Chapter

VI The Postwar Economic Achievement

Author(s):
International Monetary Fund. Research Dept.
Published Date:
October 1994
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Anniversaries are always a time for reflection on the past and future, and the fiftieth anniversary of the Bretton Woods Conference, which in July 1944 created the framework for international economic relations in the postwar era, is no exception. The multilateral organizations and agreements that were created at Bretton Woods, New Hampshire, have facilitated progress toward such goals as open trade and exchange rate convertibility. The resulting expansion of trade and financial flows has stimulated economic progress, increased interdependence among national economies, and underscored the need for international economic cooperation to safeguard systemic stability.

The period since World War II has been one of extraordinary economic achievement. While problems such as the slowdown in growth in many regions of the world in the 1970s and 1980s, with the associated problems of structural impediments, inflation, and budget deficits, should not be ignored, underlying economic growth in the world economy has been very rapid, both by historical standards and in comparison with expectations at the end of the war. This success is evident in a sustained increase in real output per capita above previous trends and in significant improvements in many wider measures of the quality of life such as literacy, infant mortality, and life expectancy. Although this success has affected all regions of the world, the most striking achievements have been in Japan, east Asia, and, in the earlier part of the period, western Europe.

There are several possible reasons for the high rate of economic growth in the postwar period. Recovery from the economic disruption of World War II and the inter-war depression was undoubtedly important, particularly in the early postwar period, but so were more fundamental factors such as high levels of education, saving and investment, technological advances, and economic specialization. These strong fundamentals were reinforced by the increasing integration of the international economy in trade, communications, technology, and capital markets. Trade has expanded about twice as fast as output throughout the postwar period, helping to stimulate growth and investment by allowing economies to specialize in those products that they make most efficiently. Free trade and rapid communications have allowed technological innovations to diffuse across countries, again boosting productivity. More recently, the liberalization of financial markets and the integration of world capital markets promise increasingly to allow world saving to be channeled into its most efficient uses, providing benefits to savers, investors, and consumers around the globe.

This increasing integration of the world economy was a key objective inspiring the architects of the postwar economic order who gathered at Bretton Woods. The economic distress in the 1930s was severely aggravated by a vicious circle of rising protectionism, dwindling trade, and declining investment. By contrast, the postwar period has been characterized by a virtuous circle involving expanding trade, high rates of investment, and relatively rapid and sustained growth, which has been aided by the expectation that international economic relations would continue to liberalize and expand. Such confidence was clearly bolstered by the existence of international institutions and agreements dedicated to achieving that goal.59

Just as the international economic and monetary system conceived at Bretton Woods has had to adapt to changing circumstances, so does the world economy continue to face a number of challenges. Trade barriers remain significant in sectors such as agriculture and textiles, and in many developing countries. In the industrial world, growth has slowed significantly since 1973, in part because of the disappearance of temporary factors at work during the “Golden Age” of the 1950s and 1960s. However, the slowdown also appears to be associated with policy-related problems such as inflation, fiscal deficits, and structural rigidities. In the developing world, real output growth in Africa, the Western Hemisphere, and the Middle East slowed sharply in the 1980s, again reflecting a combination of structural factors, including the abrupt cessation of access to international capital markets caused by the debt crisis of the early 1980s, and inappropriate government policies. By contrast, economic growth in Asia, home to more than half of the world’s population, has been sustained throughout the 1980s. It has been particularly rapid in east Asia, reflecting high levels of education and investment supported by generally sound macroeconomic policies and outward-looking trade policies. More recently, successful adjustment and stabilization efforts in many other developing countries have improved their longer-term outlook—provided that the reform process can be sustained. Finally, the transformation of the former centrally planned countries into market-based economies, and their integration into the international economy, poses further challenges, as well as opportunities, for the global economy.

Postwar Growth in Historical Perspective

The postwar period has been one of significant economic achievement by historical standards. The industrial countries shown in Table 19 represent six of the ten largest economies in the world in both 1900 and 1994.60 In every case, per capita growth of real output was significantly higher after World War II than during the period of the gold standard. It was also higher than growth in the interwar period for every economy except Germany.61

Table 19.Selected Industrial Countries: Long-Term Trends in Real Output Per Capita(Average annual percent change)
Gold

Standard

1880-1913
Interwar

Period

1919-38
Post-World

War II

1950-90
France1.3 (3.0)2.7 (6.7)3.1 (2.0)
Germany1.9 (1.6)4.2 (8.0)3.7 (3.0)
Italy1.6 (4.3)0.9 (4.4)3.9 (2.7)
Japan1.9 (5.9)11.7 (4.7)6.0 (3.6)
United Kingdom1.1 (2.3)1.1 (4.3)2.4 (2.5)
United States1.6 (4.2)0.6 (7.2)1.9 (2.7)
Note: Figures in parentheses are standard deviations of growth rates.Sources: Data before 1950 were derived from Angus Maddison, Dynamic Forces in Capitalist Development (Oxford and New York: Oxford University Press, 1991). except for the United States between 1880 and 1928, which are from Nathan S. Balke and Robert J. Gordon, “The Estimation of Prewar Gross National Product: Meth-odology and New Evidence.” Journal of Political Economy Vol. 97 (February 1989), pp. 38–92. For 1950–90, data are from Robert Summers and Alan Heston. “The Penn World Tables (Mark 5); An Expanded Set of International Comparisons, 1950–88,” Quarterly Journal of Economics, Vol. 106 (May 1991), pp. 327–68.

1885-1913.

