

– So, remove price controls

– Rationalizing investment regulations

– Reforming labour market regulations (i.e. Decreasing minimum wages, ending other regulations that distort labour market)

– Reducing G (Government expenditure), reducing untipowerty programs, among other things.

How to implement WB’s policy

reforms??

• Main instrument to put them into practice

were STRUCTURAL ADJUSTMENT

programmes and stabilization policies

imposed on countries borrowing from IMF

and the World Bank.

• Structural adjustment programmes ( 3-5

years) involving 3 kinds of measures

Measures of WB Structural

adjustment Programmes• 1) Expenditure reduction; aimed at improwing a

countries balance of trade position by reducing imports, and increasing exports- accomplished via credit and wage restrictions, contractions in the money supply, and reductions in public spending.

• 2) Expenditure switching; aimed at decreasing consumption and increasing savings and investment especially in tradable goods to be accomplished by increasing the price of food to stimulate agriculture and by devolving the currency and increasing income taxes to raise government revenue.

• 3) Institutional reform; centered on market liberalization and privatization in the belief markets allocate resources efficiently

Structural Adjustment

Programs(SAP)

• Stabilization programs were short term instruments (1-2 years) involving fiscal and monetary policies designed to correct balance of payments and inflation problems.

• Structural adjustment more basically meant changing the structure of an economy so that it mirrored the competitive ideal derived from the Wetern experience.

• Means... Getting the prices right, achieving price system that allocate resources efficiently.

SAP in late 1980’s and Early

1990’s

• SAP’s (based on ideals) needed

modification.

• Shifting slightly to a revised neoliberal

model stressing market friendly state

intervention and good governance

(political pluralism, accountability and role

of law)

World development report for 1990

• Dealt with powerty for the first time since Mc Namara era.

• Adopted 2 new approach:

– Policies that promoted the use of labour, the poor’s most abundant asset, bay harnesing(to make more usefull) market incentives and other means.

– Provision of basic services to the poor, like primary health care, education and nutrition.

The world bank became more important on setting development policy than its annual 7.4 billion $ lending, a mere 2-3 % of the capital flow to the Third World.

The IMF

• The world’s international monetary system is governed legally by the International Monetary Fund (IMF), which was established at Bretton Woods in 1944 in the aftermath of the great depression of the 1920s and 1930’s and preparation for the peace after the second World war.

• The IMF originally conceived as an institution for stabilizing the wold economy, rather than as an agency for dvelopment, providing short term loans to member countries in temporary BoP difficulties.

The IMF and the World Bank

• Responsibility for development was given to the IMF’s sister institution the World Bank, established at the same time.

• Over the years, (particularly recent years) the role of IMF has changed.

• It has increasingly become the bank manager of the poor countries, much more of a development agency, advancing longer term loans to cover what are now perceived as longer term structural BoP difficulties.

• The IMF and the World bank also rougly agree on the same Washington Concensus policies.

Beijing Consensus

• Chine resisted the pressure of washington consensus.

• Forged own development strategy

• Conrolled as opposed to forces of free market capitalism.

• Put peoples need first, not the interest of bankers and international speculators.

• Equity and powert reduction prioritiesCaution about free trade and free movement of international capital but no restrictionas about FDI

How the IMF Works

• The IMF is basically a lending institution.

• It is a source of four main forms of financial

assistance, or liquidity , to developing countries:

– A) Drawings from the ordinary facilities provided by

the IMF.

– B) Drawings made under special facilities

– C) Facilities for low income countries

– D) The periodic issue of Special Drawing

Rights(SDRs)

How the IMF Works (Cont.)

• Members’ Drawing rights, their share of SDR allocations, and indeed their subscription to the IMF and voting power are all based on quotas. (pls. See the official IMF web site for each country exact quota details)

• Every member must subscribe to the IMF an amount equal to its quota -25 % in the form of reserve assets and the remainder in the local currency.

• Initial quotas are based on a formula relating to the economic circumstances of individual countries, such as living standards, importance in world trade and so forth, and are then modified in various ways in the light of the conditions and quotas of other countries.

• The USA has the largest quota, amounting to 37 billion SDR in 2003 out of the total value of quota subscriptions of 212 billion SDR’s.

How the IMF Works (Cont.)

• When countries draw on the Fund they buy the currency they need with their own currency, and when they repay they repurchase their own currency with foreign currency acceptable to the IMF.

• The size of the quotas comes under continual review.

• While the IMF continues to place reliance on quota subscription as the main source of its finance, it is also in the market to borrow.

• A country making use of the IMF’s resources is generally required to carry out a programme of balance of payments adjustment as a condition of support.

