Composition of Fiscal Adjustment Is Crucial for Growth

• Author: James McEuen
• Position: IMF External Relations Department
• Pages: 120-121

Page 120

To set the stage for sustained growth, countries suffering from high inflation and balance of payments difficulties must pursue what can be a wrenching fiscal adjustment to resolve internal and external financial imbalances. The goals of fiscal policy, however, should go beyond simply reducing the size of the fiscal deficit. The way deficit reduction is achieved-the composition of fiscal adjustment-is as important as the quantity of the adjustment and has a critical bearing on whether reforms will be sustained and whether the adjustment will undermine a country's long-run growth prospects, according to a new IMF Occasional Paper, The Composition of Fiscal Adjustment and Growth: Lessons from Fiscal Reforms in Eight Economies, by G.A. Mackenzie, David W.H.Orsmond, and Philip R. Gerson.

How fiscal adjustment is achieved is as important as the magnitude of adjustment.

The staff study examines the composition of fiscal adjustment-tax and expenditure policies and administrative procedures, and some aspects of public enterprise reform-in a sample of eight countries (Bangladesh, Chile, Ghana, India, Mexico, Morocco, Senegal, and Thailand) during a recent period (usually 1978-93) within the context of broader efforts to increase growth. In looking at the composition of fiscal adjustment in these countries, the authors ask why some countries enjoyed more success than others. Their objective is to determine whether, and to what extent, these fiscal reforms fostered growth over the adjustment period.

One of the criteria used in the study is the degree to which countries engaged in IMF-supported adjustment programs protected social expenditure-in particular, spending for primary education and public and primary health care.Other criteria include how rapidly countries addressed other aspects of expenditure policy, basic tax reform, and administrative reforms; and how they dealt with public enterprise reform. The eight cases include both low-and middle-income countries and countries with public sectors of varying sizes at the outset of the adjustment periods. The group includes countries forced to make a draconian fiscal adjustment in a crisis environment and countries whose adjustment efforts were more gradual.

Major conclusions of the staff study include the following:

* Stabilization need not play havoc with a growth-promoting fiscal strategy. Once stabilization takes firm hold and revenue-raising measures take effect ,c uts can be at...