developing countries are taking loans in the 1980’s.
In exchange for loans countries must accept structural adjustment programs and
conditionality packages - room to determine own policies diminish. Scope of sovereignty
no longer includes deciding own economic policies.
Two components to conditionality packages:
Democracy and Free market.
FREE MARKET conditionality (Washington Consensus)
Fiscal discipline (for other countries since USA has highest debt)- balanced budget
(macroeconomic stabilization) May want to inject cash and run short term deficit so long
as the project is short term.
Fiscal deficit produces: inflation, payment deficits and capital flight
Second Concern of Washington consensus.
Reasons countries turn to IMF is because they have a fiscal deficit, spend more money
than they make. Two ways fiscal deficit can be reduced: increase revenue of decrease
expenditure. Increase revenue: increase taxes (money is more productive in private sector
according to Washington consensus) cut spending- subsidies (water, rice, electricity) cut
subsidies for items consumed by the poor. Normally produced by the market- government
should not subsidize them. Food shortages shortly follows- enormous part of population
put below starving without subsidies – food crisis. IMF riots.
Capital investments are allowed to be kept (health and education) investments in human
capital because it produces workers.
Tax reform – broad tax base, don’t get wealthy to pay most taxes or you will have capital
flight (send money to foreign country- money leaves country).
Interest rates – Market determined, but also positive. High enough that people will put
money in bank but low enough to encourage investment and loans aren’t too expensive
Exchange Rates- determined by either market or if the level seems consistent with
macroeconomic objectives. If objective is to export than it is to be expected that the
country will undervalue its exchange rate (which makes import more expensive).
Trade Policy; import liberalization – competitive prices, no import quotas, no tariffs.
Market must be open, no protectionism.
Canada Doller so high due to ‘quantitative easing’ (USA trying to boost exports)
Exports more expensive, imports cheaper for Canada (bad for our economy)
Encourage foreign direct investment: brings capital, skills and know-how. Through debt
equity swaps- when foreign country assumes part of your debt for equity in your
enterprise. Does not give them money or foreign exchange, pays the government by
taking some of their debt and paying interest to generate foreign direct investment.
Privatization: property rights guaranteed through rule of law