IMF Credit by facility and policy

• 1) Ordinary Drawing Rights (ODR)– The gold or reserve tranche (dilim)

– The credit Tranche

• 2) Extended Fund Facility (EFF)

• 3) Special Facilities (SF)– a) Compensatory Financing Facility(CFF)

– b) Emergency Assistance

– c) Supplemantal Reserve Facility (SRF)

– d) Contingent Credit Lines (CCL)

– e) Poverty reduction and Growth Facility (PRGF)

1) Ordinary Drawing Rights (ODR)

• A) The gold or reserve tranche; which usually represents 25 percent of a member’s quota and is equivalent to that part of its quota not paid in its own currency.

• B) The credit tranche, which is officially equal to 100 % of a member’s quota, but can go beyond. It is split into four parts, and access to higher tranches becomes progressively more difficult and expensive. The purchases here are almost always made under stand-by arrangements rather than directly, and certain performance criteria relating to government expenditure and money supply targets must normally be met before resources released. A strong programme is required to rectify a BoP disequilibrium.

stand-by arrangements

• Typically stand –by arrangements cover a

12-18 month period (although they can

extend up to three years) and repayments

are made with 3-5 years of each drawing.

2) Extended Fund Facility (EFF)

• The EFF was established in 1974 to allow developing countries to borrow beyond their quotas over longer priods than are allowed under ordinary drawing rights.

• The EFF arrangements gives members assistance for up to 3 years, which repayments provisions extending over a range of 4-10 years.

• Drawings under the EFF may be more than 100 % of a country’s quota over a 3-year period, but the conditions are stringent.

• The country must provide a detailed statement of policies and measures every 12 months.

• The resources are provided in instalments, with performance criteria attached.

3) Special Facilities (SF)

• Apart from the ordinary drawing rights, developing countries have access to a number of special facilities that may exist at a particular time to assist them with development difficulties arising from BoP problems. At present 4 main special facilities;– a) Compensatory Financing Facility(CFF)

– b) Emergency Assistance

– c) Supplemantal Reserve Facility (SRF)

– d) Contingent Credit Lines (CCL)

– e) Poverty reduction and Growth Facility (PRGF)

a) Compensatory Financing

Facility(CFF)

• The CFF was the first special facility

established by the IMF to compensate

developing countries for shortfalls of

export earnings below a 5-year trend

centred on the middle year.

b) Emergency Assistance

• Since 1962 the fund has provided quick,

medium-term assistance to countries with BoP

difficulties related to natural disasters; and since

1995 to countries suffering from the aftermath of

civil unrest or international armed conflict.

• Countries may borrow up to 25 % of quota, or

50% in exceptional circumstances, with

repayment over 3 to 5 years.

c) Supplemantal Reserve Facility

(SRF)• The SRF was established in 1997 in response to the

East Asian financial crises.

• Its focus is on the capital account of the balance of payments, and is intended to help member countries experiencing exceptional BoP problems resulting from sudden loss of market confidence.

• Access under the SRF is not subject to the usual quota limits but is based on the country’s financing needs, its ability to repay the IMF, and the policies it is pursuing to restore confidence. Repayment must be made with in 3 years of drawing.

d) Contingent Credit Lines (CCL)

• The CCL facility was set up in 1999 for countries anticipating a financial crises leading to outflows on capital account. It is essentially a precautionary line of credit to help prevent contagion.

• Drawings are not expected to be made unless a crises actually strikes.

• The repayment period is the same as for the SRF.

e) Poverty reduction and Growth

Facility (PRGF)• The PRGF was established in 1999 to replace the

Enhanced Adjustment Facility (ESAF) which was the IMF’s concessional financing facility to assist poor countries facing persistent BoP problems.

• The idea was to give the ESAF a more explicit anti poverty focus in keeping with the new emphasis of the IMF and World Bank on powerty reduction- hence the change of name.

• Programmes supported under the PRGF are expected to be based on a strategy designed by the borrower to reduce poverty in collaboration with civil society and the various organizations concerned with development.

PRGF

• Under the PRGF facility, 80 low-income

countries are eligible for assistance and may

borrow up to 140 % of quota under a 3-year

arrangement with an interest rate of 0.5 percent

and repayments made between 5 ½ and 10

years after disbursement.

• By 2003, 31 countries were already being

supported by borrowings of over six billion

SDR’s.

Criticims of the IMF

• Found to be anti-developmental.

• Implements Washington Consensus only.

• Prefers private investments to public,

prefers capitalism to socialism, enforces

free trade, encourages free flow of capital

• We will come back to criticisms in general

in due course.

Conclusion

• Questions

• Discussions