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THE term `second generation reform' is being increasingly used in India byministers, mandarins and the media to refer to a general continuation of the processof economic reform and liberalisation initiated by the Centre at the behest of theInternation al Monetary Fund in the early 1990s.

Second generation reform does, of course, involve a continuation of economic reform

as construed by the IMF _ but the term has a set of very specific connotations which,for reasons hinted at but not spelt out in this article, have not been identified as suchin public discourse.

The term `second generation reform' was coined by the IMF in the context of theperception by some that the globalisation of the world economy, while benefitingdeveloping countries to a degree with an increase in trade and investment, wouldalso create certain problems of a magnitude sufficient to result in their near orcomplete marginalisation.

This risk was acknowledged by the fund too inasmuch as it recognised the possibilityof globalisation leading to what it referred to as ``bouts of exchange market

volatility, the collapse of financial institutions and other financial crises'' as also marginalisation defined as ``a process that threatens to leave behind those countriesthat fail to harness the forces of globalisation to accelerate economic progress''.

The concept of second generation reform was evolved by the IMF to insulatedeveloping countries from marginalisation in the wake of globalisation. According tothe fund, globalisation would not only enhance the benefits of sound economic policybut also acerbate the costs of bad policy. Ergo, developing countries should adopt apolicy, the effectiveness of which can be tested against the criterion of whether thestate is fulfilling ``its proper role in a market economy by creating a level playingfield for all sectors and implementing policies for the common good, particularlysocial policies that will help to alleviate poverty and provide more equal opportunity.''

The IMF intended that second generation reform would supplement basic reformstructured on the achievement of balance of payments viability, reduction of government deficits, trade liberalisation and a reduction of the role of the state. Asthe former IM F Managing Director, Mr. Michel Camdessus, put it, ``we have learnedthat this first generation reform is not, by itself, enough either to accelerate socialprogress sufficiently or to allow countries to compete more successfully in globalmarkets.''

What, according to the IMF, constitutes sound policy in the specific context of secondgeneration reform?

Given the ambiguity associated with the term in India, it would be worthwhile to

examine second generation reform as described by Mr. Camdessus in somewhatgreater detail. In his opening remarks to the IMF conference on second generationreforms held las t November, Mr. Camdessus had pointed out that, for severaldecades before the 1980s, policy formulation for economic development hadproceeded in a rather compartmentalised fashion. Growth was pursued through so-called `development' policies. Periodic c hecks and policy corrections were made, if needed, to ensure stable macroeconomic conditions _ but these were often regardedas interruptions to development, almost as a necessary evil.

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``Indeed, to this day, the myth persists here and there that stabilisation policies areinimical to, rather than supportive of, sustainable development, notwithstanding theoverwhelming evidence that sound macroeconomic policies are the foundation of durable high-quality growth.''

According to Mr. Camdessus, by the early 1980s, much of the world had come to

realise that, necessary though it was, macroeconomic stability was not enough. Theneed to eliminate distortions and inefficiency in markets provided the motivation fora first generation of reforms intended to make markets work more efficiently _pricing, exchange rate and interest rate reforms, tax and expenditure reforms andestablishment of rudimentary market institutions. The need for such reforms wasemphatically reinfor ced by the most dramatic economic event of the latter part of the (20th) century _ the final demise of central planning.

Mr. Camdessus had then got down to second generation reform in the context of what he had described as ``another major development during the past decade,quieter perhaps, but of tremendous long-term portent: The acceleration of globalisation.''

He had said: ``Economies, markets, institutions and organisations have beenconfronted with the need to evolve, to adapt to this new reality. Recognising therisks to global stability that could arise, the Interim Committee, in 1996, a yearbefore the st art of the Asian crisis, formulated the Partnership for Sustainable GlobalGrowth. That document outlined succinctly the wide range of principles needed topromote high-quality growth: Sound macroeconomic policies, structural reforms andwhat we now refe r to as second generation reforms.''

The then IMF chief had added: ``...No consensus exists on how to define secondgeneration reforms. So let me make my own modest contribution toward establishinga definition. Virtually all countries now have at least a rudimentary orientation to themark et, having undertaken at least some first generation reform designed to restorebasic equilibrium and re-kindle growth. Second generation reforms may be seen asthe set of measures needed to enable a country to attain, in a sustained way, high-quality gr owth. Definitions, of course, should not be too rigid. First and secondgeneration reforms are not necessarily sequential; indeed, the institution-buildingtypically associated with second generation reform often can and should occur inparallel with the first generation. It remains that such growth will also enable theeconomy to function more efficiently in _ and to derive greater welfare from _ theglobalised economy, and thereby to contribute to a stronger international financialarchitecture.''

