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<text> <title> IMF Strategy for Economic Transformation in the FSU </title> <article> <hdr> Foreign Policy Bulletin, May/June 1992 IMF Strategy for Economic Transformation in the Republics of the Former Soviet Union </hdr> <body> Michael Camdessus--Managing Director of the International Monetary Fund, to the Georgetown University School of Foreign Service, Washington, April 15, 1992. We live at a turning point in history. The people who suffered under communism have torn down the Iron Curtain. The Soviet Union has been dismantled, and in its place are emerging fifteen republics. Like their neighbors in Eastern Europe, they have opened the door to freedom--the political freedom of the market system. They are putting in place the basic structures of a free society. Recent events in Moscow, Warsaw, and elsewhere, remind us that this is a formidable task. They face serious obstacles. There will be setbacks, time and time again. We must help make the move to freedom irreversible. For the IMF, there is no more important task than to assist countries to become integrated into a growing world economy. We were created to do that, and this has been a large part of our work since 1945. This has always been a demanding task, but never more so than now! For several months now, the IMF has been working intensively with Russia and the other republics, in close cooperation with our sister institution the World Bank and the newly created EBRD [European Bank for Reconstruction and Development], the EC, and other multilateral institutions. We have visited all of them, in some cases several times. We are extending technical assistance, and conducting an in-depth dialogue to help these countries to design their strategies of economic transformation. The IMF's Executive Board is close to completing the work on preparations for their full membership, which will make the IMF at last a virtually universal institution--something that we have looked forward to since our establishment. I would like to share with you, and especially the students of Georgetown University who are preparing for careers of international service, some of the experiences of those who have the privilege to be part of this historic process. And to explain: -- the strategy that we are helping these countries to design; -- the financial support they are likely to need from the rest of the world; -- and the feasibility of achieving this support, in a world with a limited supply of savings and competing demands on them. Three topics to cover, then, and a conviction to share with you that the solution to this major challenge is within our reach--and that it can be an important component of a global strategy to revive growth in the world economy. I. A Strategy for Transition The magnitude of the problems facing the fifteen republics is unprecedented. They go far beyond what is generally understood by the concept of economic transformation. These peoples are creating new nations, from scratch and in a very brief period. The responsibilities of their leaders are immense. The fifteen republics need to devise a strategy that is appropriate to their special situation. There are useful lessons for them, both from the recent experience of the countries in Eastern and Central Europe, which are a little bit more advanced in the transition to a free economy, and from the rest of the IMF's members. But basically we must operate there without rigid preconceptions, and be prepared to learn from experience. a. An Unprecedented Problem The fifteen republics must overcome major handicaps. -- They are taking charge of their own destiny at a time when the many years of central command and mediocre performance have left the old systems and institutions exhausted and depleted. They are just emerging from a long and devastating man-made catastrophe. Is it not striking to hear a Minister from Georgia tell us "Our country existed as an independent nation ten centuries before Christ, but after centuries of feudalism, and seventy years of Soviet Government, this spring will be the first one in which our farmers will be planting seeds in their own land..." -- Their economic structure is crippled with deeply-embedded inefficiencies, including the dead weight resulting from years of misallocated investment, misuse of their vast energy resources, and the "black hole" of the military-industrial sector. When you visit the fourteen republics (other than Russia), you hear that they have been run essentially as suppliers of materials to the centralized system, and that nothing was done to foster their own balanced growth--indeed, on the contrary. But then visit Russia, and you don't find evidence of accumulated wealth; the people there don't look more prosperous than in the other republics. -- The social and physical infrastructure everywhere is degraded, and in many respects the environment has been devastated. -- These republics are only a few months old! They are starting to hold free elections, some of them for the first time in history. They are still in the early stages of discovering the responsibilities that accompany independence. They lack a competent public administration in many fields essential to good management of a market economy. There is no more central planning to dictate what to do, to people who have become unused to the responsibility of taking the initiative. But in some quarters there still exist powerful vestiges of a well-entrenched bureaucracy that is hostile to the reform process, and is fighting to retain power. -- They are also in the early stages of dealing with powerful forces that may disrupt the social fabric and hamper economic relations. The latent problems