Note: Figures in parentheses are standard deviations of growth rates.Sources: Data before 1950 were derived from Angus Maddison, Dynamic Forces in Capitalist Development (Oxford and New York: Oxford University Press, 1991). except for the United States between 1880 and 1928, which are from Nathan S. Balke and Robert J. Gordon, “The Estimation of Prewar Gross National Product: Meth-odology and New Evidence.” Journal of Political Economy Vol. 97 (February 1989), pp. 38–92. For 1950–90, data are from Robert Summers and Alan Heston. “The Penn World Tables (Mark 5); An Expanded Set of International Comparisons, 1950–88,” Quarterly Journal of Economics, Vol. 106 (May 1991), pp. 327–68.

1885-1913.

Some of this acceleration in growth clearly reflects a recovery from the economic disruption caused by the Great Depression and World War II. Except for the United States, however, there also appears to have been a decisive rise in living standards compared with the underlying trends observed in either the interwar period or the period before World War I (Chart 24).62 Data for the five largest nonindustrial countries indicate that this pattern is also true for the developing world (Table 20). Hence, while the distribution of postwar economic gains has not necessarily been even across regions or countries, almost every country experienced significant benefits. The postwar achievement is even more striking because such rapid growth was not expected at the beginning of the period. Indeed, a major concern of policymakers at the end of World War II was to avoid a repetition of the slump that had gripped the world in the 1930s.

Chart 24.Selected Industrial Countries: Real GDP Per Capita, 1880–19901

(Index, 1913 = 100; logarithmic scale)

Sources: Data before 1950 are from Angus Maddison, Dynamic Forces in Capitalist Development (Oxford and New York: Oxford University Press, 1991), except for the United States between 1880 and 1928, which are from Nathan S. Balke and Robert J. Gordon. “The Estimation of Prewar Gross National Product.” Journal of Political Economy, Vol. 97 (February 1989), pp. 38–92. For 1950–90, data are from Robert Summers and Alan Heston, Penn Tables (5.5), described in “The Penn World Tables (Mark 5),” Quarterly Journal of Economics, Vol. 106 (May 1991), pp. 327–68.

1Gray sections of curves indicate war years, where the data are inter polated.

Table 20.Selected Developing Countries: Long-Term Trends in Real Output Per Capita(Average annual percent change)
GoldPeriod ofPost-World
StandardWorld WarsWar II
1900-131913-501950-87
Brazil1.42.03.0
China0.3-0.34.9
India0.5-0.31.9
Indonesia0.5-0.22.6
Russia1.62.32.4
Source: Angus Maddison. The World Economy in the 20th Century (Paris: OECD, 1989), Table 3.2.
Source: Angus Maddison. The World Economy in the 20th Century (Paris: OECD, 1989), Table 3.2.

In addition to higher average growth of output, the postwar period was also generally characterized by lower variability in the rate of growth of output than in earlier periods. This difference is most evident when the postwar years are compared with those between the two world wars, which included the economic problems associated with restoration of the gold exchange standard in the 1920s and the depression in the 1930s. However, output variability was also generally higher under the pre-1914 gold standard (see Table 19). In part, this reduction in the variability of output reflects smaller underlying disturbances (at least in comparison with the interwar period) and structural factors such as the growing importance of services, which are subject to smaller cyclical variability than manufactures, in overall output. Additional factors seem to have been the growing share of government expenditures and revenues in GDP, with the associated “automatic stabilizer effects” of government budgets, and the expansion of international trade. Finally, conscious efforts by governments to stabilize output through discretionary policies may also have played a role.

Another, less benign characteristic of the postwar period has been high levels of inflation compared with earlier historical periods. Price levels were generally stable in the major industrial countries during the classical gold standard, and inflation was not a significant problem during the interwar years. By contrast, prices have risen steadily throughout the period since World War II. This is particularly true of the 1970s and 1980s, when high levels of inflation worldwide hurt underlying economic performance.

The improvement in prosperity since World War II is evident in a number of more general measures of the quality of life, such as life expectancy, child mortality, and education, with many of the largest strides in these more general indicators being taken in the developing world. Worldwide, life expectancy at birth rose from 53 to 65 years between 1960 and 1990, and child mortality by the age of 5 fell from 195 to 96 per 1,000 over the same period. Education also expanded rapidly, with the percentage of children enrolled in secondary education worldwide rising from 31 to 65 percent between 1970 and 1990.63

The sources of this postwar prosperity are complex and, in many respects, not fully understood. Fundamentals such as education, which raises the productivity of workers, investment, which expands the capital stock, and research and development, which contributes to technological innovation, all performed strongly. Recovery from the devastation of World War II and the problems of the 1930s undoubtedly played an important role in strengthening growth in many regions, particularly in the early postwar years.64 World War II may also have played another role through the technological innovations it generated, although the relatively limited acceleration in the underlying growth rate in the United States after the war suggests that this may not have been a particularly important factor. Many also point to a relatively high level of social consensus in the industrial countries, and hence a reduced level of economic conflict between employers and labor, as another factor permitting rapid growth with exceptionally high levels of employment, although this was true only until the late 1960s. In the developing world, the organized system of development assistance provided by the World Bank and individual nations gave access to capital for many countries before the (re-)emergence of international capital markets. Finally, the gradual liberalization of world trade and external payments helped to accelerate Europe and Japan’s catching up with the United States through the rapid growth of foreign trade.

