Speech

Second Generation Reforms: Reflections and New Challenges -- by Michel Camdessus

November 8, 1999

I extend a warm welcome to you all at the beginning of this conference on second generation reforms organized by our IMF Institute and the Fiscal Affairs Department. As I previewed the lists of authors, discussants and participants, and glanced through the papers,¹ I could easily imagine that we are in for two days of stimulating, indeed provocative, exchange. I am particularly delighted that Jim Wolfensohn is here to deliver the keynote address. His presence signifies clearly the complementarity of the missions of the World Bank and the IMF, in helping countries develop to their fullest potential. This togetherness between World Bank and the IMF makes all the more sense as the recent crisis in emerging markets and our strengthened focus on poverty reduction have brought second generation reforms to center stage. So it is timely to ask more fundamental questions about reform issues. What have we learned? Are we on the right track? Where should we be going?

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For several decades prior to the 1980s, policy formulation for economic development proceeded in a rather compartmentalized fashion. Growth was pursued through so-called "development" policies. Periodic checks and policy corrections were made if needed to ensure stable macroeconomic conditions, but these were often regarded as interruptions to development, almost as a necessary evil. Indeed to this day, the myth persists here or there that stabilization policies are inimical to, rather than supportive of, sustainable development, notwithstanding the overwhelming evidence that sound macroeconomic policies are the foundation of durable high-quality growth.

By the early 1980s, much of the world had come to realize that, necessary though it was, macroeconomic stability was not enough. The need to eliminate distortions and inefficiency in markets provided the motivation for a first generation of reforms intended to make markets work more efficiently-pricing, exchange rate and interest rate reforms, tax and expenditure reforms and the establishment of rudimentary market institutions. The need for such reforms was emphatically reinforced by the most dramatic economic event of the latter part of the century, the final demise of central planning. In virtually every transition economy, a major reorientation to the market has been made, even though the pace and style of the reforms may have varied widely-consider the differing experiences of Russia and China, Poland and Vietnam, or the Baltics and Central Asia.

But there has been another major development during the past decade, quieter perhaps, but of tremendous long-term portent: the acceleration of globalization. Economies, markets, institutions, and organizations have been confronted with the need to evolve, to adapt to this new reality. Recognizing the risks to global stability that could arise, the Interim Committee in 1996-a year before the start of the Asian crisis-formulated the " Partnership for Sustainable Global Growth." That document, (copies of which have been made available to you) outlines succinctly the wide range of principles needed to promote high-quality growth: sound macroeconomic policies, structural reforms, and what we now refer to as second generation reforms. Already issues such as transparency, good governance, and an emphasis on the quality of fiscal adjustment were on the agenda. Alas, the world as a whole could not implement that agenda soon enough to help prevent the succession of crises that began in Thailand in mid-1997.

The countries at the heart of the emerging markets crisis, several of them in Asia, had impressive records of macroeconomic management and certainly recognized the need to develop competitive economies. What was lacking in their strategy? Why had they become so vulnerable? The crises had complex origins,² but to a large extent they developed because countries were slow to recognize the importance of these second generation reforms. And one of the reasons that the ensuing contagion, which threatened for a while to spread world-wide, could be contained was that other countries, including many in Latin America, had already taken resolute steps to initiate such reforms. Of course, countries in that region still have much to do, but they had learned-and applied-valuable lessons from the "lost decade" of the 1980s and from the Mexican financial crisis. In so doing, they offered a launching pad for the wider application of second generation reforms.

Over the past two years, a lot of attention has been devoted to the international financial architecture, the reforms of the global economic and financial system needed to prevent or to better contain crises. It seemed that the term "second generation reforms" had become less frequently used. But these concepts can be thought of as two sides of the same coin, one viewed from a global perspective, the other from the national point of view. Indeed, I note from the conference papers, even now, that no consensus exists on how to define second generation reforms. So let me make my own modest contribution toward establishing a definition.

Virtually all countries now have at least a rudimentary orientation to the market, having undertaken at least some first generation reforms designed to restore basic equilibrium and to re-kindle growth. Second generation reforms may be seen as the set of measures needed to enable a country to attain, in a sustained way, high-quality growth. Definitions of course should not be too rigid. First and second generation reforms are not necessarily sequential; indeed the institution-building typically associated with the second generation often can and should occur in parallel with the first generation. It remains that such growth will also enable the economy to function more efficiently in-and to derive greater welfare from-the globalized economy, and thereby to contribute to a stronger international financial architecture.

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A quick preview of the excellent papers prepared for this conference reveals many diverse views on the topics. But, I think few would now dispute that sound social, political, and economic institutions are a necessary, if not sufficient, condition for the sustained implementation of sound macroeconomic policies. And if there is a single common thread running through virtually all the papers, it is the importance of frameworks and institutions. Perhaps no one has put the issue more clearly than the economic historian Douglass North, when he observed, in his lecture on receiving the Nobel prize, ³ that too much attention is focussed on how markets operate rather than on how they develop. Too often, he reminds us, economic theory and policy formulation miss the importance of institutions and of time. Of course he, like most authors of the conference papers, uses the term "institution" broadly, referring not merely to organizations, but to the constraints or frameworks within which markets operate, be they formal-constitutions, laws, or regulations-or informal, such as norms of behavior, conventions, and codes of conduct.