of the many different nationalities, which Stalin thought he had laid to rest, are reemerging as powerful forces. So we see the resurgence of old rivalries, the dangerous tendency of some to protect themselves by restricting exports to the others, and the mounting risk of retaliation. As you know there has been recent violence in Armenia, Azerbaijan, and Moldova. -- And, finally, they have little or no experience of market mechanisms, and no enterprise culture. How to create market economies when there are almost no entrepreneurs? Indeed, they have to telescope into a dramatically short time all that the industrial countries achieved through slow and progressive evolution over centuries. b. A Diversified Strategy The republics are also rediscovering their diversity. They include Russia, with its immense natural resources, which should within a few years be able to assist again its poorer neighbors--but also the smallest and poorest, whose situation may be compared to that of some of the low income developing countries in Asia. This diversity requires that the reform programs reflect their special circumstances. They need to develop a diversified strategy that responds to their circumstances. Moreover, if such a strategy is to succeed, it should be their choice. We can offer advice, technical assistance, and the experience gained with other countries, but in the end the bold and comprehensive programs they design must reflect their strategy. They will take responsibility for it, explain it to their people, muster the necessary popular support, and implement it. But they are in an emergency situation, with no option to delay the implementation of reforms until there is a better economic environment. As a matter of fact, even though we all recognize that their transformation will be a long process, they must address three problems from the outset: simultaneous adoption of basic structural reforms and stable macroeconomic policies, renovation of the social protection system, and correction of common problems from the old Union. A. Structural Reforms and Macroeconomic Stabilization Under the first of these headings, we would suggest: -- the speedy putting in place of a legal and institutional framework to make a market economy function, to enforce competition, and to attract foreign investment; this includes commercial law, bankruptcy procedures, etc.; and private ownership, particularly in such sectors as agriculture where an early supply response can be expected; -- the early introduction of free prices, determined by market forces, for most products, so that the price system can send the right signals to consumers and producers; and this includes the key financial "prices"--namely exchange rates and interest rates; -- concurrently with price liberalization, firm macroeconomic discipline, including in particular a sharp reduction of budget deficits, to prevent the inevitable initial price surge from sparking off a vicious cycle leading to hyperinflation; -- an opening up of trade with the outside world, together with currency convertibility to ensure that domestic prices are related to world market prices; -- early steps to privatize public enterprises, whenever possible, and to make public enterprises operate on a commercial basis, by reducing their access to subsidies, tax privileges, or easy credit. And allied to this, a decentralization of decision-making responsibility. This means giving full responsibility to managers, so that they are judged by their results, rather than by how well the meet the arbitrary targets of administrative authorities. B. Social Security Each of the republics is having to restructure the existing social security arrangements. The need for adequate social safety net is greatest when society is undergoing far-reaching upheavals, which is now. But the republics are also discovering that the old arrangements simply cannot work; they were designed to protect everyone in the narrowly defined situation of a socialist world, but now they don't provide adequate protection, and they risk becoming too expensive. They also need cuts in the old "blind" system of general price subsidies--which benefitted the wealthy as well as the poor--and cuts in the old system of generalized social entitlements, so that more adequate benefits can be targeted more accurately and thus provide better support to those who are poorest, or most vulnerable, or least capable of helping themselves. The traumatic changes in the productive sectors are giving rise, for the first time in living memory, to open unemployment, in place of the "hidden" unemployment or underemployment that was prevalent under central planning. The changes in the structure of economy are creating an urgent need for retraining programs, and other measures to improve the mobility of labor and the flexibility and efficiency of labor markets, while facing considerable unemployment. These societies also face a more profound challenge. They need to induce a new set of attitudes on the part of the population, so that people will accept a greater degree of responsibility for their own lives, and a more effective solidarity with the rest of society--including the fundamental form of solidarity which is to say to pay taxes and social security contributions. We cannot overestimate the importance of finding an early solution to these social problems. This is not only urgent because of its human dimension, to avoid suffering and deprivation. But it is also crucial because a social system that is healthy, that provides a decent measure of security to the vulnerable, is the hallmark of a sound democracy. This is one field where a market economy has to demonstrate that it can do better then central