Growth in trade consistently outstripped growth in output in almost every region of the world, resulting in a steady rise in the percentage of output consumed or invested outside the country of origin.65 Between the 1960s and the 1980s, trade as a share of output rose by half for industrial countries and by a third for developing countries (Table 21). Although starting from a much lower base, trade in services has generally expanded at a faster rate than merchandise trade, implying an even faster rate of growth for trade in goods and services than for trade in goods alone. This expansion in world trade as a share of output has been remarkably resilient over the postwar period. It was unaffected by the switch in the early postwar period from colonial rule to independence in many parts of the developing world, the oil price rises of the 1970s, the move from fixed exchange rates between the major currencies to floating rates in the early 1970s, and the debt crisis of the early 1980s.

Table 21.Openness in the Postwar Period(In percent)
1950-591960-691970-791980-89
Industrial countries23.324.632.036.8
North America11.211.717.821.9
Western Europe37.238.948.756.9
Japan21.819.522.923.9
Developing countries28.034.438.41
Africa48.255.154.4
Asia
East47.069.587.2
Other217.219.624.0
Middle East41.560.446.9
Western Hemisphere26.323.924.927.9
Note: Openness is defined as nominal merchandise exports plus imports as a percent of nominal output. Aggregates are calculated on the basis of purchasing power parity (PPP) weights.Sources: Calculations based on data in Summers and Heston, “The Penn World Tables (Mark 5).” For Africa, the aggregate includes Algeria. Angola, Benin, Botswana, Burkina Faso, Burundi, Cameroon, Cape Verde, Central African Republic, Chad, Congo, Cote d’lvoire. Gabon, The Gambia, Ghana, Guinea, Guinea-Bissau, Kenya, Leosotho, Madagascar, Malawi, Mali, Mauritania, Mauritius, Morocco, Mozambique. Namibia, Niger, Nigeria, Rwanda, Senegal, Seychelles, Somalia, South Africa, Swaziland, Togo, Tunisia, Uganda, Zaire. Zambia, and Zimbabwe. For Asia, the aggregate includes Fiji. Hong Kong, India, Indonesia, Korea, Malaysia, Myan-mar, Pakistan, Papua New Guinea, Philippines, Singapore, Sri Lanka, Taiwan Province of China, and Thailand. For the Middle East, the aggregate includes Egypt, Islamic Republic of Iran, Iraq, Israel, Jordan, and Syria. For the Western Hemisphere, the aggregate includes Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, Guyana, Paraguay, Peru, Uruguay, and Venezuela.

1980-87.

Excluding China.

Note: Openness is defined as nominal merchandise exports plus imports as a percent of nominal output. Aggregates are calculated on the basis of purchasing power parity (PPP) weights.Sources: Calculations based on data in Summers and Heston, “The Penn World Tables (Mark 5).” For Africa, the aggregate includes Algeria. Angola, Benin, Botswana, Burkina Faso, Burundi, Cameroon, Cape Verde, Central African Republic, Chad, Congo, Cote d’lvoire. Gabon, The Gambia, Ghana, Guinea, Guinea-Bissau, Kenya, Leosotho, Madagascar, Malawi, Mali, Mauritania, Mauritius, Morocco, Mozambique. Namibia, Niger, Nigeria, Rwanda, Senegal, Seychelles, Somalia, South Africa, Swaziland, Togo, Tunisia, Uganda, Zaire. Zambia, and Zimbabwe. For Asia, the aggregate includes Fiji. Hong Kong, India, Indonesia, Korea, Malaysia, Myan-mar, Pakistan, Papua New Guinea, Philippines, Singapore, Sri Lanka, Taiwan Province of China, and Thailand. For the Middle East, the aggregate includes Egypt, Islamic Republic of Iran, Iraq, Israel, Jordan, and Syria. For the Western Hemisphere, the aggregate includes Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, Guyana, Paraguay, Peru, Uruguay, and Venezuela.

1980-87.

Excluding China.

Economies have benefited from this expansion in trade in a number of ways.66 The growing access to foreign markets has allowed countries to specialize production, engaging in activities that they do best. For example, the early postwar period saw a significant movement of employment from agriculture to manufacturing and services, particularly in Japan and some of the European countries. This promoted substantial productivity increases in agriculture and further boosted output through the high levels of productivity of these workers in the manufacturing and service sectors.67 New activities and products also encouraged investment, thereby contributing to faster output growth through rapid capital accumulation. In addition, the open trading system, foreign direct investment, and enhanced communications permitted technology transfers and a steady reduction in the technological gap between the leading economy—the United States—and other economies, by making high-technology investment goods available around the world and thereby encouraging convergence in economic performance across different economies. The reduction in the technology gap and the convergence in performance have been particularly evident among the industrial countries, to the extent that in some sectors the United States has relinquished its leading technological role to other countries. Finally, faster economic growth in turn has also stimulated trade, leading to a virtuous circle of international economic expansion.

The liberalization of trade was given considerable impetus in the immediate postwar years by the actions of the United States, in particular with respect to Europe. Marshall Plan aid, which provided significant resources to rebuild the shattered economies of Europe, was conditional on recipients agreeing to a timetable for liberalizing their trading relations.68 The immediate focus of the conditionality was on regional trade within Europe; it is a striking feature of Marshall Plan aid that the donor country, the United States, permitted recipients to temporarily levy higher tariffs on U.S. goods than on European ones while their economies recovered.69 In addition, the United States provided significant funding for the European Payments Union (EPU), a regional clearing system designed to foster trade within Europe by minimizing the need to use dollars, which were in short supply, in regional transactions. The EPU also generated a more lasting legacy, the Organization of European Economic Cooperation, subsequently renamed the Organization for Economic Cooperation and Development (OECD), which was originally formed to monitor compliance with the Code of Liberalization associated with the EPU.