So there we have it. The IMF is reluctant to define second generation reform. Andthe Indian government uses the term so loosely that it lacks any meaning.

It would be naive in the extreme to believe that this lack of conceptual clarity isaccidental. The fuzziness surrounding the meaning and scope of second generationreform is, in all likelihood, linked to the fact that this phase of reform, as outlined b ythe IMF, is quite overtly tilted in favour of private sector activity in general andinternational investors, in specific.

There is, of course, nothing particularly sinister about a governmental inclinationtowards private sector investment _ even by overseas capital. After all, the private

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sector constitutes a considerable source of finance for a country. But it would be most imprudent for the country to depend beyond a point on the private sector for itsfinance as such capital flows are just that _ flows.

Private capital is essentially transitory and flows from one country or region toanother. For instance, in recent times, there was a massive flow of investment to

emerging markets, triggered by the relatively low rates of interest on investments inthe developed countries. This flow could _ as it did in the case of Thailand _ changedirection in a flash.

Further, inflows, over a period of time, tend to be neutralised by outflows in the formof dividends, debt repayments and so on. The delicate balance involved here couldbe _ and often is _ upset, plunging a country into a balance of payments crisis witheven a marginal decline in inflows.

And then again, infrastructure projects which are central to the development of poorcountries usually generate only local currency payments. Given the high foreignexchange costs, such projects could prove ruinous if funded by overseas

investments. In a ny case, foreign investors are hardly ever in for the long haul and,therefore, reluctant to take up stakes in social sector projects which, while crucial fordevelopment, do not make for the levels of liquidity desired by such investors.

It may, therefore, reasonably be argued that economic reform which is structured toa considerable extent in favour of creating an environment for overseas capitalshould be viewed with reservation. There are other areas, too, of intense publicconcern w ith regard to second generation reform. Let us examine some of these inthe specific context of Mr. Camdessus' contention that second generation reformshould trigger growth that will enable an economy to function more efficiently and toderive benefits from a globalised economy.

To begin with, available empirical evidence suggests that while the IMF's structuralreforms (or basic reforms) programme may, in certain countries, have loweredinflation and improved their balance of payments, it has not actually triggeredgrowth of th e order implied by Mr. Camdessus. More important, there is absolutelyno evidence to suggest that the initiatives funded through the IMF's enhancedadjustment facility has reduced poverty.

The Fund has, of course, countered with the argument that this manifest lack of social benefit is attributable to the facts that the country concerned has notfacilitated private sector development and that barriers have been erected againstforeign inve stment. In other words, the results of first generation reform cannot beevaluated without the implementation of second generation reform. But how can anygovernment be reasonably expected to initiate second generation reform without

experiencing the gai ns, however marginal, of first generation reform?

Moving on, let us examine fiscal adjustment, which is central to second generationreform. The IMF has traditionally recommended improvements in the composition of fiscal adjustment through reduction in Defence expenditure and re-allocation of theresour ces so freed to education and health and the creation of social safety-nets. Sofar so good. A reduction in Defence spending is most certainly a desirable objectiveas far as the Third World is concerned _ if for no other reason than that the primaryben eficiaries of arms transactions are the G-7 countries.

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However, there is a degree of inconsistency in the Fund's stand on education andhealth infrastructure in that the IMF favours their privatisation which, in turn, impliescost recovery. The practice of cost recovery, as is too obvious to explain, placeseducation and health services outside the reach of the poor in developing countries.Ironically, the privatisation of the educational and health services sectors and theirsustenance through cost recovery have not proved acceptable to the developed

count ries in the IMF, suggesting double standards at work.

Finally, we come to the troubled area of good governance. The IMF says that secondgeneration reform should involve good governance through increased transparencyin government operations, judicial reforms, enforcement of property rights, and soon. But transparency in a corruption-ridden economy usually has strong politicalimplications _ and the IMF, by its `articles of agreement', is barred from involvingitself in the political affairs of a country.

The IMF is aware that it is walking a tightrope here, as it concedes that it is difficultto separate economic aspects of governance from political aspects. But it argues thatwhat it wants to do is to focus ``on those aspects of good governance that are most

closely related to our surveillance of macroeconomic policies _ namely, thetransparency of government accounts, the effectiveness of public resourcemanagement, the stability and transparency of the economic and regulatoryenvironment for private sector activity''. This argument does not, in any way, clarifyhow the IMF intends to mandate second generation reform without trespassing intothe political sphere.

In the light of these and related considerations, as also the fact that the merits of globalisation themselves are in doubt now (the apparent inevitability of the processnotwithstanding), it would be advisable for the Government to spell out clearly wha tit means by the term `second generation reform,' reassure the people that thismeasure is not restricted to a state subsidisation of global investment alone andadvise them of its socio-economic benefits.