planning, in ameliorating and eventually conquering poverty and in protecting people during painful times of transition. C. Common Problems The republics also face some urgent common problems, particularly where arrangements that formerly covered the entire Soviet Union have to be adapted to the new political constellation. Hence the importance of what has been called the "common economic space." Currency arrangement. One immediate common problem is the choice of currency. Clearly, one of the most important decisions to be made in the early stages, for each republic, is whether to stay within the ruble area or to establish an independent currency. This is a decision that lies at the heart of national sovereignty. For many countries, an independent currency is a potent symbol of nationhood, like the flag or the national anthem. Therefore our approach is to respect scrupulously the right of each government to decide for itself. This doesn't remove our responsibility to assist them in trying to make the right decision. And so we are sharing with them the experience we have accumulated over many years with the member countries--which often involves the reconciliation of national sovereignty with the requirements of supranational monetary arrangements. We are discussing all this with them. Also we are helping them to assess the importance of the existing economic links between them. It is important for the new states to be aware of the lesson that others have learned--sometimes painfully--that a separate currency does not, by itself, make it easier to operate its economy. or remove the need for budgetary and monetary discipline. Indeed, any republic that chooses to create a national currency must strive to create, from the beginning, the sound macroeconomic framework that gives credibility to a currency and the institutions to operate an independent monetary policy. All in all, many republics may find that they wish to remain, at least for the time being, within the ruble zone, because of the advantages in terms of inter-republican trade and the better prospects for monetary stability that might be offered by the ruble zone, compared to a hastily-introduced separate currency. This raises, of course, a whole host of issues relating to how the ruble zone will operate. These include such questions as: -- How will monetary and fiscal and exchange rate policies be managed and coordinated, so as to be both appropriate for the zone as a whole, and fair in the treatment of each of the republics? -- How will the ruble zone as a whole, and its component republics, conduct financial relations with the rest of the world? -- How will the Russian Republic--which is biggest by far--fulfill its important monetary and financial responsibilities, with due respect for the needs of the others? This will pose difficult but urgent questions of how to reconcile independence of individual republican central banks with the need for a collegiate approach to policy-making. These are important questions, and there are others. They need to arrive soon at workable arrangements for monetary cooperation that they can all live with. The need to exercise prudence, but to make timely decisions, will apply with special force to the potentially critical question of stabilizing the ruble. If the ruble zone can be given a strong monetary anchor, this would be a vital contribution to the success of the transition to a market economy. As you know, consideration is being given to the idea of a stabilization fund. Such a fund will only succeed, however, if it applies, from the outset, to an exchange rate that is perceived by the markets to be realistic and sustainable, and is backed up by sound monetary and budgetary policies. Inter-Republican Trade. Related to the question of currency arrangements are a whole array of problems relating to inter-republican trade. As we all know, the existing pattern of trade between republics is highly artificial, a legacy of the central planning system. It is likely that, over time, and as the various economies develop their export and import sectors in accordance with their genuine comparative advantage, the pattern of trade will change substantially. This change should be encouraged and facilitated. In the meantime, however, it is desirable to prevent a disorderly collapse of inter-republican trade, which would simply aggravate the reduction in output. So we are recommending to each of the republics that they try to safeguard trade among themselves, and avoid the imposition of restrictions that would hamper mutually beneficial trade; at the same time they will hopefully be expanding their trade links with the outside world. The Military-Industrial Complex. And finally, among these common problems, I cannot fail to mention the urgent need to face up to the difficult question of controlling, and dismantling in an orderly fashion, the disproportionate military-industrial complex. This sector is, of course, simply the most striking manifestation of a more general phenomenon of a distorted pattern of production. It will be a Promethean task to rechannel the resources, in particular human resources, to other, civilian, and more productive uses. There is no need, I am sure, to stress how urgent this task is, and how it is in the interests of the entire world that this process be handled effectively. We might as well forget about economic reforms, and forget about the budget deficit reduction, and forget about economic reforms, not to mention the prospects for peace and prosperity in the world, if for example, President Yeltsin fails to achieve his bold objective to reduce military spending by Russia by about half, in real terms, to about four and a half percent of GDP