Stabilization, Reform, and Growth
By a Staff Team led by Philip Young
This Occasional Paper is a compilation of papers that are linked by a common theme—stabilization, structural reform, and economic growth in the Dominican Republic. The papers summarize the authorities' stabilization efforts, how these efforts were subsequently reinforced by certain key structural reforms, and other related developments that help explain the remarkable performance of the Dominican Republic's economy in the 1990s during which the country achieved one of the highest output growth rates in Latin America, combined with low inflation, and a much improved external debt profile. The performance is all the more striking when contrasted with the severe imbalances of the previous decade—one of widening external current account and public sector deficits, accelerating inflation, and declining growth.
As a result of these imbalances, by the end of the 1980s, pressures on the balance of payments and prices had reached unsustainable levels. The government suspended certain external debt-service payments, giving rise to large external payments arrears. Conditions deteriorated to such an extent that a drastic reorientation of policies was urgently needed. This is the setting for Chapter I, Stabilization and Structural Reforms, which describes the authorities' structural reform efforts in the 1990s. The lesson that emerges is that a great deal was accomplished on the structural front, which contributed fundamentally to the extended period of growth observed in the 1990s. The administration of President Hipólito Mejía has continued, if not accelerated, the reform momentum, with the approval of a new hydrocarbons law (removing administration discretion from the setting of domestic fuels prices), substantially reducing the average external tariff rate, and increasing consumption taxes to encourage saving and provide the needed resources for priority social expenditures. Nonetheless, a comprehensive reform agenda (much of which is currently being considered by congress) lies ahead. It includes modernization of the public administration, improving the transparency of economic policies, and strengthening the supervisory and regulatory framework of the financial system.
During the 1980s, in order to protect domestic industries, the authorities
often resorted to trade-
The authorities often resorted to external arrears as a means of financing the external current account deficits of the 1980s. Although rescheduling agreements were reached with the international banking community and with the Paris Club of official creditors in the mid-1980s, they met with limited success until the authorities embarked on their stabilization program of the early 1990s. Chapter III, Successful External Debt Restructuring, gives an overview of these developments and highlights the improvement in the external debt profile in recent years.
The deepening fiscal imbalances of the 1980s, largely financed domestically, but also with external arrears, led to rapidly accelerating inflation. The economic system was at risk of collapse and it needed a rapid and substantial fiscal adjustment. In just one year, the consolidated public sector balance turned from a deficit of more than 3 percent of GDP in 1990 to near balance in the following year. The underlying theme of Chapter IV, A Review of Fiscal Policy During the 1990s and Current Policy Considerations, is that the subsequent maintenance of fiscal discipline over a number of years has been a key factor behind the exemplary performance of the Dominican economy. The chapter includes a discussion of the major tax reforms and improvements in administration that were implemented during the 1990s, as well as developments in expenditure policy. It concludes with a look ahead to the recently initiated Integrated Financial Management Program, which is expected to yield substantial benefits in terms of transparency and rationalization of the fiscal accounts.
Chapter V, Capital Accumulation, Total Factor Productivity, and Growth, considers trends in capital accumulation, technological change, and economic growth. The restoration of macroeconomic stability and the initiation of structural reforms coincided with strong economic growth and poverty reduction. The chapter shows that this growth was anchored by a resurgence of capital formation and strong productivity growth. Sustaining high economic growth rates requires continuous efforts in fostering investment and productivity growth. This in turn will necessitate continued structural reforms and investment in health and education, the types of investment that help to "crowd in" rather than "crowd out" private sector investment.
In addition to the chapters described above, this paper also includes two technical papers, Chapters VI and VII. The first provides an empirical estimation of money demand in the Dominican Republic. Real money balances are found to be cointegrated with real GDP and interest rates. In the short run, changes in opportunity cost variables (including either domestic interest rates or the differential between domestic and U.S. interest rates) also help explain changes in real money balances. The strength of this relationship holds up over time when money is defined as M2. It dissipates over time, however, when money is measured as M1 (that is, the long-run coefficient is not statistically significant). In the second paper, monetary and exchange rate policies (including reserve movements) are combined in a model of exchange market pressure defined as the sum of exchange rate depreciation and the outflow of official reserves. Consistent with a stable money demand, a reduction in domestic credit results in a decline in the exchange market pressure index. Thus, contractionary monetary policy can be effective in raising official reserves.