Let me, therefore, pose four questions on which I hope your deliberations will cast some light.

First, how can we resolve the tension between the individuality of each country's institutions in the social, cultural, and political domains and the apparent demands of globalization for harmonization of standards and norms? Much of the present work to strengthen the international financial architecture aims to achieve better governance and greater transparency through developing internationally recognized standards. And these standards, codes, and practices when applied at the national level, represent a major contribution to implementing second generation reforms. We must find ways of helping countries to recognize the benefits of adopting these changes while respecting their sovereignty, emphasizing the voluntary, market-based aspect of reforms.

Second, as a corollary to the first, how can countries' "ownership" of the reform policies be strengthened? Many of the issues-standards, the balance between public and private sectors, and the quality of fiscal adjustment-go to the heart of countries' social and political decision-making. Certainly international agencies have a role to play through policy dialogue, technical cooperation, and financial support. But years of experience have demonstrated that stabilization policies or structural reform are truly effective only, where the national authorities-and even more important, the people-are committed to change. This is where mechanisms for engaging civil society-labor organizations, employers, domestic NGOs, religious groups, and other local bodies-are essential for a participatory approach to reform and to development. We in the Fund are eager to work with all concerned on the most effective ways of encouraging governments to foster a constructive relationship with civil society. All of us have much to learn.

Third, what are the implications for the international organizations, in their respective work with member governments, as they attempt to foster the successful implementation of second generation reforms? One key word will be collaboration. Even though the international agencies are clearly obliged to pursue their primary mandate, the complexity of issues in today's world also obliges them to work jointly on key issues. Work with other organization, especially the World Bank and the Basle-based institutions, has been a hallmark of the Fund's work, especially recently in the financial sector. The Fund is also considering how it can assist to monitor the standards and codes of good practice that have been developed by other international agencies. But clearly, a crucial challenge arises in the domain of social policy and poverty reduction, where the Fund and the Bank are strengthening their collaboration to help countries formulate strategies for reducing poverty. At the same time the United Nations and the World Bank are leading work to define principles and good practices for social policy-a crucial step in implementing the pledges of the 1995 Copenhagen Declaration.

Fourth, we know that new approaches almost inevitably entail risks. What are the most likely pitfalls in the implementation of second generation reforms? As we enter an era in which "institutional reform" will have heightened importance, how can we ensure that it acquires a positive connotation, and that robust support is built for it, including in the poorest countries? Too frequently these programs have been portrayed-quite wrongly-as running counter to the interests of the poor.

This leads me to suggest one direction for part of your discussion. One of the clearest lessons that emerges from past reform experience is that key social goals, especially poverty reduction, must be-must be-an integral part of the overall policy agenda and a key objective of second generation reforms. Progressively over the past two decades, social policies acquired greater attention, although often it was only in a passive way. Fund-supported programs began to incorporate an assessment of the social impact of adjustment and strong efforts were made to minimize adverse effects through safety nets and other social policies. But it was plainly not enough. The links between economic objectives and social needs had to be better defined. That is why the Fund and the World Bank are developing a much closer collaborative approach to help the poorest countries to prepare a poverty reduction strategy. This approach is most promising and as a minimum it will have to embrace cost-effective expenditure programs aimed at human development and reducing poverty; a well-targeted safety net; a tax system that ensures a fair distribution of the tax burden; and labor market policies aimed at ensuring high levels of productive employment.

It will not surprise you if I say that sound macroeconomic policy, and determined implementation of reforms-first and second generation-are indispensable in pursuing growth. And growth is ultimately the best way to reduce poverty. What we are trying to emphasize in our work on poverty reduction is that without clear goals for social progress and sustained poverty reduction, efforts to implement sound policies, be they macroeconomic policies or second generation reforms, will founder. Broad-based support is the key to sustainable reform and, in the final analysis, to high-quality growth. If people cannot see or hope for tangible progress, and if poverty is not alleviated, then the support for reform risks being short-lived.

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In closing, let me come back to a commonplace: the global economy is continually evolving, becoming steadily more complex and more interdependent. To tap the tremendous potential of globalization, each country is responsible-to its own citizens and to the rest of the world-for adapting to the changing economic landscape. This holds true for all: from the most advanced nations to the poorer developing economies. This creates for us also an obligation to revisit frequently the models of economic development that we use, the premises on which they are built, and the policy agenda that we derive from them.

New policies, and certainly adapted institutions, are essential to help us respond as the world evolves, often in unexpected directions, and at unpredictable speed. I would certainly encourage you to review thoroughly our experience thus far with second generation reforms, and to consider how to strengthen their implementation. And as one generation of experience leads to another, may I suggest that it might not be too early to imagine the next round of reforms. And so I leave you with yet another question. Can we yet conceive of the content of such a third or fourth generation of reforms? But then, please, stop there. Thank you.

1 Available on the IMF Website, www.imf.org.

2 Lane, Timothy, and others, 1999, IMF-Supported Programs in Indonesia, Korea, and Thailand-A Preliminary Assessment, IMF Occasional Paper No. 178 (Washington: International Monetary Fund).

3 Douglass C. North, "Economic Performance Through Time, " American Economic Review, March 1994, pp. 359-368.