in 1992. Clearly the industrial countries will have to cooperate and support this effort. No doubt action in all these areas will be needed, and urgently. But how can the republics combine all these elements into programs that are strong enough, and carry sufficient credibility, that they will attract the confidence of their own population and the support of the rest of the world? How can we meet this challenge? Let me suggest three guiding principles: -- Reform is a continuing process. The programs that will come into effect are not like the traditional programs, for which the IMF extends standby arrangements for cyclical balance of payments financing. Rather they will not solve the whole problem. Rather, they could be the crucial first steps in a process of basic transformation that will take many years. -- Programs must be realistic. Realism calls for a bold and comprehensive approach. Full transformation will take time, but that is a reason to start immediately and to take advantage of the dynamism of the present period to create, irreversibly, the basic structures and framework of a market economy. -- Programs should be coordinated. The programs of all the republics, soon to be members of a cooperative institution, should be designed to take account of their effects on their neighbors and partners. They could be, and should be, mutually supportive. These three principles may seem straightforward, but it will be important to remember them in the weeks and months ahead, when we confront the complex demands of day to day implementation. These programs will require a major effort, an effort already under way in many republics, that will have to be sustained. If they persevere in their efforts, to the best of their abilities, then the support of the community of nations must be extended to them. Our financial support for their efforts must be large enough, and credible enough, to give an added boost to their reform efforts, and to encourage them to persevere. All that I have said so far shows what a demanding task lies ahead. They can't cope with this task alone. Never, since the reconstruction after the World War II, have we seen such a need for international cooperation, in a shared enterprise that will entail so much for the common destiny of mankind. II. How Much Support is Needed? And now comes the question--what will it cost? Let me stress a very basic fact. The transformation of the economies of the fifteen republics is essentially their task. International assistance is critical, but it can only be a complement to their efforts, their savings, their investment in infrastructure and in expanding the productive base of the economy. Indeed, the republics have recognized this. This is the attitude of their people to the task that lies ahead. They are proud people, well-educated and resourceful, and they are ready to take full responsibility for their own destiny. I still hear the words of the senior representative of one of the republics, when he told the IMF's Executive Board last week--"give us a chance and we will roll up our sleeves and do the work." Yes, they will do the work. And history shows us that is how it happens. The recovery of the economies of Western Europe after the devastation of the Second World War, and the strong growth of many Asian countries over several decades, show clearly that substantial inflows of official capital from abroad have been an essential ingredient in getting the growth process started (and how private capital inflows can sustain the expansion) but they also show that it is then up to the people of the countries that are seeking economic progress, to help themselves. And people are capable of making these efforts. External financing (whether private of official) is basically seed money. Even as seed money, the amounts required are large. Our present estimates are still very tentative. The IMF staff has been working on this problem with Russia and the other republics for several months. We have arrived at estimates for the balance of payments that are rough but, I believe realistic. In the case of Russia, our estimates show only a rather modest recovery of imports in 1992, by about twelve percent, after the dramatic fall of 46 percent last year. After taking account of the expected level of exports, the debt service obligations, the need to replenish the international reserves, and making an allowance for a stabilization fund for the ruble (about $6 billion) one can come to a financing requirement for 1992, for Russia alone, of about $20-25 billion. You will probably recall the figures recently endorsed by President Bush, Chancellor Kohl, and other leaders, when they recently announced their support for Russia's reform program. Now what about the other fourteen republics? Most of them are in a more difficult situation than Russia. And here our balance of payments estimates are even more tentative. Our projections suggest that the fourteen republics will have an external financing requirement of about $20 billion in 1992. Therefore we are contemplating very large amounts of assistance. Moreover we should plan ahead for the next few years. We have to prepare for a major cooperative effort. But not only for the fifteen republics. Because the IMF is a universal institution, we must consider these new demands in a global context, and try to reconcile them with the other challenges to the world economy, notably: -- the heavy investments needed in the industrial countries themselves, to support their own growth in the decade ahead; -- the investment needs of the developing countries, to promote their development, protect the environment, reduce poverty, and complete the job of solving the debt problem. How could we