These actions led the way to the general resumption of current account convertibility by the European nations on December 31, 1958. Since that time there has been a gradual move throughout the industrial countries toward liberalizing external payments. As a result, the industrial countries are now essentially free of exchange controls on both current account and capital account transactions, and international capital markets are rapidly becoming globalized. The developing world has also seen a trend toward both current and capital account convertibility, particularly during the past few years. Although foreign exchange payments are still far from being free in many parts of the world, even for current account transactions, there is a clear trend toward liberalization.

Despite the generally favorable comparison with earlier trends, the postwar experience is by no means uniform across time or regions (chart 25). For the industrial countries, the period as a whole shows a significant convergence in performance over time. Although there was some acceleration in growth in the 1960s compared with the 1950s in most regions, the most noticeable feature is the slowdown in growth since 1973. This slowdown is most evident in Japan and Europe, and least obvious in North America (chart 26).70 Part of the deceleration reflects the gradual disappearance or reduction of some of the forces at work in the recovery from World War II. In particular, the rapid accumulation of capital in the 1950s and 1960s meant that the same investment ratio provided a smaller boost to the capital stock, while the expansion of trade over the same period realized many of the benefits from greater specialization in production, including the movement of labor out of the agricultural sector, and substantially closed the technology gap. Hence, in addition to a tendency for the share of saving and investment in GDP in the industrial countries to decline somewhat from the levels seen in the 1960s, the impact of this investment on growth probably diminished over time (Table 22).71 The increased importance of service industries, which tend to have a lower rate of productivity growth than industrial sectors, may also have contributed to the slowdown.

Chart 25.Postwar Real GDP Per Capita

(In 1985 U.S. dollars; logarithmic state)

Sources: Summers and Heston. “Penn World Tables (Mark 5)”; and World Economic Ouilook data base.

Chart 26.Industrial Countries: Postwar Real GDP Per Capita

(In 1985 U.S. dollars; logarithmic scale)

Sources: Summers and Heston, “Penn World Tables (Mark 5)”: and World Economic Outlook data base.

Table 22.Investment as a Percent of Output
1950-591960-691970-791980-89
Industrial countries24.527.828.326.2
North America24.824.824.123.6
Western Europe24.129.428.925.2
Japan21.636.139.935.9
Developing countries20.324.923.51
Africa12.517.214.6
Asia
East14.223.027.2
Other215.316.917.1
Middle East12.616.320.6
Western Hemisphere17.717.520.817.2
Source: Summers and Heston, “The Penn World Tables (Mark 5),” The countries in each group are the same as in Table 21.

1980-87.

Excluding China.

Source: Summers and Heston, “The Penn World Tables (Mark 5),” The countries in each group are the same as in Table 21.

1980-87.

Excluding China.

However, the slowdown also appears to have been associated with policy-related factors, including the economic disruption caused by the oil price hikes and subsequent policy responses. Many governments in the industrial countries reacted to the recessions caused by the 1973 and 1979 oil price hikes with expansionary economic policies. These may have resulted in some short-term economic benefits, but they also exacerbated rising inflationary pressures that had begun to emerge in much of the industrial world toward the end of the 1960s. The delay in the 1970s in realizing that the slowdown represented a shift in trend growth rather than a temporary cyclical episode contributed to delaying necessary adjustments in labor markets. The resulting rise in structural unemployment and the subsequent restoration of inflation to low and predictable levels during the 1980s proved to be very costly.

Underlying budgetary trends also changed in many industrial countries during the 1970s, contributing to the declining trend in national saving and in business investment as shares of GDP. The 1950s and 1960s had seen a general reduction in the ratio of government debt to output from the very high levels existing after World War II. Starting with the 1974–75 recession, however, fiscal positions deteriorated sharply and have remained in deficit ever since in most industrial countries. This persistence of large structural deficits over the past two decades has reflected a number of factors, including difficulties in controlling the built-in momentum of the rapid growth of public expenditures that had begun in the 1960s together with expectations about potential growth that proved to be optimistic. The large deficits resulted in a steady buildup of government debt that necessarily had to be financed by crowding out potential private investments through high real interest rates.

That the slowdown in growth coincided with the switch from fixed to floating exchange rates between the major industrial countries suggests a relationship. The rise in exchange rate volatility that accompanied this switch in exchange regimes cannot be completely discounted as a factor in the reduction in growth after 1973. However, it appears unlikely to have been a major cause. There is little evidence that the rise in exchange rate volatility had a significant impact on trade, which continued to grow at a faster rate than output after 1973 (see Table 21).72 On a more positive note, the period of floating exchange rates has also seen a significant liberalization of both domestic and international capital markets, thereby enhancing the efficiency of resource allocation within and across countries. Rather than attempting to suggest a clear-cut conclusion on this controversial issue, it is relevant to note that both exchange rate volatility and the slowdown in growth seem, at least to some extent, attributable to the policy-related macroeconomic imbalances that have plagued many industrial countries for much of the period since the late 1960s.

Box 10.Non-Oil Commodity Prices

Non-oil primary commodity prices have been an important concern of policymakers, particularly in developing countries, throughout the postwar period. In the late 1940s, Raul Prebisch and Hans Singer argued that there had been a secular deterioration in the terms of trade of commodity-dependent developing countries since at least the 1860s.1 They also argued that this trend was likely to continue and urged commodity-exporting countries to protect against the resulting decline in their terms of trade by adopting import-substitution policies, a suggestion that had a profound influence on thinking about trade and development issues during much of the postwar era. Price volatility has been another important concern for policymakers, so much so that John Maynard Keynes proposed a separate Bretton Woods institution to stabilize commodity prices.

