World Bank Document

ties includes many countries in Latin America and countries-including both oil importers and oil
some major debtors. The reasons for their financ- exporters-delayed raising their domestic energy
ing problems are more complex, but three com- prices, thus increasing pressures on their balance
mon features are (a) fiscal and monetary policies of payments; many other countries avoided these
that were too expansionary to achieve a sustain- pressures by raising energy prices earlier. Furtherable
external balance; (b) overvalued exchange more, investment decisions are influenced by the
rates that prevented exports from competing on appropriateness of pricing structures, including
world markets and encouraged capital flight; and interest rates. Governments need to evaluate care-
(c) increased domestic savings efforts but invest- fully their own investment programs and to create
ment increases that were even larger. Some coun- a framework of incentives to ensure that private
tries, such as Chile and Uruguay, attempted com- investors allocate resources in the most efficient
prehensive economic reforms, but parts of their way. Countries such as Brazil, Ecuador, Ivory
policy package were defective and the timing of Coast, Nigeria, Peru, and Turkey combined negameasures
taken was inappropriate. Other coun- tive real interest rates with overambitious or ineffitries
borrowed heavily and undertook some policy cient investment programs. By contrast, Colombia
changes (for example, Brazil, Ivory Coast, and the and Malaysia had more appropriate interest rate
Philippines), but they underestimated the length levels and investment incentives.
and depth of the recession and the large rise in * Exchange rates and trade policies also play an
interest rates in the early 1980s. Many of these important role. In the 1970s and early 1980s many
countries are now in the process of reforming their countries-notably Argentina, Chile, Mexico,
policies, with results that are thus far encouraging. Nigeria, the Philippines, Turkey, and Uruguay-
The diverse experiences of developing countries allowed their exchange rates to become overvalued
emphasize certain basic lessons for policy. One can and their trade policies to become distorted. This
be summarized as the need for flexibility. A charac- biased production toward the domestic market,
teristic of foreign finance is that it requires both stimulated imports, and provoked capital flight.
borrowers and lenders to take account of uncer- Comprehensive trade and price reforms by Turkey,
tainty. The best way of doing so is to be able to following difficulties it experienced in the late
respond flexibly to changes in the external envi- 1970s, produced good results.
ronment. Countries as varied as India, Indonesia, * Efforts to raise domestic savings should be
Korea, and Turkey have adapted their economic strengthened despite the availability of external
policies to changed circumstances. The most criti- capital. The correct role of foreign finance is to supcal
changes in the short term are the ability to plement domestic savings; it must not substitute
reduce fiscal deficits and adjust real exchange rates for savings. The danger of poor savings perforand
real interest rates. When for political or other mance was well understood by many governreasons
countries cannot adjust their policies ments. In fact, many developing countries manquickly,
they should be conservative in resorting to aged a creditable performance on savings in the
foreign borrowing.
1970s, with two-thirds of a sample of forty-four
A second lesson is that the policies required to developing countries increasing their domestic
make best use of external finance are essentially savings ratios. They included such diverse econothe
same as those that make best use of domestic mies as Cameroon, India, Korea, Malawi, Malayresources.
A country must earn a return on its sia, and Tunisia. In other cases, including Morocinvestments
which is higher than the cost of co, Nigeria, and Portugal, inadequate domestic
resources used. In the case of foreign finance, savings efforts contributed to overborrowing.
however, a country also has to generate enough Improvements in savings performance require
foreign exchange to cover interest payments, plus measures by both public and private sectors. In the
remittances of dividends and profits. This depends public sector, tax measures, realistic pricing of pubon
three groups of policies:
lic goods and services, and cuts in spending are
* Key economic prices must be aligned with required to reduce deficits and increase public savopportunity
costs. These encourage activities in ings. If higher public spending is financed by borwhich
the country has a comparative advantage rowing more from abroad rather than by increasand
increase the flexibility of productive struc- ing fiscal revenues, cumulative strains are put on
tures. Subsidies, when used, should be carefully budgets (since governments have to pay debt
targeted, for example, to the poorest segments of interest) and the balance of payments. Mexico's
society. When oil prices rose in 1973-74, many experience in 1981-82, when the budget deficit
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