in the Fund forget, for instance, the problems of India, with its 850 million people, and with which we have a major program in place? And how could we forget the thirteen countries of Southern Africa who are suffering the devastating effects of the most severe drought of the century? To put all this in the right perspective, let us say that this is the uncompleted agenda from the 1980s, to which we must now add our four new challenges of the 1990s, each of which will add to the global need for investment: -- reconstruction of the countries that suffered severe destruction in the Middle East war; -- German unification; -- Eastern Europe; -- and all that we have discussed today, in the transformation of the former Soviet Union. The additional investment needs I have just listed, for these four challenges of the 1990s, may increase total investment needs by over $100 billion a year for the period 1992 to 1996. This figure, which I have repeated many times since we published it last October in the World Economic Outlook, would be about two percent of total world investment in 1991. III. The Global Financial Challenges of the 1990s How can we add over $100 billion to global investment without reviving inflation, and without prejudice to the investment needs of the poorest countries? My answer is, the world can do it, provided all countries (and not only those that apply for IMF support) pursue sound policies and reconsider their policy priorities, and provided they cooperate with each other. But where will we find the additional $100 billion? The answer is to cut unproductive spending! The possibilities for budget cuts will vary from country to country--wherever there is waste or inefficient investment, or unnecessary prestige spending, or programs that have outlived their usefulness. We need, for example, to tackle one of the most pernicious examples of unproductive spending--excessive protective subsidies in the major industrial countries. Reductions in these subsidies could release substantial resources for other, more productive, uses. This should be regarded as an essential complement of a strategy to promote efficiency and competition. There are so many examples, but I will cite only the familiar one of agricultural subsidies. Abolition of the agricultural support mechanisms in the industrial countries would allow a reduction in budgetary outlays of more than $100 billion a year. Military spending, next, is another area where substantial savings are now possible. International tensions are subsiding, and this should allow deep cuts, for the first time perhaps in more than half a century. A lot is at stake here. Average military spending, worldwide, is some 4.5 percent of GDP, which is surely much too high in present circumstances, even allowing for the fact that in some respect the world we live in is still a dangerous one. If the countries whose military spending is unusually high would reduce it to the world average, they would, after the major initial costs of reallocating resources, release some $140 billion a year for other uses. Looking at this another way, the additional assistance that is needed for Russia and the fourteen republics, and Eastern Europe, for the period 1992-96, would be the equivalent of about 7 percent of the defense budgets of the industrial countries (in 1988). This is surely not an excessive amount! I have singled out subsidies and military spending. Of course there are other areas that should be scrutinized carefully. But just these two areas, together, offer scope for cuts that would amount to much more--I repeat, much more--than the additional needs for investment in order to meet the new global challenges. Such cuts will not be easy. Strong vested interests will oppose these cuts, and it will take considerable courage and statesmanship to confront these vested interests. My emphasis has been on action to improve public saving, because that is where governments can achieve major results quickly, and because the problem of global savings is more a problem of misuse of resources than of actual shortage. In addition, some improvement in private saving is both possible and desirable, and governments should strive to remove the existing disincentives to private saving. I am pleased to note that there is widespread agreement among countries, at all stages of development, on the importance of a common strategy, such as I have outlined, to improve global saving and allow sufficient resources for investment in the priority areas. Many countries are already taking action, and they know they will have to keep this up for the next several years. Even if sufficient resources for the fifteen republics can be mobilized, will they be channelled properly, on appropriate terms and conditions to the countries undertaking reforms? This is where I see the importance of the emphasis put by President Bush and other world leaders on the role of the multilateral institutions. The IMF's types of assistance are particularly appropriate to support stabilization and to help countries face the transitional external costs of transforming an economic system. Fortunately the 156 countries that make up the IMF's membership are for now far along in the process of approving a 50 percent increase in IMF resources. I welcome the support extended by President Bush for the increase in the IMF's capital (the so-called quota increase), and his support for an early activation of the Fund's General Arrangements to Borrow, which is designed to enable the IMF to cope with exceptional needs of the international system. This will provide a useful supplement to the additional resources coming from the quota increase. The IMF's financial support for the fifteen