Although postwar commodity price developments provide some support of a long-term downward trend in commodity prices, after some twenty years of experimentation import-substitution policies have been largely discredited. The experience of primary commodity exporters instead highlights the need for sound macroeconomic management in the face of commodity market booms and busts, outward-oriented domestic reform strategies to raise economic efficiency and promote export diversification, and the implementation of efficient mechanisms for international risk sharing. In Africa, the most commodity-dependent region, long-term trends in the external environment, including commodity prices, appear to have played only a secondary role in the secular decline in growth, although African countries’ limited capacity to manage terms of trade fluctuations has often led them to adopt exchange rate, fiscal, and agricultural policies that have undermined growth over the medium term.2

Real commodity prices have fluctuated widely over time, reflecting the higher volatility of nominal commodity prices compared with the prices of manufactures (see chart). These large fluctuations make it extremely difficult to distinguish long-term trends from short- and medium-run cycles. Recent empirical work suggests that real prices have decreased at an average annual rate of approximately 0.6 percent since 1900.3 There is also evidence that the trend in prices may have changed over time. Commodity prices trended upward for the first two decades of the twentieth century before dropping abruptly after 1920 and then remained highly volatile, but without any clear trend, for the rest of the interwar and World War II period. Prices trended slowly downward during 1950– 73 but did not exhibit the extreme fluctuations of the interwar period. The downward trend in commodity prices steepened markedly following the surge in oil prices in 1973 and the slowdown of trend growth in the industrial countries. After a sharp run-up in prices in the mid-1970s, reflecting the coffee boom among other things, prices began fifteen years of almost uninterrupted decline. In 1992 the price of non-oil commodities relative to that of exported manufactures reached its lowest level in over ninety years. Formal analysis suggests that much of the weakness is secular, not temporary.4

Real Non-Oil Commodity Prices, 1900–92

Sources: Enzo R. Grilli and Maw Cheng Yang, “Primary Commodity Prices, Manufactured Goods Prices, and the Terms of Trade of Developing Countries: What the Long Run Shows,” World Bank Economic Review, Vol. 2 (January 1988), pp. 1–47; and Carmen M. Reinhart and Peter Wickham, “Commodity Prices: Cyclical Weakness or Secular Decline?” Staff Papers (IMF), Vol. 41 (June 1994), pp. 175–213.

Note: Commodity prices are deflated by the export unit values of manufactured goods.

The volatility of real commodity prices appears to have increased in the early 1970s. The breakdown of the Bretton Woods exchange rate system, the subsequent marked changes in the exchange value of the U.S. dollar (in which most commodities are priced), and the oil shocks of the 1970s and 1980s have contributed to this rise. There are several ways in which commodity-exporting countries can, in principle, protect themselves in the short run from higher price volatility. For example, there are now a number of hedging strategies, using available market-based instruments, that countries can pursue.5 Similarly, building up foreign assets can provide a buffer against unexpected declines in commodity prices, particularly if access to international credit markets is limited during periods when export revenues decline sharply. There have also been renewed calls for international price stabilization agreements, a Common Fund, and the development of multilateral facilities along the lines of the IMF’s compensatory and contingency financing facility (CCFF).

The decline in prices has affected all commodity-producing countries to some degree. For some countries, productivity growth in the commodity export sector has increased export volumes sufficiently so that they have not experienced a decline in total real earnings. This is particularly true for the industrial countries and the developing countries in Asia. For most African countries, however, the commodity price decline of the past decade has caused a sharp decrease in both the volume of exports and the real value of export earnings.

The decline in commodity prices has had its greatest impact on countries with the least diversified production structures. These countries, which include many of the world’s lowest-income countries, tend to have less flexible economic systems, making substitution away from commodity production more difficult or costly. Reliance on primary commodities as the main source of export earnings has diminished only slightly over the past two to three decades for many of these countries, particularly those in Africa. Although a more diversified export structure is not necessarily an economic objective in itself, in the long run export diversification is probably the most important way to reduce vulnerability to volatility and sustained declines in commodity prices.

Analyses of commodity market developments have usually focused on the macroeconomic conditions in industrial countries as the principal factor affecting prices. Given the role of many commodities as inputs for manufacturing industries, their demand is closely related to the level of world industrial production, the major part of which takes place in industrial countries. The apparent acceleration of the trend decline in commodity prices in the past two decades is, at least in part, related to the secular slowdown in the growth of real output in the industrial countries since the early 1970s. The declining intensity of resource use for some commodities, owing to technological change, has also reduced demand for commodities.

A remarkable feature of developments in commodity markets in the 1980s has been the vigorous growth in the volume of commodity imports by industrial countries. Since 1983, the volume of commodity imports has almost doubled, a larger increase than that for imports in general. This increase in volume, accompanied by a decline in prices, points to the importance of supply-side factors in explaining price developments.

Several factors have contributed to the expansion in supply. Technological innovation and productivity enhancement have been important in some cases. Agricultural policies in the industrial countries typically have also stimulated domestic output, reduced imports, and raised exports. In addition, in the early 1980s many developing countries faced considerably more restricted borrowing opportunities in international financial markets as the debt crisis unfolded. This situation required balance of payments adjustment, which may have contributed to the expansion in the output of commodities in some countries. Finally, the collapse during the 1980s of international stabilization schemes for some major commodities, particularly tin and coffee, also contributed to the supply expansion and the downward pressure on prices.

