Lessons of Economic Stabilization and Its Aftermath.

Feldman, David

This book is the product of a 1990 conference co-sponsored by the Bank of Israel and the Inter-American Development Bank. The conference brought together economists and policymakers to assess the stabilization episodes of five Latin American nations and to compare their experiences with that of Israel, Turkey, and Yugoslavia. Together with an earlier MIT Press volume (Inflation Stabilization, 1988), this collection of essays offers an impressive description of the major "heterodox" efforts at economic stabilization undertaken over the past decade. The chapters are organized by country, and useful comments follow each piece.

Juan Antonio Morales reviews the Bolivian experience while Vittorio Corbo and Andres Solimano examine Chile. Both cases confirm that fiscal restraint, tight monetary control and heavy exchange rate doctoring can have a profound immediate effect on runaway inflation. Long run stability and future government credibility remain uncertain if fiscal restraint is achieved by slashing social and infrastructure expenditure and high real interest rates limit private investment. Corbo and Solimano also estimate a simple model of inflation determination to evaluate why inflation took so long to fall in Chile. As one discussant noted, their approach is subject to the Lucas critique in that they assume key macroeconomic coefficients are invariant to the policy regime.

Daniel Heymann and Eliano Cardoso examine the failed heterodox programs in Argentina and Brazil, respectively. The Argentine chapter is dated since the conference preceded the Menem government's reforms. Miguel Kiguel and Nissan Liviatan follow with a comparative look at the inflation-stabilization cycles in these countries. Both nations experienced highly unstable rates of inflation after implementing stabilization programs. Kiguel and Liviatan attribute this to repeated use of incomes policies as a substitute for getting the fundamentals right, and not to fiscal imbalance or debt overhand per se. In such a climate, anticipation of government actions by firms and workers soon create the unstable money demand that fuels inflationary explosions.

The Israeli experience is described by Michael Bruno and Leora Meridor. Israel, like many other nations, slipped into recession during its stabilization/reform program, though the downturn was quite delayed by Latin American standards. Despite the Intifada as an exogenous factor, they see the recession as an endogenous feature of Israeli structural reforms. Recession in the Latin American context occurred as governments used real exchange rate appreciation to establish anti-inflationary credentials. In Israel, by contrast, firms were forced to shed workers and to raise productivity as the goods and credit market distortions of the earlier inflationary environment were eliminated by a government that had already established its credibility.

Mexico's (thus far) successful heterodox program, like many others, has not fully stabilized aggregate demand, nor have real interest rates returned to more "normal" levels, yet recession was avoided and economic growth has begun to pick up. Guillermo Ortiz attributes this to successful sequencing of a complete package of reforms beginning with orthodox demand management to restore fiscal and monetary fundamentals, and followed by heterodox incomes policies to generate stabilizing expectations together with structural adjustment (privatization, trade liberalization and deregulation) to increase efficiency and introduce the price discipline of external competition.

The final two country studies are by Dani Rodrik on Turkey and Velimir Bole and Mitja Gaspari on Yugoslavia. Rodrik argues that the Ozal regime's early success at changing relative prices and real wages was due in part to a society rendered temporarily docile by the military. Bole and Gaspari attribute the acceleration of Yugoslav inflation to a "shocks and accommodation" mechanism in concert with de facto public deficits encouraged by the decentralized political structure in which provincial fiscal excesses were absorbed without penalty by the central government.

A trio of related themes links the essays. First, macroeconomic stabilization is but the initial step in a long process of structural reform, and governments that fail to plan beyond the initial stabilization efforts often see a quick erosion of credibility. Most authors also stress control of the budget and of entitlements (indexing and subsidies) as a necessary, though not sufficient, prerequisite for sustained (credible) stabilization. And finally, the goals of reform programs--such as secure state finances, a stable macroeconomy, resilience to external shocks, and efficient markets in goods and financial services--exhibit enough political-economy tensions to leave any reform effort facing a significant probability of failure.

One discussant remarked about a particular paper that it was rich in microscopic detail but less convincing in its description of macroscopic behavior. The remark is generalizable. The book's emphasis is macroeconomic and country specific, so broader theoretical lessons about the liberalization process are hard to piece together. More importantly, the political economy of reform appears only in brief and unconnected snippets. Why is it, for instance, that Mexico's heterodox program seems to have succeeded more quickly (better?) than Israel's (Israel caved in more readily to union real wage demands)? In the Southern Cone, Chile is a success story relative to Argentina. Of course Chile could borrow during its stabilization process whereas Argentina faced a stricter liquidity constraint. Credibility and sustainability of reform seem intimately bound up with domestic political structures and with standard political economy concerns over income distribution. As we move from authoritarianism toward more democratic regimes these questions assume a particular pertinence.

Michael Bruno wisely notes in the introduction that this volume is centered around actual country experiences, so critiques like mine are somewhat out of bounds. An immodest suggestion: perhaps the next conference should address the strategic interplay of interests within differing political structures in order to identify common themes across all national experiences. Such a discussion seems necessary if we are to learn how best to transplant models of successful stabilization and structural reform into different political-economy settings. For as Nissan Liviatan noted in the final panel discussion, "... we did not realize how destabilizing heterodox policies can be in case of failure."