republics could amount to as much as $25-30 billion over the next four to five years, provided they persevere steadfastly with excellent programs (this figure assumes that the stabilization fund will be established). The IMF's support is focussed on the balance of payments needs of members, and their need for stronger international reserves. The support from other multilateral sources of development and structural financing, especially the World Bank and the newly established EBRD will also be critical. Even at the beginning of the reform process, macroeconomic reforms and structural reforms must go hand in hand. The multilateral sources of finance will not suffice, however. A critical role will be played by financing extended on a bilateral basis by friendly creditor governments. This will have to include appropriate terms for official debt rescheduling, after the present phase (where the emphasis has been on debt deferral). In addition, there will have to be an exceptional effort by all possible sources of bilateral assistance, until the reforms achieve their expected success and inflows of private capital take off and permit a reduction in official financial support. I would also see much merit in adopting a consortium approach in such important areas as the reinforcement of the safety of nuclear plants and the conversion of the military-industrial-complex. Clearly the job of supporting Russia and the other fourteen republics will have to be shared fairly among the many possible sources of financial assistance. And if this transformation is to succeed, the emphasis on official assistance in the initial phases will have to diminish, and private capital flows will have to play the leading role. Note also, that, in the meantime, a high proportion of the assistance to Russia, in particular, will be in the form of loans, rather than grants. This is appropriate, since Russia is basically a rich country whose need is for substantial loans over a limited number of years. Indeed, Russia was, until recently, a net supplier of assistance to the poorer republics in the Union, and I would hope and expect that in a few years it will be able to fulfill this role again. But by contrast, it is clear that several of the southern republics will need concessional assistance in support of longer-term development. For all of the republics, I must repeat that perseverance with strong reform programs will be crucial, and this will be the key to continued international support. They will have to avoid the pitfalls of allowing "pauses" in the implementation of reforms, which could so easily jeopardize the whole process. It will take considerable courage to show the necessary perserverance, because people will expect early results from the new policies, but inevitably the full positive rewards will take years to materialize. Ladies and gentlemen, one last basic question remains to be answered. Will public opinion in the United States and the other industrial countries support the large transfers of resources to the fifteen republics, at a time when the industrial countries, themselves, face difficulties such as the sluggish pace of recovery from the recession; the poor levels of consumer and business confidence; and all the factors that give rise to protectionist and isolationist attitudes? There are no easy answers to this question. Many have doubts. But let me stress my conviction of one basic truth. In an interdependent world, all countries will gain if we can help turn the countries of the former Soviet Union from a drag on global growth into a positive contributor to growth. The seed money to the reforming countries should be seen as part and parcel of a strategy to revive and sustain growth in the world economy as a whole, including in the industrial countries. This is particularly true if the money is raised by eliminating waste, so that resources can be put to more productive uses. Consider the following: If we can increase the growth rate of Eastern Europe and the former Soviet Union, together from the negative growth they suffered in 1991-92 (a decline of some 17 percent), to some 4 percent annually--which is what we are projecting over the medium term--this will add some 1.8 percent to world growth. And this would more than double the projected overall world increase in output in 1992 (about 1.4 percent, after a decline of 0.3 percent in 1991). In this interdependent world, growth in any country--including the United States--is linked to growth of world markets. So everything we can do, to help generate a stronger growth performance by Russia and the others, will have positive effects on all. Furthermore, over time the efficiency gains from increased trade between these countries and the rest of the world will raise productivity growth--and hence living standards--in all countries. Especially when world output is below its potential, the industrial countries could benefit from increased exports to Russia and the others. This would provide a timely and useful fillip to the present timid recovery. This is a reminder that good economics is usually a positive sum game--that countries can usually gain, provided they accept change, take risks, and adjust to new circumstances. And provided they recognize that their neighbors are partners in progress, that they will all have a real stake in each other's success. With the ending of the Cold War, we live now in a world where countries, both here and over there, have no worse enemy to fear than unemployment, poverty, and desperation, but where we face the opportunity to create a better future for all mankind. (Text provided by the External Relations Department, International Monetary Fund, Washington.) </body> </article> </text>