More recently, developments in central and eastern Europe and, particularly, in the countries of the former Soviet Union have also exerted downward pressures on commodity prices. These countries are important participants in international trade in commodities, and their demand for imported commodities fell with the fall in output and aggregate demand that followed the collapse of centrally planned economic systems. The downward pressure on prices was probably most pronounced in metals markets, where the countries of the former Soviet Union are important suppliers, and where there were dramatic increases in exports of some commodities: exports of zinc, for example, rose by nearly 700 percent during 1989–92.

Stronger growth in industrial countries will help to relieve some of the downward pressures in commodity markets, but it appears unlikely that it will be sufficient to reverse the declines of the past decade. The empirical evidence suggests that an annual average growth of 2½ percent in industrial countries over the next two years would generate an increase of between 6½ and 9 percent in real commodity prices over the same period. Other factors—in particular, trends in the supply of commodities, economic developments in the countries of the former Soviet Union, and the successful conclusion of the Uruguay Round—could also tend to boost commodity prices.

The past two decades highlight the importance of precautionary saving and hedging against commodity price swings in the short run, and of policies that facilitate the diversification of the export base and foster increases in productivity in the primary-commodity-producing sector in the medium term. The commodity exporters that have been most successful in adapting to the downward trend and the increased volatility in commodity prices are those that have used macroeconomic stabilization policies to cope with the inevitable booms and busts, rather than trying to protect private producers from price uncertainty through marketing boards or price stabilization funds.

1 See Raul Prebisch, The Economic Development of Latin America, and Its Principal Problems (New York: United Nations, 1950); and Hans Singer, “The Distribution of Gains Between Investing and Borrowing Countries,” American Economic Review, Vol. 40 (1950), pp. 473–85. All subsequent references to commodity prices and commodity exports exclude energy products.2 See Chapter IV of the May 1994 World Economic Outlook; and World Bank, Global Economic Prospects and the Developing Countries (Washington, 1994).3 See J.T. Cuddington and T. Feyzioglu, “Long-Term Trends in Primary Commodity Prices: Resolving Our Differences Using the ARFIMA Model,” Georgetown University Working Paper (Washington, July 1994).4 See Carmen M. Reinhart and Peter Wickham, “Commodity Prices: Cyclical Weakness or Secular Decline?” Staff Papers (IMF), Vol. 41 (June 1994), pp. 175–213.5 See Stijn Claessens and Robert C. Duncan, Managing Commodity Price Risk in Developing Countries (Baltimore, Maryland: Johns Hopkins University Press for the World Bank, 1993).

The growth experiences in the developing country regions in many respects differ from those of the industrial countries.73 The African and the Western Hemisphere regions show a similar pattern of a slight acceleration in growth followed by a large decline that has already been described for the industrial countries. However, the accelerated rate of growth occurred at the end of the 1960s, not at the beginning, and lasted through the 1970s. The deceleration in per capita growth in these regions in the early 1980s was also much more dramatic than in the industrial countries, and it resulted in declines in per capita output in both regions.74 The Middle Eastern region shows a similar pattern, with relatively rapid growth in the 1960s and early to mid-1970s, followed by a downturn in per capita GDP in the late 1970s. Data for the early 1990s indicate that growth in per capita output has resumed in the Western Hemisphere and Middle Eastern regions, while the rate of decline in Africa has slowed.

The deceleration of economic growth in the early 1980s in these regions reflects several interrelated factors, of which the most important are the decline in real commodity prices, the high volatility of commodity prices after 1973, the debt crisis, the rise in world real interest rates in the 1980s, civil strife, and problems of economic management. Depressed and highly volatile real commodity prices had, and continue to have, a negative effect on the fortunes of those countries, particularly in Africa, where primary commodities represent a major source of export earnings (Box 10). Growth was also adversely affected by the need to restore external viability after the debt crisis abruptly closed access to international capital markets for most developing countries in the early 1980s and by high world real interest rates. These external problems were often exacerbated by poor economic management, characterized by excessive government regulations of the economy, relative price distortions, inward-oriented trade policies, and unsustainable levels of government borrowing and inflation. The resulting economic problems caused major stresses to the international monetary system, and they continue to generate significant challenges for the international community in general and the IMF in particular.

Box 11.Economic Convergence

Two definitions of economic convergence have been used in the literature on economic growth. According to the first, there is convergence if poor economies tend to grow faster than rich ones. The second definition is that there is convergence if the dispersion of real per capita income across groups of economies tends to fall over time. Although these concepts are related—if poor countries grow faster than rich ones, then it is natural to think that they are getting closer together, and if they are getting closer together, then it implies that poor countries are growing faster—they are not identical and could occur separately. In practice, however, virtually all empirical studies find that when convergence occurs it does so in both dimensions simultaneously, and the two definitions will be treated as equivalent below.

The chart shows the relation between the level of per capita income in 1960 and the growth of per capita income during 1960–85 for a set of 114 developing and industrial countries. Convergence among these economies would be indicated by a negative relationship between these two variables: the poorer a country is at the beginning of the period, the more rapidly it would be expected to grow during the period. The chart, however, suggests that, if anything, the relation between these two variables is positive, as shown by the regression line. During the past thirty years, poor economies do not appear to have caught up with wealthy ones. Cross-country inequality also seems to have increased over the same period.

