| I. Overview
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-
restricting measures. This resulted in a highly protected domestic industry,
which was ill-prepared to enter an increasingly competitive world market.
Recognizing that domestic firms risked being unable to keep pace with
international conglomerates, the authorities have embarked on a trade
reform program. Chapter II, Trade Reform Continues, provides a history
of these reforms, which form an integral part of the structural reform
agenda. The restrictiveness of the trade regime has been diminishing—for
example, congress recently approved several regional trade agreements,
lowered tariffs further in 2001, and plans additional reductions in coming
years—and this is leading to a harmonization of the Dominican Republic's
trade policies with those of its neighbors.
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.
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