Inadequate economic policy-making

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] 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.