The finding that there has not been convergence across countries became apparent as soon as comprehensive data on comparative growth became available in the mid-1980s.1 At the end of the 1980s, researchers started focusing on the concept of conditional convergence. According to this concept, a country’s long-run level of income and its growth rate are determined by other factors, such as macroeconomic and structural policies, as well as how poor the country is relative to the rest of the world. Factors that have been found to be significant in cross-country analyses of growth include the level of education of the labor force, investment distortions, financial repression, political and civil unrest, government interventions, and the degree of macroeconomic disarray as measured by extreme inflation rates or public deficits. These studies suggest that economies with higher levels of education have grown faster, and that economies with more distorted investment prices, more public intervention, and more political and macroeconomic instability have grown more slowly. In addition, when the initial level of income is included in these models, its coefficient is negative and highly significant, a result that has been found to be robust under many different specifications.2 Hence the data shown in the chart appear to be consistent with conditional convergence.3

An interesting aspect of this type of analysis is that the implied speed of convergence—the average rate at which the gap between a country’s current and its long-run level of income is closed—is generally about 2 percent a year. This speed of conditional convergence is very similar to the estimated speed of unconditional convergence estimated across regions within countries or across groups of closely related countries. For example, the level of per capita income of the states of the United States has converged at a speed of 2 percent a year since 1880. The same is true for per capita income across the 47 Japanese prefectures since 1930; and for GDP per capita across regions within Belgium, Denmark, France, Germany, Italy, the Netherlands, Spain, and the United Kingdom.4 This convergence is unconditional, since the other factors that determine growth are likely to be essentially the same within countries or groups of similar countries, whereas this is unlikely to be true for a cross-section of developing and industrial countries. The similarity of the speed of convergence across such a diverse set of countries and regions is remarkable, although it is not clear why this is the case.

The estimated rate of convergence is, however, quite slow. Consider a gap of 10 percent between a country’s current income and its long-run level of income. A catch up speed of 2 percent a year suggests an immediate increase in annual per capita growth of 0.2 percent. It will take thirty-five years to reduce by one-half the gap between the current level of income and the new long-run level, and seventy years to eliminate three-fourths of the gap. This relatively slow rate of convergence implies that changes in macroeconomic and structural policies that raise the long-run level of income will result in sustained periods of higher growth, as is suggested by the recent performance of many developing countries.

Convergence Across Countries1

1 The samples includes 114 developing and industrial countries.

1 It was partly due to this empirical finding that the new theories of endogenous growth, which did not predict convergence, enjoyed great success. Virtually all empirical research on convergence is based on estimates of per capita GDP on a purchasing-power-parity (PPP) basis; see Robert Summers and Alan Heston, “The Penn World Tables (Mark 5): An Expanded Set of International Comparisons,” Quarterly Journal of Economics, Vol. 108 (May 1991), pp. 327–68.2 Robert J. Barro and Xavier Sala-i-Martín, “Convergence,” Journal of Political Economy, Vol. 100 (April 1992), pp. 223–51.3 Much of this work, however, implicitly assumes that the rate of growth of technical progress is equal across countries. Investigators who have made this assumption have found less strong evidence for convergence. There is also an issue of the degree to which variables such as civil unrest are truly exogenous to the growth process.4 See Robert J. Barro and Xavier Sala-i-Martín. Economic Growth (New York: McGraw-Hill, forthcoming), Chapters 11 and 12, for a summary of these results.

By contrast, economic growth in Asia has been sustained throughout the 1980s and, if anything, has accelerated over time. This is particularly true in east Asia, where growth in per capita output accelerated sharply in the late 1960s to 5½ percent a year in the 1970s and 1980s;75 several of these economies have clearly already caught up with some industrial countries (Box 11). As a result, average per capita incomes in this region have now overtaken those in the Western Hemisphere and the Middle East. Growth in the rest of Asia (excluding China, for which annual historical data are very limited) has been more modest, with an underlying annual rate of growth of output per capita of just over 2 percent throughout the period from the late 1960s. Recently, however, this region has also shown signs of entering a period of higher growth.

The sources of the very high rates of growth seen in east Asian countries over the past two decades are numerous.76 High levels of education, labor force participation, diversification of the export base, and saving and investment have all contributed. The successes in these areas were supported by generally sound macroeconomic management and outward-oriented trade policies, which provided a stable economic environment conducive to saving, investment, and education. As in Europe after World War II, expansion of international trade allowed these countries to specialize production in activities that they do best and to import new technology. The result has been high and rising levels of investment and productivity, and a swift expansion in trade, which in turn have generated a virtuous circle involving investment, trade, and economic growth—an experience that a growing number of emerging market economies now seek to emulate.

Future Challenges and Opportunities

Although the postwar period has seen a tremendous increase in trade, there remains considerable potential for further integration. In particular, there is scope for much deeper integration between the “old” market economies and the transition economies of central and eastern Europe, Russia, and Transcaucasus and central Asia. For these emerging market economies, which have experienced a sharp contraction of previously command-driven trade within the former communist bloc, the expansion of trade ties with other countries is vital for the success of the transformation process. For many of these countries, the natural trading ties are with western Europe. The deepening of trade ties with the transition countries will create new export markets for western European producers. At the same time, however, it will also increase the need for economic restructuring, which could meet with considerable resistance because of the high levels of structural unemployment that have characterized western Europe for almost two decades. Increased flexibility in western European labor markets will therefore be crucial to pave the way for a relatively rapid integration with the transition countries of central and eastern Europe.77

