A country's ability to mobilize domestic resources and to translate them into investments depends on both external factors and the domestic policy environment. The policy response of countries to the deterioration of the external financial and trading environment has not always been timely and adequate. Significant economic mismanagement may be reflected in poor investment decisions, internal disequilibria as manifested by large budget deficits, and rapid rates of inflation and rates of growth of aggregate demand that are not sustainable.
[Developing countries]
Until the end of the 1970s growth in GDP in developing countries remained generally strong, continuing the trend of the 1960s. After 1980 their growth rates dropped from an average of 5.4% a year during 1973-80 to 3.9% for 1980-87. China and India were important exceptions because of major growth-promoting policy reforms during the 1980s. The decline can be traced in part to unforeseen changes in the world economy. These changes not only had a direct adverse affect; they also exposed the unsustainability of the macroeconomic policies that many developing countries had adopted during the 1970s. Those most profoundly affected had four things in common: high levels of external debt; major macroeconomic imbalances, such as large fiscal deficits and high inflation; distorted and inflexible markets; unresponsive policies.
[Former socialist countries]
Due to the inefficiency of the economies of former socialist countries, inflation, shortages, food queues and lack of consumer products were commonplace occurrences. The inefficiency was due to poor organization, with few incentives for high productivity or free enterprise In addition, statistics are often confused and difficult to interpret, thus discouraging Western trade.
While many developing countries, including major debtors as well as poorer developing countries, have embarked on rigorous adjustment programmes to increase their efficiency in the mobilization and use of available resources, such efforts have failed to offset the deterioration of the external environment.
The effects on the natural environment of poorly designed public finance policies are illustrated by the energy sector. In most developing countries energy prices have until recently failed to reflect opportunity costs. At the same time low prices have reduced returns on investments in energy conservation, perpetuated inefficient fuel use, and in turn caused environmental problems. For example, in countries where coal is an important fuel, prices have often been below economic costs, so that mines operate at a loss and require government subsidies. Yet each step in using coal also involves potential damage to land, water, and air quality. Similarly subsidized electricity prices intended to promote industrialization in many developing countries have led to uneconomic growth in electricity demand and inefficient levels of public investment in power-generating capacity. This in turn has led to excessive or premature development of hydro resources and unnecessary pollution from coal or oil-fired plants.
Economic backwardness in former socialist countries makes economic reform urgently necessary. However, it is difficult for such countries to reform planning and management institutions so as to stimulate productivity and yet allow gentle transition from traditional institutions and practices. For instance, schemes which offer greater rewards for greater productivity threaten egalitarian wage payments and job security. Increasing the role of technical experts and professionals threatens the traditional role of the Party apparatus.
The stabilization policies (concentrating on inflation control and currency devaluation) advocated by the West caused much of the very large and persistent fall in output in Central European countries during 1991-92, and did not lead to any fundamental, and constructive, restructuring. There is a good case that those devising policies and forecasting their outcomes simply got their policies wrong. Crucial institutional and infrastructure reform was sacrificed to macroeconomic goals, even when there was no serious macro imbalance at the outset. An exaggerated concern about the amount of untapped demand in the economies, the monetary overhang and the desirability of "free-market" exchange rate, meant that policy advisers pushed for large-scale devaluations. These, in turn, caused unnecessary inflationary shocks, which required excessively deflationary policies which hit the small, emerging private sector just when they needed support.