International integration has also remained relatively limited in many other regions. This is particularly true in the Western Hemisphere, Africa, and parts of Asia, where tariffs and nonprice barriers to trade have remained high in many countries. As a result, trade among countries within these regions is often relatively low; indeed, many countries have trade relationships that are skewed away from regional trade and toward trade with industrial countries.78 Trade barriers by the industrial countries in areas such as agricultural products and textiles have also limited the expansion of international trade. Nevertheless, prospects for greater trade integration are currently promising. The completion of the Uruguay Round of the GATT negotiations, assuming that it is ratified by national governments, promises to lower barriers to trade worldwide across a wide range of goods and services, as well as providing benefits in areas such as trade dispute settlements and intellectual property rights. Regional trade agreements, most notably the North American Free Trade Agreement (NAFTA) as well as many other arrangements in South America and in Asia, and the trend toward current account convertibility in many developing countries, also indicate an increased commitment to open trading regimes.79 Many regional integration efforts are inspired by the experience of the European Union, the most economically integrated group of countries in the world (Annex I). Finally, the problems of access to international capital markets generated by the international debt crisis of the 1980s appear to be largely resolved.

The expansion of international capital markets, together with domestic financial deregulation, provides an additional opportunity for improving the underlying performance of the international economy. Free markets in capital allow saving to be directed toward its most productive uses, providing both a more efficient way of channeling saving into investment and greater incentives to save and invest. Reaping the full benefits of these opportunities, however, requires recognition of interdependencies among national economies, and cooperation to safeguard systemic stability. Open international capital markets are now almost universal across the industrial countries, and they are being instituted in an increasing number of developing countries. One feature of this expansion in capital flows is the role played by foreign direct investment recently, particularly into Asia and Latin America; foreign direct investment may have accounted for almost half of all external finance for developing countries in 1993. Another feature has been the rapid expansion of securities markets in emerging market economies.80 Open international capital markets can also discipline government policies, although, as the debt crisis of the 1980s illustrates, it can also increase the volatility of investment flows.

This regime has much in common with the pre-1914 period. Then, as now, capital transactions were relatively free, and capital flows were dominated by securities markets. Hence, the current regime can be seen as a return to the liberal international order that existed before 1914 after a long diversion brought about by the disruptions of two world wars. The main benefits from the liberalization of capital markets, in terms of enhanced private saving and more efficient global investment, probably lie in the future. Even in the industrial countries, much of the move to liberal capital markets has been very recent. Capital market transactions were liberalized in Japan only in the early 1980s, and in the EU in general at the end of 1990, as part of the Single Market program.

Free international transactions in goods and capital provide an important basis for successful economic expansion. Another foundation is sound domestic macroeconomic and structural policies. Great strides have been made toward reducing inflation back to low and predictable levels in the industrial countries during the 1980s and early 1990s. Unfortunately, the same cannot be said for many of the developing countries outside of Asia, or for the countries in transition, where inflation continues to be high. Such high levels of inflation impair the underlying performance of markets by creating macroeconomic and microeconomic uncertainty.

Fiscal policy is another area of concern. The rapid increase in government spending during the 1970s and 1980s was accompanied by a steady expansion in the ratio of government debt to output in most industrial countries, and, despite many attempts to control fiscal deficits, government debt-to-income ratios have continued to expand in many of these countries. In developing countries and in most of the transition countries, where financial markets are often less well-developed, the need to fund the fiscal requirements of the government is often a major reason for high inflation. In all cases, lax fiscal policies have been detrimental to underlying performance.81

The 1970s and 1980s also saw an increase in structural rigidities in the industrial countries, as government policies increasingly impinged on underlying market mechanisms.82 The most obvious manifestation of these rigidities has been in labor markets. Both the actual and the “natural” rate of unemployment have continued to rise over time, with this trend being most obvious in Europe. Structural unemployment causes hardship for individuals and unnecessary costs for society, and steps to reduce it by improving the functioning of labor market mechanisms through policy reforms are urgently needed.83 Structural problems caused by government interference in private markets have also created many problems in the developing world. It is notable that in east Asia, the region of the world with the most successful growth record, governments have often relied relatively heavily on market mechanisms, particularly in agriculture.

These two issues—sound government policies and open markets for international goods—are not unrelated. History indicates that when sound government policies have been combined with open international markets, a virtuous circle can be created in which individuals have incentives to save and invest, thereby creating high underlying economic growth, which in turn provides the best support for sustaining appropriate policies and generating adequate saving around the globe. Fortunately, as discussed above, the benefits of such policies are being increasingly recognized. There appears to be real momentum behind the move toward better macroeconomic and structural policies in many areas of the world. At the same time, the liberalization of exchange markets, the successful completion of the Uruguay Round agreements, the soon-to-be-established WTO, the completion of the EU Single Market, and the completion and possible expansion of the NAFTA all point toward the continued deepening of the process of international economic integration. Together, such domestic and external liberalization should ensure that economic progress touches as many people as possible.

The benefits that flow from sound government policies and open markets will be gradual, but they will also be lasting. The economic achievements of the postwar period throughout the world, in particular those in Europe and Japan in the 1950s and 1960s and elsewhere in Asia and parts of the Western Hemisphere more recently, were built year upon year, with the benefits accumulating steadily. Looking back after fifty years, it is clear that this steady progress has added up to a period of extraordinary progress, unsurpassed in historical terms. Further moves in this direction should generate high and sustained levels of economic growth worldwide, with a gradual convergence to the performance of richer countries similar to the experience of Europe and Japan in the “Golden Age.” At the same time, it is incumbent on the world community to provide assistance to the poorer countries of the world to promote economic progress. Although many types of assistance may be required, the most valuable help will be liberal access to foreign markets.

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